CFO of Life #110: Assets and Liabilities - all you need to know!

Everything you own is either an asset or a liability!

And it is paramount you understand what is what and why, as if you don't, you are one wrong decision away from disaster.

 The most frequent disaster is seeing your car as a 100% asset when it is a liability, which is not a controversial statement to make. But the controversial statement is that your house (primary residence) is 100% a liability until you pay off your loan. Before you give in to the temptation of arguing otherwise, let me present to you my point.

 Essentially, an asset is something that has an economic value and can be sold for money. So by definition, both your car and your house are an asset! At the same time, a liability is something that you own, so if you purchase your car or your primary residence with a loan, it can be seen as a liability.

 Now, another way to look at your assets and liabilities is through the lens of “Productive” and “Unproductive” assets. That gives a much better explanation of what goes where and why.

 That’s why in this week's newsletter, I will break down the topic of assets and liabilities to get you 100% up to speed with the topic, with the most important points being:

1. Why should you even care about this topic?

2. What is an asset?

3. Types of assets that you should care about in your personal finances

4. What is a liability?

5. Types of liabilities that can push you under and towards bankruptcy!

6. The distinction that most people miss “Productive” vs “Unproductive” assets or liabilities

 If this is your first time reading this blog, my name is Simeon Ivanov (Si-Me-On). I write this weekly blog about personal finance called CFO of Life to bring you on the journey towards becoming the CFO of your Life! I hope you like it and that you stick around for the long term!

Now, let’s get into the thick of it!

Before we go into what is what, it is essential to answer the question: “Why should I care about this topic?” From my point of view, it is important to understand what is an asset, how it works and why you need it as much as what is a liability and how it can make or break your personal finances!

 For me, it was important to get a good grasp of the idea of assets and liabilities, as those are the two quintessential components of your net worth. It is important to understand the distinction between an asset and a liability, but also the fine line between owning one or the other.

 Also, this is important as if you pick the wrong liabilities, you can quickly spiral towards bankruptcy. Just imagine how damaging a payday loan with a 200% interest rate is, that is an insane amount but many people have fallen for this trap and taken the loan. And don’t tell me that people know what to do with their debt, over the last 12 months about 9% of credit card debt owners in the USA defaulted on their payments.

 There are many more reasons why you should care, but assets and liabilities are the two things you acquire with your money, so you need to understand them well!

It is the fancy word for anything you own, regardless of its value, shape, size or when you acquired it.

 An asset is a resource/item or a belonging that has economic value, regardless if you own it, your business owns it or it is owned by a country. It can be a tangible asset like all your cash, your car, the house you live in, a pile of notebooks or a library full of books, or it can be an intangible asset like your knowledge and intellectual property (this article).

When it comes to your assets, it is good to have a variety of things. Just like a well-balanced meal, you don’t want to have just the carbs, right? So you should consider having a few different types of assets depending on your goals and aspirations.

 Cash - is the best thing to have as you can directly use it to buy anything and everything. Now, this is a simplification, but for the sake of “a good asset to have” it is something worth having. The caveat is that there is a limit to how much cash you should keep and where, but that is a discussion.

Real Estate - you might be surprised that I recommend this, but real estate is a great asset to have as it can produce good profits, but it is something that most of us recognise. Now, I need to caveat that I am talking about real estate that is generating cash, not your primary residence as the latter is more of a liability than an asset.

Intellectual Property - this is the one ‘asset’ that many people ignore and forget to continuously acquire. For me, intellectual property is anything that makes you smarter, better rounded as a person and better prepared for life. This is everything from education to the money you spend on your hobbies, therapy, personal training and any educational experiences you can get. Interestingly, intellectual property has the highest return on investment, but it takes a lot of time to see that. Now, you probably see how much I love this topic, hence why we will pick this up in detail next week!

Liability is the fancy word for debt, a risk or something you owe to another person or a company.

 For you, that could be your car payment, your rent, your credit card bills or your student loan. For your business, this could be the lease on the shop you have, the money you owe to your supplier and to your employees or any other loans you need to settle. In general, this is all you owe to everyone else and all the value you need to settle with them.

This will be short and sweet, unlike the experience in a situation where you have a lot of those “fun” liabilities. Now, there are many, many different types of bad debt, but I will put them in two categories: Expensive debt and useless debt.

Expensive debt is the type that costs you a lot of money for no reason. Here you can add your credit card bills, your payday loans, unsecured lending or any “shady” loans you have taken out. But if you are looking for a % value, for me anything above 8% interest rate is expensive, as that is more or less how much you can expect to make from the stock market for a year.

 Useless debt is the debt you take out for things you don’t need but just want. That is usually the debt for any impulsive purchase regardless of size and costs, it is something that you decided on a whim or didn’t think through enough! Usually, this is the debt that can topple your personal finances, as it is usually an expensive debt that you didn’t need to start with, but got because you wanted to do so!

For the culmination of the article, this is the most controversial point I want to make. It is controversial as it might go against the grain of what most people think. But hopefully, it will show you a new way of thinking and a new way of considering some of your assets. Before we dive in the controversy, we need to look at how I define productive and unproductive assets 

 Productive assets are those assets that generate a return on the investment you made, it can be a direct or indirect return. The easiest example is you buying a stock that pays you dividends or you going to a food course that teaches you how to make and sell sushi.

 Unproductive assets are the ones that generate no continuous return, but also continuously cost you money! An example of an unproductive asset is your car, it costs you money to buy, money to run (fuel), money to store (parking) and it even costs you money to use (insurance and road taxes). 

 Hopefully, you see my point, a productive asset will bring you more money after you acquire it, but any unproductive asset will continue to cost you more and more without having any utility.

 Now, for my controversial view, I see a primary residence (or the house you live in) as an unproductive asset. Just hear me out.

 Your primary residence is usually a liability as most of us need to take a mortgage to pay for it. Which by itself does not generate any income, it only takes out additional income. And with the current interest rates, if I take out a mortgage for the apartment I live in, even with a 35% down payment (which is crazy) in 30 years, I will have paid more than £420k, where my initial mortgage would be only for £200k.

 You see, that is £7.3k a year that I have to pay extra to the bank just so I can live in my house. And that is the cost of owning the house, not including any insurance, maintenance or even improvements. 

 Another way to see how unproductive this is - I can take those £220k and pay my rent for 15 years. And if I am smart and invest it wisely or set it up in a low-risk account, I can maybe stretch to cover 20 years of my rent. And that is only if I take the money I would otherwise “throw-away” by covering the interest on my mortgage. All those start to paint a really interesting picture of how unproductive a mortgage can be.

 But that is my personal opinion. It is based on my beliefs, goals and aims and my current thinking on the topic. For you, this might look different and you might value the security of having your own home. Regardless, do take the time and crunch the numbers, take the time and think this through as one unproductive purchase could easily cost you thousands and thousands of dollars/pounds.

 Next week we will deep dive into “Intellectual Property” as an asset. The one asset that we all have, but many fail to develop. The one asset that could easily return you hundreds of percent per year, but it would take much time to realise that. And the one asset that I love acquiring the most!

Post #110 in the series CFO of Life #si #personalfinance #CFOofLife