Tuesday, July 17, 2012

Rule #3 Defining Assets and Liabilities

We aim to accumulate Cash-Producing Assets that increase their cash-flow over time at or above the rate of inflation.  This is one of our big overarching rules for our Financial Independence strategies.  At a later time, I will talk more about this strategy, but for now I want to tackle some definitions.    This strategy revolves around how we define things we own in our lives, and it is one of the rules where we tend to deviate from other financially-minded people.  We view almost everything we own as either an Fiscal Asset or a Liability.

Here are OUR definitions:

Asset: An asset is a thing that you own that produces positive cash-flow
Liability: A liability has negative cash-flow.... it pays you nothing or costs you money to own.

This sounds fairly straightforward until you start putting things you own in each of the buckets.  So lets list off some.

Some Assets would be:
  • Rental Property 
  • Stocks that Pay a Dividend 
  • REITs 
  • A Profitable Business you own or have shares in
  • Bonds 
  • Farm Land that is being rented for farming 
  • Royalties from something you created, designed, or have the rights to 

Some Liabilities would be
  • A Car
  • A Home 
  • Bare Land 
  • Gold
  • An iPhone
  • Stocks that Don't Pay a Dividend
  • A Television
  • A Computer
  • A Swimming Pool
  • An Unprofitable Business
  • General "Stuff"
  • A Pet

While taxes and debt are also a liabilities, I will talk about those at another time as we treat them differently.  People often take exception of us putting a car, home, and swimming pool in the liability bucket.  Especially their home.  All of this things have intrinsic value so on a typical net worth statement, they would go in the Assets column, however the way we look at it, all of those things cost you money to maintain them once you own them.  So by buying them, you are also adding on a monthly-burden of other costs such as fuel for your car, taxes and upkeep for your home, a mortgage payment on bare land, a monthly plan for your iphone, cable for your TV, Internet for your computer, and chemicals for your pool.  You also need to store your "stuff" which may require that you rent or buy a bigger place to live in.   Its not to say that we don't own some of these things because we do, or have done so in the past, but we are very conscious of how much these things will add to our monthly operating expenses as a family.  These are not one-time buy-and-then-you're-done items.  They can add a lifetime of monthly costs to you.  Ultimately our goal is to minimize things in our life that create monthly-burden payments.

Gold and Stocks that don't pay a dividend are a bit special because many would consider them assets as they have a reputation for going up in value. Well, if you bought Gold at $1000 and it went up to $2000, how much have you made?  The Answer is $0 unless you sell it.  We don't count paper gains (or use mark-to-market valuations) as true gains like the banks do.  The very next day, your gold could go down to $900, and if you didn't sell it on the way down from $2000, now your gold is in a losing position.  Gold pays you nothing to hold it, the price can fluctuate up and down, and it never sends you a dividend cheque for all of your trouble and not to mention the risk you put up just to hold it.  I'm not saying you shouldn't buy some because it may make sense to you to do so.  Gold has appreciated in value quite a bit a these last few years, but there is nothing to say it won't go back down again.  This holds true for non-dividend paying stocks as well (Think Research in Motion - You only made money on it if you got in and out at the right time)  This is why we do not consider Gold, and Stocks with no dividends, assets.


  1. This is a really great post. I don't know if you have heard of Tim Sales, but he has a video online that outlines these exact definitions. Creating wealth is an asset, not something that has constant expenses. Keep writing! I love that you are spreading the knowledge of wealth creation.

  2. Thanks Colin,
    I don't know Tim Sales, but I had a quick look at some of his stuff, and his stuff looks pretty good. Unfortunately, this is not the kind of knowledge they teach in school. I adopted and modified these definitions after Reading Kiyosaki's Rich Dad Books about 10 years ago. I can't remember if he spelled them out like this or not, but its where I base the definitions.

  3. Another great post, Ryan...There is a such a huge difference between 'paper' assets and liabilities, and the real life applications of these concepts...The consideration of the family home as an asset is a perfect example - it's certainly a worthwhile purchase, but to include it as a 'cash value' on a personal balance sheet or to consider its value as part of one's retirement plan (unless there are concrete intentions of selling) can only lead to significant eventual challenges...

    Thanks for sharing your 'rules'! I look forward to reading more!

  4. Thanks for the note Will,
    I've heard of folks who get to retirement age and have a paid off house but not enough cash-flow to maintain it into retirement. This results in the sale of the family home when perhaps they are not interested in selling. Its nice to have equity in the house to draw on, but in the end, your house pays you nothing.