A New Car or $53K In The Bank? You Decide.
My previous blog post was on cash flow, and this post focuses on Assets and Liabilities. I wouldn’t blame you, if you were starting to feel as though you’d stumbled across a corporate finance blog, instead of a personal finance one, but not so fast! Though “Assets” and “Liabilities” are words commonly found on a company’s balance sheet, they play a key role in personal finance, and we sometimes need a gentle reminder.
I recently visited a car dealership because I’ve been getting that itch to replace my car. It’s a perfectly good car, with low miles, only five years old and 100% owned by me. It more than serves its purpose, but that itch to replace it wouldn’t go away. My visit to the dealership gave me a much needed dose of reality.
I went to the dealership with a very specific car in mind: A Ford Explorer Sport. Not a Lexus, Mercedes, or Porsche and since I hadn’t completely lost my financial mind, I wasn’t looking for a new car. Within seconds of arriving at the dealership, I found a sharp looking 2014 model with all the bells and whistles, including a 365 horsepower engine (very necessary for driving 7 miles to work and 2 miles to the grocery store). Even though the price sticker was missing, I guessed that it would have a price tag around $40,000. Unfazed, I asked for a test drive, and my husband and I took it out for a spin. It was nice, smooth, spacious, and any other adjective you could use to describe a car.
After the test drive, it was time to crunch some numbers. The total price was around $39,000, and I gave my husband a knowing look, while mentally patting myself on the back. Next step was discuss financing. I qualified for the best rate they had to offer – 2.49%, and selected a 72-month repayment period, which resulted in a monthly payment of $583.69.
The sales person asked if the monthly payment was ‘doable’ and, without thinking, I responded with “It’s doable, but is it necessary?”
I had come down to earth quickly. How could I justify going from $0 a month to $583 a month, while also filling up my tank weekly instead of twice a month? It didn’t make financial sense to acquire a liability, and at the same time, double the outflow of cash towards operating the new car.
If I invested $583 a month, for 72 months with an annual return of 7%, I would have $53,547! I’m pretty sure with the proper TLC, my current car could last 72 months and I could be $53,547 richer.
Do you know the difference between an asset and a liability? Are you acquiring liabilities thinking that they are assets? I almost made that mistake.
I read Robert Kiyosaki’s book The Cash Flow Quadrant about a decade ago and credit it for helping me view financial decisions from an asset or liability viewpoint. A simple trick to keep you focused when faced with a financial decision is to remember that assets flow cash in, while liabilities flow cash out.
Your home, unless you are renting a part of it, is a liability. Your car, unless it also doubles as a cab, is a liability. Rental property (with breakeven or positive cash flow), stocks, bonds are some examples of assets. This isn’t to suggest that you shouldn’t own a home or a car; however, knowing where these items belong from an assets and liabilities standpoint will paint a clearer financial picture.
Conclusion
Think of your finances in terms of cash flow (income and expenses) and a balance sheet (assets and liabilities). The less cash you have flowing out, and the more assets you acquire, the closer you get to achieving financial independence.
“Your home, unless you are renting a part of it, is a liability.” I don’t get this one. Isn’t an asset so long as you are building equity on it?
Here’so my take, Mba: The definition of an asset is that it generates cash flow. The equity you’re building comes from your pocket in the form of a down payment and monthly principal repayment. So not extra cash flow. If the home appreciates, that’s a potential cash flow, except that you would need to calculate the rate of return vs. your cost, to determine whether you’re really earning a return.
Thanks for your comment Mba. From a cash flow point of view, your home is a liability because cash flows into it, with no measurable return. An asset, generates income, directly or indirectly.