This Is Why Your ‘Assets’ Are Keeping You Poor!
A paradigm upended
Would you like to be rich? Would you like the opportunity to retire, spend time with family, travel, read that stack of books you promised yourself you would read? Of course! Would you like to dine at fancy restaurants, or take your spouse on a romantic adventure — free to roam the streets of Paris and kiss under the Eiffel Tower? Definitely! Most, if not all, of us want that freedom. And that’s what being rich is all about — the freedom to do or not do things according to our passions and desires. But, in order to achieve that freedom, you must rid yourself of preconceived notions of what being rich really means and how you acquire wealth. To do so, you must understand the real difference between assets and liabilities, and understand how they help or hurt your income statement and balance sheet. Getting this wrong, misunderstanding or confusing the assets and liabilities, will lead you away from your goals and keep you locked in financial poverty.
So, what is an asset and a liability?
Most of us have heard the terms ‘asset’ and ‘liability’. For those who have heard the terms, we even possess a general understanding of what an asset is: something that has value; whereas, a liability is something that costs us money. That’s normally where that understanding begins and ends. To add to our understanding, we turn to financial professionals or friends who are supposedly financially literate. Financially literate people will often throw out seemingly simple phrases to teach us and illuminate our understanding. For example: “To become wealthy, grow your assets.” They will then go on to list assets: houses, cars, bank accounts, private jets, yachts, vineyards. Robert Kiyosaki, Author of Rich Dad Poor Dad famously wrote in 1997 that your house is a liability and not an asset (he was right!). Nonetheless, most of us will look at that list and begin thinking of ways to leverage ourselves to acquire those ‘assets’. When it comes to liabilities, those financially literate people will then caution us against liabilities. They will say something to the effect of, “Liabilities are debt, and debt is bad.” They will then caveat that with, “Debt can be good if it’s used to acquire assets.”
This thinking is incomplete and circumlocutory, which makes it dangerous!
While that list of houses, cars, jets seems true for the definition of an assets — it is an incomplete picture, and therefore, a misunderstanding of an asset. Likewise, ‘debt is a liability’, is also an incomplete picture, and therefore, a misunderstanding of a liability. Even with the caveat that using debt to buy assets is a good thing (this is more commonly called leverage) it fails to capture the meaning of a liability. The definitions for assets and liabilities falls short of a complete definition because they fail to account for where they land on your personal balance sheet and income statement. I know this sounds complex but stay with me and do a quick exercise.
An exercise in balance sheets and income statements (don’t sigh — it’s fun!)
Here’s an exercise to help you understand your financial life. We’re going to look at what a balance sheet and income statement look like. This will be the tool to use when determining an asset versus a liability. Robert Kiyosaki demonstrates this in Rich Dad Poor Dad. I have broken it out slightly different to make it more easily digestible for you.
Directions (with a picture below):
Take a sheet of paper and draw a large ‘T’ on the top half of the paper. Above the top ‘T’ write the words “Income Statement”. Then on the left-hand side of the ‘T’, just under the top bar of the ‘T’, write the word “Income”. On the right side, write the word “Expenses”. Now leave a little space and on the bottom half of the paper draw another large ‘T’. Above the top ‘T’ write the words “Balance Sheet”. Then on the left-hand side of the ‘T’, just under the top bar of the ‘T’, write the word “Assets”. On the right side, write the word “Liabilities”. It should look like this:
The Income Statement
Income:
The top left is your personal income section. This can take the form of many things, but most people only think of one thing: job income. To be fair, a job is an income. But what other forms of income are there? Rental income, perhaps? Yep. Royalty income — say, from writing on Medium? Definitely. Interest from dividends, stocks, bonds, savings? Absolutely! Those are some of the best forms!
Expenses:
The top right is your personal expenses such as rent (or mortgage), food, clothing, gas, electricity. Even here, there is an often-overlooked expense: taxes! Taxes are actually one of your largest expenses — in many cases, taxes are a person’s single largest expense. Taxes are sneaky expenses too — they show up when you purchase goods and services; they’re Social Security taxes; Payroll taxes; Medicare taxes — and don’t forget income taxes!
The Balance Sheet
Liabilities
In the bottom right corner of your sheet we have the liabilities. But what makes up a liability? Correctly defined, liabilities are anything that takes money our of your pocket and puts that money into someone else’s pocket (be it a bank, dealership, loan shark, credit card company, or family member). There is no caveat here that says leveraged debt is not a liability if it’s used to buy assets. No. Leveraged debt is still a liability. So, in this definition, a liability can be a mortgage on your home, your personal car loan, your business car loan, student loans, credit card debt, other consumer loans, such as a HELOC (Home Equity Line of Credit), or money borrowed from your brother to buy a Harley. Simply put, debt is always a liability, unless it is owed to you. Then it becomes…
Assets
In the bottom left section, we have the final and arguably most important section: assets. Assets are one thing and one thing only: things that put money into your pocket. Real estate that generates income? Asset. Stocks, bonds, CDs? Assets. Intellectual property (IP), such as your Medium article? Asset. Remember that debt someone owed you? That’s an asset because it puts money into your pocket. It’s the other person’s liability. Think about the previous two sentences. There’s a critical idea there:
An asset on your balance sheet is a liability on someone else’s balance sheet. A liability on your balance sheet is an asset on someone else’s. That’s why it’s a balance sheet — it balances assets and liabilities.
Further Explanations:
At this point a lot of people push back. They’ll say, “my accountant told me my house is my biggest asset!” I’m saying that although your accountant is not wrong, traditionally, I am saying the paradigm has shifted — it has been upended. Unless your house generates income for you, it is a liability. Take a moment to think about what your house costs you. You have a mortgage, maintenance, water, sewer, trash, electric, property taxes, insurance — that all costs you money while putting nothing into your pocket. Ergo, it’s a liability.
Remember that I asked if you wanted to be rich — if you’ve read this far, I believe you do. However, if you treat your house, your car, or motorcycle as an asset, and they do not generate money for you, then they are liabilities. Liabilities just lead to poverty. To understand why, you must understand the flow of money.
Still have your sheet? Let’s look at it again:
First, I’m going to show you the Income Statement and Balance Sheet of poor people:
Now let’s look at the Income Statement and Balance Sheet of rich people (this is what we want for you!):
See the difference? Do you see how drastically the dynamic changes? Under the poor person diagram, the only way to generate income was to work. From that work, they had to pay taxes, student loans, mortgage, credit card payments, and more.
In contrast, the rich person diagram demonstrates that assets increase your income — they pay for themselves (taxes, loans, and all). The additional income then pays for the everyday expenses like food, clothing, and subscriptions. More importantly, assets can do one other thing brilliantly:
Assets generate income to purchase more assets that generate more income!
True assets are like a snowball rolling down a hill. Every rotation the assets increase in size by adding to what they already are. The more assets you own, the greater the power they possess to generate more cashflow and increase your Income Statement and your Balance Sheet. This is wealth — this is being rich!
Now it’s your turn:
Fill out your balance sheet. Think of all the liabilities, expenses, income, and assets. List them all. How does your balance sheet look? You might see that it’s like the Poor Person balance sheet. That’s totally fine! You now know what you need to change, rethink, and do. Or, you might see that it’s a blend of the Rich and Poor Person balance sheets. That’s good! You can focus on growing. Ask yourself: What steps can you take to improve it, and make it look more like the rich person’s balance sheet? If you’re like me — I buy dividend stocks and use those dividends to buy more dividend stocks — it’s my favorite thing to do with my income! Some people prefer to buy Index Funds and re-invest those dividends. Great option for many! Maybe you see yourself renting out part of your house to start generating income, and then buying your own rental property one day. Awesome! Maybe you create some amazing content on Medium and collect your royalties! Your opportunities are boundless. To become truly rich, you must look for those opportunities and acquire the assets necessary to generate income. Acquiring assets does take time. Give it enough time and you will be rich! Always make sure you know the difference between assets and liabilities — then focus on buying those assets!
Finally, if you have never read Rich Dad Poor Dad, I commend it to your reading list. Robert Kiyosaki did for finance what Apple did for the cell phones.
If you have questions or comments, please leave them below!
As always: Keep the FIRE burning!
This article is for informational and entertainment purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
