Here is the secret to wealth – Buy Assets and Avoid Liabilities. The first time this became clear to me was when I read Rich Dad Poor Dad by Robert Kiyosaki. The book is an easy read, but it has many flaws*. If you haven’t read it yet, I encourage you to check it out from the library and give it a quick once over. However, you need to take the book with a grain of salt and don’t blindly follow it 100%. You’ll have to separate the wheat from the chaff. The biggest takeaway I got from Rich Dad Poor Dad is how to differentiate between assets and liabilities. Turns out, I had it wrong for years. Once I figured that out, building wealth became much smoother. It makes a lot more sense to accumulate assets and avoid liabilities.
* There are many problems with Rich Dad Poor Dad. Mr. Kiyosaki is a great motivational speaker and salesman. That’s how he made his fortune. His books are designed to sell more books, courses, and seminars. Don’t fall for the seminars! They are too expensive. You can learn a lot more for free on the internet and the library. I recommend reading The Millionaire Next Door and Your Money Or Your Life before Rich Dad.
Assets and Liabilities
I used to think assets meant anything that has a cash value. However, that’s not quite the right way to look at it. If you want to become wealthy, you need to think of your household finance as a business. An asset is something that, in the future, can generate cash flow for you. Assets make money. Anything that takes money out of your pocket is a liability.
This was a revelation to me. I used to include our home, car, piano, and other personal belonging in the asset column. That’s the wrong way to look at it. All these things are really liabilities. It changes how I think about spending. In my 20s, I felt fine when I purchased our BMW convertible because I thought it was an asset. Now I know that it’s a liability and that’s why I’ll never buy another luxury car as long as I’m building wealth. Once you think about assets and liabilities this way, it is much easier to build passive income.
Let’s go over a few “assets.”
I’m sure you’ve heard that your home is your biggest asset. Is this really true? When you buy a house, you’ll have to pay the mortgage, property tax, HOA, insurance, utilities, repair and maintenance, yard work, and furnish it. That’s a lot of $$$ going out of your pocket every month. Sure, the house can appreciate, but would the appreciation be enough to surpass all the expenses? It doesn’t always work out like that. We all need a place to live and a house is great, but it isn’t really an asset.
A house is good because it forces people to save. A portion of the mortgage payment goes to the principal and you’ll get that back when you sell. Appreciation is nice, but it usually isn’t much more than inflation in the long haul.
There is one way to generate some money from your house – rent out the extra rooms! We used to rent out the extra room at our old home to new engineers. This worked out great. They were never home and the rent helped pay our mortgage. Renting out an extra room is even more lucrative today with Airbnb. Lots of people are making extra money with it. This really depends on your personal situation, though. Most people value their privacy too much to rent out the extra room.
For many people, their car is the second most valuable thing they own (next to the house). A car is a necessity to most people and it costs a lot of money. However, it’s not an asset. It’s even worse than your house because a car depreciates every day and you also need to buy gas. A car is basically a money pit. How much money do you spend on your car every month? Can you imagine investing that money instead? Most of us need a car to go to work and run errands. It’s an unavoidable expense for many of us. However, I don’t think anyone should buy a luxury car unless they are already wealthy. I’ll buy another convertible someday, but it can wait until I’m rich.
Everything else you own
Pretty much everything you own is sitting around depreciating. Furniture, TV, laptop, tablet, kitchenware, clothes, and everything around you are losing value as you read this. It’s a funny way to look at your possessions. I can see dollars signs floating away from everything I own. Does this give you pause before you buy the next gadget on sale this coming Black Friday? Maybe it’d be better to just kick back and take it easy at home instead.
Let’s look at it another way
- Good assets– Income producing assets such as stocks, rental properties, real estate crowdfunding projects, bonds, and a business.
- Neutral assets – Appreciating assets such as your home, gold, artwork, antiques, and collectibles. I’d say these are neutral because you never know if the appreciation will beat inflation and the cost of upkeep.
- Liabilities– Depreciating assets like your TV, furniture, and other personal properties. These things are just sitting around leaking money.
- Worse Liabilities– Income consuming assets like your boat, car, and cell phone. These things need a monthly cash infusion to stay functional.
Of course, most of us need our car and cell phone to function in the 21st century. It’s okay to have more liabilities than good assets when you’re starting out, but you need to accumulate good assets to become wealthy.
Where are you on this wealth scale?
This is a scale I made up. It’s a bit different than how we normally think about wealth. We usually think wealthy people live in a big house, drive a luxury car, and belong to an exclusive country club. However, are you really wealthy if you spend all your income every month? Wealth isn’t how much you spend; it is how much you keep.
- Poor – You’re poor if you have a lot of liabilities and need to keep working to feed your lifestyle. People can be poor even if they make a great income.
- Middle class – You have been investing for a while and own some good assets. If the value of your good assets is more than 50% of your net worth, then you’re firmly in this class.
- Financial Independence – This should be the goal for everyone. Once the income from good assets, aka passive income, surpasses your expense, you can retire and live life the way you want.
- Wealthy – This is beyond financial independence. You have plenty of income from your investment to keep reinvesting. This way your wealth will keep growing and you can pass it on to the next generation.
Most of us start off poor and the progression to the next level is very slow. The American consumerism culture encourages everyone to spend money on things they don’t really need. It’s not easy to put your hard earned money into good assets when you don’t understand the difference between assets and liabilities.
On the other hand, the rich get richer. They know it’s important to invest and generate passive income. The rich don’t depend on earned income to fund their lifestyle. They use investment income to buy their luxuries.
What about you? Where are you on this scale and where will you be in 10 years? Are you accumulating assets or liabilities?
*This article was originally written in 2013. I revised and updated it to reflect my current thinking.
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Joe left his engineering career behind to become a stay-at-home dad/blogger at 38. Today, he blogs about financial independence, early retirement, investing, and living a frugal lifestyle. See how he generates Passive Income here.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help DIY investors analyze their portfolio and plan for retirement.