If I was to ask you, do you know the difference between an asset and a liability, you would probably respond with ‘yes’. But do you? If everyone thinks they know the difference, why is it that the majority of people have more liabilities than assets? This is the question we all need to ask ourselves and then do something about it.
Rule #1: Know the difference between an asset and a liability, and buy assets
Anyone who has read Robert Kiyosaki’s ‘Rich Dad Poor Dad‘ will be familiar with the first rule of financial literacy. If you haven’t read his book, I highly recommend you read it. Kiyosaki says, “Rich people acquire assets. The poor and middle class acquire liabilities that they think are assets.” Once you let that statement sink in, if you had a ‘light bulb’ moment like I did, you will have got it.
Put simply an asset puts money into your pocket, a liability takes money out of your pocket. It is that simple. So if you buy something and it is costing you money after you have bought it, it is a liability. Take buying a home for example, it is regarded as the largest investment the average person will make, everyone has heard the phrase “my home is my biggest asset”. But is it? Do you have a mortgage? If you have bought your house outright, fair play, you are doing better than most. But if you are like most you will have bought your home with a mortgage from the bank, this is a liability. By buying your home you have committed to paying x-amount every month for x-amount of years.
Now I am not saying that you shouldn’t buy a house, I am saying that you need to know the difference between an asset and a liability. Your house is a liability until that mortgage is paid off, and you should treat it that way. This can be applied to any product – cars, personal loans, credit cards – avoid as much as possible. If you can’t avoid liabilities such as a mortgage, work hard to get rid of them as soon as you can.
Its all about cash flow!
A business is required to keep accurate records of accounts, monitor spending and revenue – in other words its cash flow. You need to do this in personal finance too! I monitor my monthly income and expenses like I would a business with an income statement and balance sheet.
Your income statement is a summary of money coming into your accounts verses your expenses leaving your account. If this figure is positive, great; if it is negative you need to review your budget immediately. Your balance sheet is a summary of the assets you own verses your liabilities. Again, if this figure is positive, you are going in the right direction; if negative you need direct any spare money to your liabilities.
Positive cash flow is where you have more money coming in than going out as illustrated by your income statement. It is this excess cash flow you should direct towards financial goals – savings, or investments
If you acquire assets you will become financially independent
Personally, I direct any positive cash flow from my income statement into assets that will give me a long term positive return. So what assets should you invest in? Well that is down you your own personal circumstances. If you are saving for a house deposit, you should direct your savings accordingly. I personally invest in assets such as stocks and shares, debt (peer-to-peer lending) and cryptocurrency. But as always keep an emergency fund, you always need to have a pot of money in case the unexpected happens.
In order to acquire assets, you need to first educate yourself. Its all good me saying that I invest in the stock market, there is a whole process behind it. Before I make any sort of investment I do my research, be that reading company financial reports, broker forecasts etc. Never invest in anything you do not understand. Additionally, you need to improve your financial literacy. Learn the basics of accounting, how to read balance sheets, what financial products there are etc.
Ideally, this is the sort of thing people should learn at school, but it is left to society which is why it is normal to have credit card debt and older people without retirement savings. So we need to teach ourselves the difference between assets and liabilities so that we can achieve financial security.
None of the content in this article should be considered financial advice, I am not a financial advisor and you should always do your own research prior to investing. These are my opinions only.