Hello again, and welcome to another blueprint for our ongoing escape tunnel. I write this as I stare at a long line of cars at the coffee shop drive-thru at 8:45 a.m. These are no doubt people on their way to a job. People who complain about having too little money, not enough time, and that gas costs too much. Yet here they are, engines running instead of walking in, wasting time to buy expensive coffee that they could make at home for less money (take a look at a Nespresso machine). This land is so rich with irony you could cut it with a knife, and everyone misses the daily comedy.
And then there’s you, a noble financial freedom fighter, who sees all the madness and seeks the path of light instead. Let me light the torch and guide you to another place with the simple gift of knowledge…
Something you’ve heard me say before is, “Money has a homing instinct. It always flies home to its master.” What do I mean by “its master”? Money’s master is the person who understands money, who has a financial education that school doesn’t provide.
Accounting has to be one of the driest subjects out there, but it doesn’t take much to get a grasp on the basics that you need to know. There are really just two words I’ll talk about today: ‘assets’ and ‘liabilities’. Now please stay with me, because this is going to be far from boring- in fact, what I’m going to say will surprise you…
I have an unorthodox definition of assets and liabilities. It’s unorthodox, yet logical when you appreciate that I focus on INCOME, not NET WORTH. Why? Well, when a corporation goes broke it’s hardly ever because of low net worth; it’s because of LOW CASH FLOW. Cash flow, or income, is what it’s all about. Income is what you need to live, not net worth.
So with that in mind, let’s consider assets and liabilities in terms of INCOME…
Look at it in this simple way: an asset is something that generates income for you. A liability is something that generates expenses for you. Comprendez? If you keep this in mind, you will have a clear idea of when you’re acquiring assets and when you’re acquiring liabilities.
And the name of the ultimate game is to acquire assets. To win at monopoly in real life. And then go home and do what you want each day.
When you have enough income-generating assets to meet your expenses, you’ve won the game.
So when you buy a TV or a sofa on credit, you are adding to your liabilities because these are things that take money from your pocket. If you’d bought shares in Wal-Mart with the money, you would be adding to your assets because the dividends would be putting money IN your pocket.
Think of each dollar you make as an employee that must work for you. If that dollar takes money from you, then YOU are the employee of that dollar!
So let’s run a few examples to look for the exceptions to this rule…
If you own a business, is that business an asset or a liability? This is a good question, because I don’t consider a business that you have to work in every day to be an asset. Yes, it may put money in your pocket, but if the whole idea is to gain financial freedom, then PASSIVE income is what we need; automatic income that requires little or no involvement from you. A business can be wiped out in a flash by a single lawsuit or government intervention, whereas rental property mostly can’t.
Real estate is where the wealthy park their profits!
Okay, so time for another test question: is your home an asset or a liability?
I can hear you cry: “Duh! It’s an asset, dummy!”
Really? Shall we apply my rule about assets and liabilities and find out…?
Does your personal residence that you own put money IN your pocket, or take it OUT?
Your home that you own takes money out of your pocket in the form of property tax, HOA, mortgage interest, maintenance, etc. So that constitutes a LIABILITY.
This truth is something that the middle classes will never understand, and why they will be forever living hand to mouth!
I live in a nice house because I want a nice life for my family. I’m not saying to live under the expressway. But when I look at a personal residence I just see a big fat bill, from an unemotional perspective. But your personal residence IS an emotional thing, I respect that, I’m just clarifying my point about assets and liabilities, because understanding this principle is KEY to your financial freedom.
USING MY DEFINITION, maximize assets, minimize liabilities. This is the inside track to freedom.
A rental property on the other hand, DOES put money in your pocket, and so this would truly be an asset. Now, if ‘investors’ had been thinking ONLY in terms of income from rental property, they would NOT have been burned in the property crash because they’d have only bought a property if the price was low enough to make an income. Most of the property in the boom was priced too high to make a profit from renting, but people just bought anyway and prayed for prices going up forever. Wrong!
This is why you should ALWAYS think in terms of cash flow, income, return on investment.
Now, I’d like to conclude with an interesting final question: Is your CAR an asset or a liability?
If you’ve been paying attention, your natural reasoning is to say that a car is a liability because it doesn’t put money in your pocket, it takes money out. And strictly speaking, that’s true in most cases. But here’s the exception to the rule…
Like it or not, we live in a fairly superficial country where everyone is judged on appearances. Humans are psychologically inclined to formulate fast decisions about you so they can categorize you, we look for patterns in everything. Should we give this person a loan, will he pay us back? Should I trust this person? Should I listen to this guy’s sales talk? Should I go into business with him? Shall I invest in his idea?
Our brains are just computers. In the face of a wall of questions like those above, the computer between your ears looks for the fastest way possible to meet the user request. The way it does this is by ‘stereotyping’.
Hence the golden truth: Perception is Reality.
So I class my Mercedes as an ‘unquantifiable asset’ because it probably puts money in my pocket by other peoples’ perception of me. Now, it just so happens that the car I drive matches my finances and success level, but the good news is that it doesn’t have to. You can get a lease on an expensive Mercedes, but live in the ghetto, or even sleep in the darn car itself. Nobody sees your home, they only see what you drive. What you drive is who you are in this country if you’re out there fighting the good fight for financial freedom and facing prospective people who can advance your goals.
(Sidebar: I am not saying that this is how things should be, merely how they ARE. This is all a means to an end, not the meaning of happiness. One of the richest men I know drives a Prius!).
So if you go and buy a new, top of the line Toyota Camry, no disrespect to Camry-owners, this car is MOST DEFINITELY a liability. Nobody will be impressed with that car so it cannot put money in your pocket, it can only cost you money. Ironically, under this definition, a car that costs three times as much as a Camry will be more likely to be an asset to you because it will project a perception of you that could put money in your pocket. OR, taking this idea further, getting an older, but still current model, Mercedes that costs LESS than a new Camry will be more of an asset!
Yes, it’s also about how you look. Now, I live in Florida so there’s no way I’d put on a suit and tie every day, but here’s a couple of tips I recommend to effortlessly create an impressive look, and these are also exceptions to the rule about assets and liabilities…
Get a decent watch. Rolexes hold their money, and there are plenty of second hand Rolexes.
Get a nice jacket. You can wear just a simple jeans and T-shirt, but throw a $500 Boss sports jacket over that to go with your Rolex and you’re transformed from ‘bum’ to ‘hip young entrepreneur’ in the eyes of the confused population. Add the nice car and you actually look wealthier than the guy in a suit these days, in my opinion.
An interesting digression. But the main lesson here is to know the INCOME definition of an asset and a liability, and to buy more assets, and fewer liabilities.
When your rental income equals your living expenses, you’ve won the game of monopoly. It’s time to pack up and sip martinis all day.
Monopoly is a wise game if your goal is financial freedom, and the time to begin playing this game has never been better. Just make sure you don’t procrastinate too long on unproductive things like choosing which piece you’re playing with!