What is an asset?
THE question, “What is an asset?” seems like an absurdly simple question. But if you understand the answer to that simple question, and act on it, you have started down the path that leads to riches. Few people become rich, so clearly then, few people understand the answer to this question. Let’s have a closer look.
The Oxford English Dictionarydefines an asset as “a useful or valuable thing or person; [or as] property owned by a person or company.” This is the strict dictionary definition of the word ‘asset’. However, if I use this definition of ‘asset’ when deciding how to spend my money then I am likely to make mistakes. That is, I am likely to make decisions that I would not have made had I really understood what an asset is.
Using the Oxford dictionary definition of ‘asset’, I could be mistaken for thinking that my Mercedes that I have parked out the front is an asset. I own it, it is very useful and it is definitely valuable. This satisfies the dictionary definition of an asset. In addition, the bank will usually be willing to count my Mercedes as an asset when I ask for a personal loan.
In Rich Dad Poor Dad, Robert Kiyosaki makes the insightful point that, “what defines an asset is not words but numbers”. Let’s consider the numbers relating to my Mercedes. Every month I have a series of expenses that I incur because I own my Mercedes. My expenses might include: fuel $400, on-road maintenance costs $50, and insurance $200. So, every month my Mercedes costs me $650 in expenses. This doesn’t sound much like an asset.
According to Robert Kiyosaki, an asset is “something that puts money in my pocket every month.” By this definition, my Mercedes is not an asset but a liability. It costs me $650 each and every month, and that’s not including depreciation.
But, what about my house, is that an asset? The conventional wisdom is that you’re house is an asset, and the bank will certainly let you count it as an asset when you ask to borrow money. Let’s apply Kiyosaki’s definition to see whether a house is an asset. Every month you might have to pay: property taxes $200, loans $3000, utilities $200, and maintenance $100. In this example, your house costs you $3,500 each and every month. This doesn’t sound much like an asset.
It is true that, unlike my Mercedes, houses usually appreciate in value. However, there are three problems with this:
- Property does not always appreciate in value. The recent sub-prime mortgage crisis in the United States has taught us all that lesson, if we didn’t know it already;
- Tying up all of your money in your house comes at a high opportunity cost. So, while the value of your house may be rising and you are managing to pay off your mortgage, you may be unable to take advantage of great opportunities that are presented to you. “I would, but I have to make mortgage payments”;
- Your home does not put money in your pocket every month. The only time that you can obtain money from your house is when you sell it. For one reason or another, people are often reluctant to sell their homes. This fact remains true even when people are in tight financial circumstances.
The kind of assets that I’m talking about come in various forms, five examples include:
- Businesses that do not require your presence. If you need to be there to run the business it is a job and not a business;
- Income-generating real estate; and
- Royalties from intellectual property such as books or music.
Once you understand the difference between assets and liabilities, it is a good idea to concentrate your efforts on only buying income-generating assets. This is the path to wealth and riches.
What does it mean to be wealthy?
If the main game is to become wealthy, it would pay to stop for a second and consider what it would mean to be wealthy.
I am inclined to accept the definition of wealth that Kiyosaki puts forward, borrowed from Buckminster Fuller.
Wealth is a person’s ability to survive so many number of days forward into the future if they were to stop working today. So, I have become wealthy when my income each month, which is generated from my assets, fully covers my monthly expenses. If I want to increase my monthly expenses, I must increase my cash flow obtained from my assets in order to maintain my wealth.
To say that someone is wealthy, then, is to say nothing about whether that person is rich. I can be wealthy without being rich.
How much income do I need each month, generated from my assets, before I can consider myself rich? The answer to that question is up to you. The definition of ‘rich’ is in the eye of the beholder.