What Is The Difference Between An Asset And A Liability?
Why do only a few people get rich? I’m talking about $10m + in net worth. That’s real money. What makes these people “special” or “different”?
Truth is, most people live a life of relative modesty. Some might be comfortable, but most aren’t genuinely wealthy. There’s a pretty simple explanation: most of us don’t understand the difference between liabilities and assets.
“Wealthy” people accumulate assets. “Poor” people buy liabilities. But it’s probably not quite what you think. You can be a millionaire and still make “poor” decisions. We’ll find out why in a minute.
If you want to get rich, you need to think and act rich. As such, we need to understand how this decision-making process works. To do so, let’s explore what it means to own assets, and see how you can set yourself up for success by accumulating a diverse portfolio of assets from a young age. Equipped with this insight and knowledge, you’ll be light-years ahead of your liability-buying peers and on the road to financial freedom! Let’s get cracking.
What is an asset?
Most of us probably have a vague idea of what an asset is. According to the dictionary, an asset is “property owned by a person or company, regarded as having value in generating income.”
OK, so an asset is any piece of property – whether that’s a house, a parcel of land, or an investment – that has value and, *crucially*, generates income at the same time.
Rich people are smart. Why? Because they think and act like rich people. These individuals understand that it’s important to delay instant gratification and purchase assets that produce income or a higher principal value further down the road.
What is a liability?
Again, I think you might be surprised by what qualifies as a liability. According to the dictionary, a liability is “a thing for which someone is responsible, especially a debt or financial obligation.”
OK, so a liability is any piece of property – whether that’s a car, a rented apartment or a new watch – for which you are responsible and, *crucially*, costs you money at the same time.
Poor people aren’t so clever when it comes to liabilities. Why? Because they think and act like poor people. These individuals take their disposable income and spend it on instant gratification, purchasing bad assets and liabilities that are a drain on finances both now and in the future.
Re-defining an asset
Here’s the number one rule all rich people follow: take your existing money and buy assets that make more money. Sounds simple enough, right? Well, kind of. The problem is, it’s human nature to buy things that give us instant gratification. We do it for ourselves and our loved ones all the time. And to confound things, if you’re not wealthy and you’re spending money on items that aren’t giving you money back, you’re never going to accumulate wealth!
Consider this. Most people think a car is an asset. Far from it! This is the classic “poor” man’s decision.
Let’s say you win the lottery and decide to buy a supercar. As soon as you drive your new Ferrari off the lot, it instantly loses 10-15% of its value, maybe more. Then you need to purchase fuel, repairs, parking, and stay on top of your monthly payments. Every single day you own the car, it depreciates in value. Let’s say you spend $300,000 on a new Ferrari today. Five years and 50,000 miles later it’s worth $125,000. You just lost over half your original investment!
Start generating wealth
To really start generating wealth, you need to make a list of all the liabilities in your life. See which ones you can cut and which ones are essential. Obviously, things like phone bills and gym memberships are considered necessary to most of us. Fine! Your phone probably contributes to your ability to make money anyway. But that new watch you spent $2,000 on? Really? Or that second pair of shoes you just “had to buy”?
Figure out where you’re spending wrong and start spending right. For most of us, that may mean not spending at all – but saving! Take your liability money and invest it in a safe ETF, like a Vanguard fund. Keep growing and watch your money begin to add up. Then, when you’ve reached a certain amount, what we call the critical mass, you can purchase your first asset.
Remember, an asset is something that appreciates in value over time. Maybe you decide to put a down payment on a house or an apartment. Property can be a great asset. Think about it – not only do you own the property itself (which should only increase in value over time), but you can rent that property out to make money in the short-term as well. Let’s say your mortgage payment is $3,000 a month, but you make $5,000 a month from your tenants. That’s $2,000 a month you’re making for free! AND you still own the house itself – the ultimate asset.
So to get started on the right track, make a list of all the assets and liabilities in your life and figure out how you can stack the deck in your favor. Remember, you can be a millionaire and still act like you’re “poor”. So think like a rich person and purchase more assets than liabilities. This is the way to financial freedom.