Today let’s discuss the difference between assets and liabilities. This is a very important topic of personal finance and has also been talked about in the famous book ‘Rich Dad Poor Dad‘.

Difference between Assets and Liabilities

Generally, people associate a swanky house, a high-end car, boats, and even planes as assets. However, in finance, an asset is defined as something that can generate value or cash in the future. The above-mentioned items are arguably not something that will generate cash for us in the future and hence it would be ‘financially wrong’ to term them as assets. These would essentially be liabilities because these would generally need money to keep them in good or even in working condition.

So if assets were somethings that will generate future income then investment holdings like stocks, bonds, real estate that can generate rental income, business holdings, etc would be financial assets. And the idea is that one should accumulate these assets to try and generate passive income. This passive income can then be used to buy fancy things like cars, boats, etc, and to pay for their upkeep.

Difference between Assets and Liabilities
Difference between Assets and Liabilities

However, there are many aspects to life other than money – people would argue that my car is an emotional asset or an asset that saves me time/ energy and hence does qualifies as an asset for me. So there might also be an emotional difference between assets and liabilities.

True, this is a very important consideration that is not delved into deep in the book. If a person’s time is money – let’s say a person can generate Rs 1000 per hour when he works – and he can save 1 hour per day if he buys a car. Then in that case this can be considered as an income and buying may be financially justified provided: 1000*T – E > R

  • The investment return that could have been generated = R
  • The person actually does work for T hours/day extra due to buying the car – this can surprisingly be negative in some cases
  • Other increased expenses per day – more outings, maintenance etc = E

If this holds, it is not only ok, it should be recommended that the person buys the car. This can also be used to see what is the value of the car that person should buy. Taking that value and the expected return % we can arrive at R. We can deep dive into the methodology in another blog.

The idea is that there are returns other than direct financial returns – these can be time, energy, status {example coming up} etc. These while not monetary directly can turn into monetary values and may actually have an astronomical impact.

Status: How can that turn into a monetary benefit?

Say you buy a car and then start getting associated with the rich and famous (getting invited to events which otherwise you may haven’t – yes it happens sometimes). You may develop connections with other successful people and get a business/ job opportunity which otherwise you may haven’t. It may also happen that you are giving a lift to some colleagues etc who might help you out in another way or again maybe help you get a better job or business opportunity.

However, these indirect benefits may be difficult to compute and may be uncertain many times. Hence over-optimistic values should not be assumed for them to justify the expense/ purchase. Otherwise, the decision will not have a strong financial footing.

So does that mean that we should not indulge in luxurious goods or take a break and go to a holiday and keep on making excel sheets to see if we are making a financially responsible choice? The answer is resounding No. This is because these indulgences and breaks actually increase our productivity many times and are essential to boost morale. However, we should be prudent in our decisions such that these instances do not go out of hand.

Basically we should have a goal in mind. This goal can be to become rich, to retire early and enjoy life or even just to work till retirement age and live comfortably after that. The higher the goal, higher is the amount of near term (compounding effects – further the sacrifices the more we will have to make – more on compounding in another blog) sacrifices to be made – so willingness to make sacrifices is important while deciding on goals.

The 2nd aspect is the financial knowledge to create a plan for that goal. This is very important – because only if we truly understand how the plan is made and what is the impact of our actions on the plan can we truly be willing to follow it.

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The last and maybe the most important aspect is the behavioural discipline to take decisions after considering their impact on the plan. Without this there won’t be much benefit of creating plans – only to see them getting derailed and suffering to see that goals will not be met – at least on time.
However, this willingness generally increases as you get more educated on the financial aspects and you can clearly see the light at the end of the disciplined tunnel and the financial turmoil at the end of the impetuous spree.

Let me know in the comments how do you perceive assets and liabilities and about your decision process while spending large sums of money. Also, check out my informative blog on important things to keep in mind while deciding investment channels