An intriguing prelude to personal finance is understanding the difference between what you have and what you owe. Do you really have enough to cover what you owe? Or should you have realized that you need not have owed this much in the first place? People often think that what they have are assets for them. And what they owe are liabilities. But we say, stop, take a look back and think again.
Once we figure it out, we are well on our way to think about avenues and ways in which one can save, and invest in assets and lessen liabilities, which is what personal finance is all about.
So, what is an asset?
In pure accounting terms, an asset is anything that gives “service potential’ or has “future economic benefits”. In a business enterprise, a profitable asset means that it has to generate positive cash flows for the business throughout it’s holding period. The same goes for any individual. In terms of personal finance, what classifies as a good investment and a good asset is what slates to bring in some sort of benefit to you, after accounting for all the expenses.
We are never taught the basics of personal finance and the importance of accumulating wealth in life. Everyone wishes to acquire money. This, in fact, also drives academic engagements like going to school, and college, which further translates to getting a job someday so that we can have money. But does anybody teach you the concept of managing money? It is largely something we learn through experiences, old adages, and lessons passed on through society, that we pick up some bits and pieces of information along the way.
Most of us have heard the words assets and liabilities at some point in our lives. We understand it from an accounting point of view. The definition of asset is as far as anybody goes. However, its importance in an individual’s life? Not so much. Hence, we are going to explain personal finance, and why a car or a house accounts as an expense rather than asset.
Many would be pondering over that statement. How is a car not an asset? It saves a lot of time, it is very convenient, and one gets to go to places without being dependent on anybody. But it really just comes down to one point – if one is not using it for a business, is a car generating positive cash flows for the person?
A lesson from Rich Dad Poor Dad – ask yourself: Is what I am about to buy an asset or a liability?
If you have read the book, ‘Rich Dad Poor Dad’, then you would understand what is being said. Is a car an asset or a liability?
Theoretically, yes. A car is an asset as it can allow one to travel anywhere and any belonging that one possesses that has some value today is an asset. A minute observation here: a car is a depreciating asset. This means over time, as soon as one bought it and drove it off the store, it started losing value. An old and used car is never going to be as good as a new one because the parts that go into it suffer from wear and tear and lose their efficiency over time. In the end, all one is left with is the car’s resale value which is not even going to be half the amount one had spent into it.
Throughout the life of a car, the spending is on its fuel. One spends on regular maintenance and repairs like flat tires and dry cleaning, but most of us also don’t have the requisite amount to buy a car from our own money. We take out car loans and cling on to financial help to pay for it – with hefty interests, about 7-9% in most banks. We also pay insurance for our cars, should any irreparable damage happen, or if it gets stolen.
You get what we are hinting at. In lieu of social conventions, people think having and owning a car, or any other such personal belonging as a matter of social status. The more expensive one’s car, the higher one’s rank in terms of wealth in society. Hence, it does not matter in society if you are going to spend the rest of your life trying to make up for this expense.
Warren Buffett’s golden rule is – “Rule no. 1 is never lose money. Rule no. 2 is never forget Rule no. 1”. Do not take a bad loan to finance a bad asset. One may argue and say that the benefits outweigh the expenses. For a salaried person, driving a car to work may be saving one a lot of time. If the value of this time can be ascertained on a per hour basis and compared with the monetary expenses, one may as well say that a car is a good investment. It differs from individual to individual. What if one lives in an area that has low-cost public transport and they hardly need to travel as much? Also, with the pollution and traffic that India has, driving a car can sometimes mean more loss in time. Yes, it has some resale value, but the intention of selling the car does not make it an asset.
Importance of building up good assets
You may think that we are telling you not to buy a car. Our intention is not that. We merely want you to understand the difference between a personal belonging and an asset. One may think investing in a car is something which is going to give one benefit, but instead, it’s just going to be a leech on people’s bank accounts.
So what should one invest in? We like to say that investing is more about psychology than anything else. One can do a lot of technical analysis on stocks but ultimately, it depends on the risk you are willing to take to earn a good return. Investing in equity or debt instruments, or a mix of both will definitely help one to grow wealth.
Build up one’s assets in a way that is going to help one pay for expenses like owning a car. Saving and cutting back on trivial expenses, and then putting them to good use. So it will not only help us buy better things but also beat inflation, which just eats up your money. Buying a car or owning a house are just some of those things that are socially respected and exaggerated. We would end with a quote by Rhonda Katz and say, “Wise spending is part of wise investing. And it’s never too late to start.”