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.