Learning the difference between assets and liabilities was a paradigm shift for us. If you ask an accountant or a banker to illustrate your balance sheet, here's what he or she would probably show you:
Assets – Home, Car, Boat
Liabilities – Credit Cards, IOUs, College Loans
This is what we were taught growing up. You hear the advice that you should buy a lot of assets in order to increase your wealth. That's great news because who would not want a home, a car, and a boat? So, before my wife and I got married, we signed for a house and we already had two cars. All we needed was a boat.
The irony here is that if accumulating these assets are good, then how come they seem to cripple people financially? The issue here is that what we were taught were assets are not really assets. They are liabilities.
After reading the book Rich Dad Poor Dad by Robert Kiyosaki, we learned that if you ask the rich to illustrate a balance sheet with the same items above, they'd show you this:
Liabilities – Credit Cards, IOUs, College Loans, Home, Car, Boat
Notice the red items. What once were assets in our mind has shifted over to be liabilities. This is an "unconventional" way of defining assets and liabilities. The distinction is simple.
Assets put money into your pocket. Liabilities take money out.
So let's take your home for instance. The mortgage on the home is the liability. You pay the mortgage monthly, which is money leaving your pocket. You receive no income from your home. This is why it is a liability.
But then the question arises, "What if I pay off my home, is it an asset then?" Not likely. Because you still have to pay property taxes and maintenance. Money is still leaving your wallet. You either have to sell your house or refinance to receive any cash.
"The fact is, when a banker tells you your house is an asset, they are not really lying to you. They're just not telling you the whole truth."
Now, if you have a property that you are renting out and the monthly rent produces positive cashflow (money leftover after the expenses are paid, like the mortgage), then the property is an asset. It's putting money into your pocket.
My wife and I have a real estate property in Tennessee. After the expenses of the mortgage, taxes, insurance, and property management are paid, we have a positive cashflow of $ 45. It may not look like much, but come tax time, we can depreciate this asset and take other tax deductions.
What about your savings account?
Your savings account looks an asset because it is earning you interest. So, on your bank's balance sheet, it's a liability to them. However, remember that it may not be keeping up with the rate of inflation. This can be eroding your wealth. Now, I'm not saying that it's bad to have a savings account or an emergency fund. But, just consider the fact that it may be taking money out of your pocket.
So what's the goal here?
The goal is to have enough positive cashflowing assets to generate enough income to cover your expenses. When this occurs, you can choose to either leave your current occupation or stay. Your assets should be on autopilot, with little or not involvement from you. This is financial freedom.