Invest in assets and avoid having liabilities
Posted: Thu Dec 12, 2024 3:18 am
A company's assets are what a company owns. They include buildings, machinery, computers, software, but also stocks, accounts receivable from customers and current accounts at banks.
Liabilities include the sources of financing that allow the financing of these assets. They include equity, but also long-term or short-term debts or accounts payable to suppliers.
Table of Contents
Assets and liabilities in the family economy
Assets and liabilities: the prudent view
Assets and liabilities even more extreme prudent views
Investing in assets with liabilities
Invest in assets and control your liabilities
Assets and liabilities in the family economy
Although the family economy is not a business, applying certain financial concepts can be of great help. Just like in a business, in a family we have assets , for example: our home, our car, shares in a company, financial investments or current accounts. But, on the other hand, we also have liabilities : personal loans, mortgages, credit card balances, etc.
Let's see an example: when we buy a car with a personal loan, we acquire an asset (the car) and at the same time we create a liability: the loan that we must repay (normally in monthly installments). In other words, we commit part of our future income to pay the car loan.
Another example: when we buy a home, we acquire an asset and normally at the same time we create a liability, the mortgage, which helps us, either partially or totally, to finance the acquisition of the home. In other words, we “mortgage” part of our future income to pay the mortgage on our home.
Download guide Learn to invest easily
Assets and liabilities: the prudent view
When we go into debt we create liabilities and these liabilities have a cost, the interest rate that takes wealth away from our family economy.
This is why it is often recommended that we control our debt, that is, the liabilities that we generate in our family economy. The prudent approach is to limit this debt to a certain percentage of our income. The International Monetary Fund (IMF) suggests that the level of debt should represent no more than 30% of family income . If we are above this limit, it means that we would be assuming too many risks in the use of credit.
A fairly common example that shows the negative side of indiscriminately getting into debt is the use of credit from our credit card. Just as a mortgage has a very tight interest rate, the use of credit from the card means paying effective double-digit interest rates that indisputably erode the family economy. Therefore, a clear piece of advice is to avoid using credit from our cards .
A prudent financial vision is one that recommends avoiding getting into debt and, if you do, limiting that debt to a reasonable ratio of your income and paying off your debts as soon as possible. It is also advisable not to take on additional debts before paying off old debts. Let us remember that debts generate interest rates that increase our expenses and limit the possibility of creating wealth in our family unit.
Assets and liabilities even more extreme prudent views
A more extreme view would be that of the FIRE movement . In this movement, debt has no place, as it is about saving and investing very actively.
Other views also question what assets really are. Can a family economy consider a car an asset? Well, it is very debatable. A car depreciates by 30% to 50% as soon as you buy it, and it causes constant expenses, insurance, gasoline, parking, taxes, maintenance, etc. It is very debatable whether a car is an asset for a family, but rather a liability that generates expenses. Today we are starting to have options for buying a car via pay-per-use¹. If we use the car sporadically, it will surely be much more beneficial to pay for that use than to take out a loan to buy a car.
Robert Kiyosaki, author of the best-seller “Rich Dad, Poor Dad”² , quite in line with the previous point about the car, makes a somewhat more extreme definition of assets and liabilities.
“An asset is something that puts money in my pocket”, for example, dividends, interest income…
“A liability is something that takes money out of my pocket,” that is, it generates expenses and detracts wealth from my family unit.
Under this concept, Kiyosaki goes so far as to suggest that even a house is a liability. When we buy a house, we not only mortgage ourselves (create a liability) but we also get caught up in additional maintenance, services, etc. expenses associated with that house.
There are probably cultural/social differences behind Kiyosaki's conception. In Spain, for example, housing is considered one of the best investments. On other occasions we have already talked about what real estate investment represents , and whether financial or real estate investment is better .
What Kiyosaki conveys in his book, not without reason, is that the decision to buy a house has a very high opportunity cost. That is, investing in a house deprives us of the opportunity women database to invest in other assets first, which do put money in our pocket, and which do not generate additional expenses. Kiyosaki thus shows the different visions of his two fathers: “One believed (the poor father): “Our house is our biggest investment and our biggest asset.” The other believed (the rich father): “My house is a liability, and if your house is your biggest investment, you are in trouble.”
As for the first home, this concept may be questionable, since the alternative to not buying can be even more expensive. But again, there are cultural/social issues involved. The average Spaniard thinks this way because he is thinking of not moving from his hometown. For a person who has to move around the world, buying a home is clearly a liability. And if we reflect a little more, we will see that a second residence can undoubtedly be a great liability.
Beyond the discussion about whether a house is an asset or a liability, we do fully share Kiyosaki's view that it is important to start investing as soon as possible in assets that put money in our pockets, whether it be dividends from stocks, increases in value, interest, profits from a business or real estate income. Curiously, Kiyosaki's very capitalist conception coincides with what we saw in FIRE .
Investing in assets with liabilities
We have seen in the previous point how important it is to equip ourselves with assets that generate income for us.
A more radical and certainly less prudent approach, also reserved exclusively for very sophisticated investors, is to invest in assets using liabilities.
Let's take an example from the real estate sector again . We can decide to invest in properties by taking out a mortgage (partially or fully) in order to rent them out . This works as long as the expected income (return on investment, in this case the rents we generate) is clearly higher than the cost of the liability, i.e. in this case the interest rate we pay on the mortgage.
This is what central banks are playing at today. They are reducing the cost of money to zero or negative rates to stimulate investment of all kinds.
Let's imagine that we are able to buy and rent a property that generates 5% (net of all expenses) on the investment while the bank asks us for 1.5% interest on the mortgage. In this case we would have an asset-liability that generates a net 3.5% (5%-1.5%). We have used the real estate example again because it is easy to understand. This type of "business" is very popular in Spain. What many forget is to compare this "business" with other alternatives . For example, financial investment can be more profitable (and more liquid) than real estate investment. In any case, we should remember that it is advisable to diversify our investments.
The process of borrowing to create wealth is what a businessman or very advanced investor who knows well the assets in which they invest and the risks they run constantly does. The less sophisticated investor does not have to and should not complicate his family life . This type of operation requires having a very sophisticated control that we are capable of generating sufficient income in the worst moments to pay our liabilities. That is why it is not recommended for most families. It requires having a training similar to that of a businessman, that is to say a financial culture and important knowledge of business and accounting.
That said, having training and acquiring this ability can help us achieve financial independence more quickly or more easily. In short, Kiyosaki's book goes in this direction.
Invest in assets and control your liabilities
From all that has been said above, it is clear that a family economy is not very different from a company. A family must acquire assets that generate returns as soon as possible . To do this, the most prudent thing to do is to control our expenses well at the beginning, save and invest as soon as possible and limit our liabilities. To do this, it may be important to make a family budget and have good control of our income and expenses .
On the other hand, we must be clear that not investing (not taking any risk) is in itself a risk : that of losing purchasing power and never having a certain financial independence. Each person has to invest at their own pace, having clear financial objectives and knowing their risk profile . If we only save and do not invest, we will not be adding assets to our family balance sheet, limiting our ability to generate returns with our savings.
Beyond this, it is advisable to train yourself financially . Once you have obtained a certain training, you will be able to take on more complex financial challenges.
Liabilities include the sources of financing that allow the financing of these assets. They include equity, but also long-term or short-term debts or accounts payable to suppliers.
Table of Contents
Assets and liabilities in the family economy
Assets and liabilities: the prudent view
Assets and liabilities even more extreme prudent views
Investing in assets with liabilities
Invest in assets and control your liabilities
Assets and liabilities in the family economy
Although the family economy is not a business, applying certain financial concepts can be of great help. Just like in a business, in a family we have assets , for example: our home, our car, shares in a company, financial investments or current accounts. But, on the other hand, we also have liabilities : personal loans, mortgages, credit card balances, etc.
Let's see an example: when we buy a car with a personal loan, we acquire an asset (the car) and at the same time we create a liability: the loan that we must repay (normally in monthly installments). In other words, we commit part of our future income to pay the car loan.
Another example: when we buy a home, we acquire an asset and normally at the same time we create a liability, the mortgage, which helps us, either partially or totally, to finance the acquisition of the home. In other words, we “mortgage” part of our future income to pay the mortgage on our home.
Download guide Learn to invest easily
Assets and liabilities: the prudent view
When we go into debt we create liabilities and these liabilities have a cost, the interest rate that takes wealth away from our family economy.
This is why it is often recommended that we control our debt, that is, the liabilities that we generate in our family economy. The prudent approach is to limit this debt to a certain percentage of our income. The International Monetary Fund (IMF) suggests that the level of debt should represent no more than 30% of family income . If we are above this limit, it means that we would be assuming too many risks in the use of credit.
A fairly common example that shows the negative side of indiscriminately getting into debt is the use of credit from our credit card. Just as a mortgage has a very tight interest rate, the use of credit from the card means paying effective double-digit interest rates that indisputably erode the family economy. Therefore, a clear piece of advice is to avoid using credit from our cards .
A prudent financial vision is one that recommends avoiding getting into debt and, if you do, limiting that debt to a reasonable ratio of your income and paying off your debts as soon as possible. It is also advisable not to take on additional debts before paying off old debts. Let us remember that debts generate interest rates that increase our expenses and limit the possibility of creating wealth in our family unit.
Assets and liabilities even more extreme prudent views
A more extreme view would be that of the FIRE movement . In this movement, debt has no place, as it is about saving and investing very actively.
Other views also question what assets really are. Can a family economy consider a car an asset? Well, it is very debatable. A car depreciates by 30% to 50% as soon as you buy it, and it causes constant expenses, insurance, gasoline, parking, taxes, maintenance, etc. It is very debatable whether a car is an asset for a family, but rather a liability that generates expenses. Today we are starting to have options for buying a car via pay-per-use¹. If we use the car sporadically, it will surely be much more beneficial to pay for that use than to take out a loan to buy a car.
Robert Kiyosaki, author of the best-seller “Rich Dad, Poor Dad”² , quite in line with the previous point about the car, makes a somewhat more extreme definition of assets and liabilities.
“An asset is something that puts money in my pocket”, for example, dividends, interest income…
“A liability is something that takes money out of my pocket,” that is, it generates expenses and detracts wealth from my family unit.
Under this concept, Kiyosaki goes so far as to suggest that even a house is a liability. When we buy a house, we not only mortgage ourselves (create a liability) but we also get caught up in additional maintenance, services, etc. expenses associated with that house.
There are probably cultural/social differences behind Kiyosaki's conception. In Spain, for example, housing is considered one of the best investments. On other occasions we have already talked about what real estate investment represents , and whether financial or real estate investment is better .
What Kiyosaki conveys in his book, not without reason, is that the decision to buy a house has a very high opportunity cost. That is, investing in a house deprives us of the opportunity women database to invest in other assets first, which do put money in our pocket, and which do not generate additional expenses. Kiyosaki thus shows the different visions of his two fathers: “One believed (the poor father): “Our house is our biggest investment and our biggest asset.” The other believed (the rich father): “My house is a liability, and if your house is your biggest investment, you are in trouble.”
As for the first home, this concept may be questionable, since the alternative to not buying can be even more expensive. But again, there are cultural/social issues involved. The average Spaniard thinks this way because he is thinking of not moving from his hometown. For a person who has to move around the world, buying a home is clearly a liability. And if we reflect a little more, we will see that a second residence can undoubtedly be a great liability.
Beyond the discussion about whether a house is an asset or a liability, we do fully share Kiyosaki's view that it is important to start investing as soon as possible in assets that put money in our pockets, whether it be dividends from stocks, increases in value, interest, profits from a business or real estate income. Curiously, Kiyosaki's very capitalist conception coincides with what we saw in FIRE .
Investing in assets with liabilities
We have seen in the previous point how important it is to equip ourselves with assets that generate income for us.
A more radical and certainly less prudent approach, also reserved exclusively for very sophisticated investors, is to invest in assets using liabilities.
Let's take an example from the real estate sector again . We can decide to invest in properties by taking out a mortgage (partially or fully) in order to rent them out . This works as long as the expected income (return on investment, in this case the rents we generate) is clearly higher than the cost of the liability, i.e. in this case the interest rate we pay on the mortgage.
This is what central banks are playing at today. They are reducing the cost of money to zero or negative rates to stimulate investment of all kinds.
Let's imagine that we are able to buy and rent a property that generates 5% (net of all expenses) on the investment while the bank asks us for 1.5% interest on the mortgage. In this case we would have an asset-liability that generates a net 3.5% (5%-1.5%). We have used the real estate example again because it is easy to understand. This type of "business" is very popular in Spain. What many forget is to compare this "business" with other alternatives . For example, financial investment can be more profitable (and more liquid) than real estate investment. In any case, we should remember that it is advisable to diversify our investments.
The process of borrowing to create wealth is what a businessman or very advanced investor who knows well the assets in which they invest and the risks they run constantly does. The less sophisticated investor does not have to and should not complicate his family life . This type of operation requires having a very sophisticated control that we are capable of generating sufficient income in the worst moments to pay our liabilities. That is why it is not recommended for most families. It requires having a training similar to that of a businessman, that is to say a financial culture and important knowledge of business and accounting.
That said, having training and acquiring this ability can help us achieve financial independence more quickly or more easily. In short, Kiyosaki's book goes in this direction.
Invest in assets and control your liabilities
From all that has been said above, it is clear that a family economy is not very different from a company. A family must acquire assets that generate returns as soon as possible . To do this, the most prudent thing to do is to control our expenses well at the beginning, save and invest as soon as possible and limit our liabilities. To do this, it may be important to make a family budget and have good control of our income and expenses .
On the other hand, we must be clear that not investing (not taking any risk) is in itself a risk : that of losing purchasing power and never having a certain financial independence. Each person has to invest at their own pace, having clear financial objectives and knowing their risk profile . If we only save and do not invest, we will not be adding assets to our family balance sheet, limiting our ability to generate returns with our savings.
Beyond this, it is advisable to train yourself financially . Once you have obtained a certain training, you will be able to take on more complex financial challenges.