Before I read the book “Rich Dad Poor Dad”, I had no clue whatsoever as to what was meant by assets and liabilities. I didn't even know that these terms existed. I am sure most people still fall into this category. Robert Kiyosaki explained the difference between the two in the simplest of terms in his book “Rich Dad Poor Dad”. You can grab your copy here. It is the #1 personal finance book of all time.
In simple terms, assets and liabilities represent the fundamentals or foundation for your financial picture. Assets encompass everything you own or control that holds value and appreciates over time while liabilities encompass your financial obligations and debts that take money out of your pockets. Effectively managing the relationship between assets and liabilities is key to achieving financial prosperity.
ASSETS
Simply put, assets are those things that appreciate over time and bring money into your pocket. In other words, assets refer to any possessions or investments that an individual owns that have value and can be used to generate income or provide financial security. Think about owning real estate, stocks, bonds, index funds, etc. Real estate can be owned in multiple forms such as your primary home, rental properties, residential and commercial real estate, etc. Stocks, bonds, and index funds are valuable investments that can be owned through brokerage accounts, and retirement accounts and provide a passive source of income through dividends and appreciation.
Types of Assets
a. Physical Assets- these are items that have a physical form, and they appreciate over time. For instance, real estate properties, artwork, jewelry, or any other physical item with value.
b. Financial Assets- these represent entities that provide future financial benefit and can be exchanged or liquidated more easily than physical assets. For instance, cash, stocks, bonds, retirement accounts, CDs, etc.
Why should you own Assets?
Let’s evaluate some reasons why it is important to own assets-:
1) Wealth accumulation- Assets help to maximize your net worth. Calculating your net worth is a way to assess your financial health and stability. Net worth is the difference between your assets and liabilities.
How to calculate net worth
To calculate your net worth, find out the total of all your assets which includes bank accounts, savings accounts, retirement accounts, investments, and market value of real estate properties. Then find out the total of all your liabilities such as a mortgage, credit card debt, car loan, student loan, personal loan, etc. Then subtract your liabilities from your assets.
Net Worth = Total Assets – Total Liabilities
For example, John has a total of $50,000 saved and invested in a brokerage account. According to Zillow, his house is worth $300,000. So, the total of John’s assets is $350,000.
However, John has a credit card debt of $15000 and a mortgage loan of $250,000. So, the total of John’s liabilities is $265,000.
Hence, John’s Net Worth = Total Assets – Total Liabilities.
$350,000 - $265,000 = $85000
Thus, John’s Net Worth is $85000.
Please note that this is a simplified example. You can use this formula to calculate your net worth. A positive net worth means your assets exceed the value of your liabilities and you are responsible with your money. Whereas a negative net worth means that you have far more debts than assets and lenders view you as a risky borrower that adversely affects your credit score and your ability to secure a loan with better terms. It is essential for you to focus on reducing your debts and increasing your assets.
2) Generating passive income- Rental properties and dividend-paying stocks generate a passive source of income that adds to your overall cash flow. If you reinvest your dividends back into the stock market, then your money makes money which makes more money. This is called compound interest. Once your portfolio is large enough that your passive income can pay for your lifestyle, that’s when you achieve financial freedom. You no longer must trade your time and work for money because the passive income from your rental properties and stock portfolio can fund your lifestyle.
3) Future growth opportunities- You can leverage assets for using other people’s money to buy more assets such as investment properties, secure loans, or lines of credit that maximize your returns and increases your net worth.
LIABILITIES
On the contrary, liabilities are things that depreciate over time and take money out of your pocket. For instance, cars, cell phones, electronics, furniture, etc. are items that depreciate soon after purchase and cost you money as opposed to making money. Also, liabilities refer to the financial obligations or debts that you owe to others such as car loans, student loans, personal loans, credit card debt, unpaid bills, unpaid taxes, etc.
It is imperative to understand our liabilities so that we don’t make the mistake of considering them as false assets and adversely affecting our net worth and financial health. Assets and liabilities affect our ability to save, invest, and achieve our financial goals. Our goal is to manage our liabilities responsibly by making regular payments, paying off high-interest debt, and keeping our debt levels within reasonable limits.
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