We often classify big-ticket items as assets because we spend a lot of money on them. As a result, we assign more value to them than our other purchases. We also consider items as assets when we believe that they will “pay off one day.” While assets are sometimes worth some money and should be of some benefit to us in the future, we also have a tendency to stretch this definition. In fact, what we often think of as assets are actually liabilities.
Accountants define assets and liabilities based on how they would appear on a balance sheet. However, Robert Kiyosaki, author of Rich Dad, Poor Dad, has a simpler definition that makes more sense on a personal level. According to him, an asset is something that puts money in our pocket, while a liability is something that takes money out of it.
A case of mistaken identity
A car, when bought for personal use, makes our life more convenient, but is it an asset? Based on Kyosaki’s definition, it’s not. On the contrary, it’s a liability because we end up throwing money at it long after we’ve bought it. We pay for gas, maintenance, and insurance. Sure, we can always sell it after, but by the time we do, its value will have almost always depreciated.
Other items that masquerade as assets or investments include gadgets, travel, and credit cards. Yes, they probably make our lives better on some level, but they don’t put money in our pocket.
The same principle applies to our home. It’s not an asset until it makes us money. One could argue that, unlike the previous examples, real estate actually appreciates in value. One could also say that our home will eventually be worth more than what we originally spent for it. While both statements are true, it’s also true that until then, it’s a liability. Why? Because if there’s one thing that life has taught us, it’s that we shouldn’t count our chickens before they’re hatched.
Consider the current situation. In the last few years, a number of people might have taken the plunge and bought their own home, thinking that it would make for a good investment one day. They’re not necessarily wrong, but they probably didn’t expect a pandemic either. To be fair, no one did. Now, some of them might have lost their jobs or taken pay cuts, which, in turn, might have forced them to sell their home. The really lucky ones might have been able to sell theirs at a profit, but most of them, well, they might consider themselves fortunate just to find a buyer.
Even without the pandemic, which is admittedly an extreme situation, there are a number of different scenarios that could have played out, and until all the cards are laid out, it’ll do us good to think of our house as a liability and not an asset.
The benefit of knowing which is which
The point of emphasizing the difference between assets and liabilities isn’t to devalue existing purchases, but to avoid putting more stock into them than we should. It’s not meant to scare anybody into not making purchases or taking risks, but to make sure that we make informed decisions every time we do.
Once we understand the difference between assets and liabilities, we stop making too many decisions based on the vague, and sometimes false, expectation that “it will pay off one day.” We ask ourselves, for example, whether a car is really something we need without inaccurate projections about its potential value clouding our judgment.
Being fully conscious that we’re accumulating liabilities and not assets, should also make us rethink our wealth strategy. How can we acquire more assets instead of liabilities? Find out how assets help sustain the wealth generation cycle when you click here.