You get a great job and you start saving for the future. At this point many people start buying things that they want to call their own. A new phone, a new wardrobe, a new car and maybe even a house. Great, you’ve built up so many assets, you must be building wealth for the future! You may start looking like the part, but think honestly to yourself, are you really building wealth with material things?
The goal of saving is so that you can invest. The goal of investing is so that you can make your money work for you to make more money. That’s how wealth is built. Wealth, in general, is calculated by taking the assets you own minus any liabilities that you have. In simple accounting terms, an asset is something that has value. A liability on the other hand is the opposite, as it relates to something that makes you owe money. With these definitions, things like a car, a house, your phone could all be considered assets because you can sell them, even used, and still get money in return. A car loan, your credit card debt or your student loan could all be considered liabilities because you owe money on those things.
I don’t normally agree with Robert Kiyosaki’s, author of Rich Dad Poor Dad, concepts, but when it comes to investing I do tend to agree with his arguments that assets should be considered things that generate you positive cash flow on a monthly basis. On the contrary, liabilities are things that generate negative or no cash flow on a monthly basis.
If you think about that statement a little bit, you will notice that it will conflict with the standard accounting definition of an asset or a liability. Many things that we deem to have value would not be considered an “investment asset”. Does your cellphone produce you monthly income? Does your car print you cash? Does your house pay you to live there? Think about those things, are they actually considered an investment when you buy it with your money? When you look at your monthly cash flow, is it adding to money or is it something you have to pay for?
If we follow this rule, then the biggest misconception that people have about investing is their own home. Think about the costs associated with your home on a month to month basis. Is the home generating a positive cash flow on a month to month? Is it helping you pay the credit card bills and the mortgage? For most people the answer to that would be a resounding “No”. For most households, the home is actually a liability. The monthly utilities, the property taxes, the maintenance fees, the list goes on. All of those expenses provide a negative cash flow on your monthly budget. So how does one make their home an investment? For starters, considering renting out rooms in your house. Rent out the basement. That’s how one can make their home an “investment asset”. Remember that the goal is to achieve a positive cash flow at the end of every month.
The second biggest asset that any single individual would purchase is probably a vehicle. Under accounting terms, a car would definitely be an asset. It’s something of value. Would you agree that a car is an investment? Unless you bought a vintage 1950’s Ferrari, your Honda Civic sitting on the driveway probably isn’t growing in value. If you think about the expenses associated with having a car such as insurance, gas, plate registration and simple depreciation, then the picture becomes clear. The car is a liability.
When trying to determine what “investment assets” to buy, it’s important to determine whether or not these assets have the ability to generate a positive return on a monthly basis. If what you buy has no potential to generate a positive cash return, it’s not a very good investment. This is not to say that everything you buy should generate income. You still have to live, buy food, buy clothes, and provide yourself with entertainment, but when it comes to buying something that is supposed to build wealth for the future, you definitely want assets that have a potential for positive returns on a monthly basis.