Accountants, financial advisors, and the popular press talk constantly about “assets.” Most people have only a vague notion of what an asset really is. My favorite definition comes from the book Rich Dad Poor Dad. An asset puts money in your pocket. A liability takes money out of your pocket.
Let’s think about that a minute. What kinds of things take money out of your pocket? Well, that bass boat sure does. Unless you make a heck of a lot of money fishing, more money goes into the monthly payments and upkeep than comes out in the form of income. If you are like most of us, you don’t expect any money to come your way on account of that boat. That, friends, is a liability.
This is not being judgmental, by the way. If you enjoy fishing, buy that boat by all means. As long as you have the money, live it up. In the case of a pleasure boat, no one really expects to make money. But what about your house? Haven’t you always been told that it is an asset? The truth is, it takes money out of your pocket too. Even if you have paid it off, you are still spending money on upkeep, utilities, and insurance. That makes your house a liability. But don’t you make money when you sell? Try that about now. And even if you could sell it, where would you live?
The only thing that truly counts as an asset is something that puts money in your pocket. Assets are money machines. When you put some amount of money in an asset, you expect to receive more money than you put in at some point in the future. There are two ways to accomplish this. One is for the asset to throw out a stream of money like, say, a savings account. (I know. It’s not much of a return, but stay with me.) As long as you keep that money in the account, you earn money. Another example is a stock that pays a dividend.
The second way for an asset to make money for you is appreciation in value. Imagine buying a Silver Eagle coin for $15 and selling it six months later for $20. This type of asset makes you money, but you have to sell it to realize the gain. House flipping was a popular form of this type of investing until the housing market crashed.
A successful business is a tremendous asset. By building a business, you can realize both kinds of return. A business creates an income stream as long as you own it. If you build it the right way, you can also sell it at some point for much more money than you put into it. Another great thing about building a business is that you can put much more than just money into it. You can put your know-how, your time, your social network, and your creativity into it. The bank does not care what I know or how hard I am willing to work when I open a savings account. I park some cash and it works for me for the rate determined by the bank, end of story. A business gives me an opportunity to capitalize on things other than money.
It all comes back to value. All businesses operate on the principle of creating value that other people are willing to pay for. Many times, we vastly underestimate how valuable we are to others because we are stuck in the J-O-B trap. Chances are, you have much more potential value than you realize. Next week, we’ll take a look at some ways to tap that hidden value.