What is an Asset? What is a Liability?
I agree with Robert Kiyosaki, but not entirely.
Hello friends!
This is, if I do say so myself, Issue Numero Uno for the new Toonie Newsletter. Whether this is the ultimate format is anyone's guess at this point, and I'm even setting myself up for failure by sending out an email on the first Friday after announcement.
Either way, I'm excited about the prospects of talking directly to an audience. For some reason, the words "Hello friends!" at the top feels that much more personal. Like writing a letter to a pen pal.
I'm currently in the midst of a hiatus from Twitter, which means I have little means of sharing this newsletter to the world. I'm going to share by good ol' fashioned word of mouth instead. Let's see how quickly newsletter gossip can travel in the year 2020.
Quick Thought of the Week
I once read that Warren Buffett measures the cost of an item not by today's dollars, but by the opportunity cost and compounded amounts of the item. So, that $1 ice cream cone you want to buy, in Buffett's mind, costs well over $10 in real terms. (For some reason, I thought Buffett considered the cost $18, but I'll go with $10 as that number is more conservative and backed by a compound interest calculator I found online somewhere.)
Taken in reverse, your youngest years are best spent planting seeds — the longer they grow, the more powerful the earnings down the road.
Link of the Week: Seth Godin's "Money Costs Money"
July 24th seems like ages ago, but Godin's advice will always stand the test of time:
Time costs money too.
That’s not the same as saying “time is money,” which it isn’t. Time is magnificent, hard to stockpile and impossible to recover.
But it still costs. Which means that it’s worth considering whether something worthwhile comes back for your investment and your effort.
What is an Asset? What is a Liability?
One of the hallmark lessons to be learned in the famous personal finance book Rich Dad, Poor Dad is this:
An asset is anything that puts money into your pocket. A liability is anything that takes money out of your pocket.
This is a great analogy, and one which is a little less conventional.
Taken literally, this analogy would suggest your home is actually a liability, as it doesn’t provide actual cash in your pocket on a monthly or yearly basis.
Robert Kiyosaki, the author of Rich Dad, Poor Dad, is mostly correct here. It’s a simplistic lesson to help people get on the right path.
But the business world treats assets and liabilities differently than Robert Kiyosaki’s analogy. This includes banks, investor firms, and big or small businesses. And so, we should too.
There are four major categories to personal finance, two of which are defined further below:
Assets
Liabilities
Incomes
Expenses
I believe an asset is any item or resource that puts money in your pocket or which can be used as security for a loan. I also tend to view appreciating things — such as an artwork collection or a coin/banknote collection — as an asset, as they increase in value over time.
A liability is any amount owed to someone that you’ll have to pay back in the future, or an asset that depreciates over time.
So Josh, you say, where does that put my camera and lens? (I’m a hobby photographer on the side, so I have to use this as an example!) Are they an asset or a liability?
Well, if you use the camera to earn money, then it’s an asset so long as your earnings with the camera are greater than the cost of the camera, the cost of interest (if you borrowed to buy the camera), and the cost of disposing of the camera (specifically, I’m thinking eBay fees here). A lot of personal net worth calculations will include a camera as an asset as long as it’s insured, but that’s outside the bounds of this conversation.
Since the camera has a residual value (the value of the asset that you can sell it for when you’re done with it), then it’s quite likely the camera can be deemed an asset if you earn money with it.
So, it’s an asset if:
Earnings with asset + residual value - original cost - interest - selling costs > $0.00.
Or in real words: If earnings with the asset plus its leftover value are greater than what you have paid for it (including interest), it's an asset.
And it's a liability if:
Earnings with asset + residual value - cost - interest - selling costs < $0.00.
If you don’t earn money with it, then it should be classified as an expense and be part of the cost of running your life. Generally, I’d say not to borrow to purchase expenses (like a camera you simply get enjoyment out of), but there are exceptions.
And where does this leave your house? Though Kiyosaki may consider your personal home a liability because it takes money out of your pocket each month, you can, in fact, use your home to secure debt that allows you to purchase assets that earn you income. Like a rental property, for instance.
This is why I will likely always have some sort of outstanding debt secured by my principal residence.
(More on that in a future email.)
Plus, when you go to sell your home in the very end, it’s very likely the residual value of the house will be greater than its original cost. Weirder things have happened, but home prices going up seems to be as close to true as it gets these days.
So by and large, don’t go including your iPhone, or your wardrobe, or your home office chair on an asset list on your personal net worth statement just because they earn you money. But don’t consider anything that has an on-going cost as a liability either.
Like always, there’s a bit more to it.
Thanks for reading. If you feel like spreading the gossip, this guy wouldn't mind.
Have a great weekend.
JG