Have you ever thought that your understanding of two of the most basic terms of finance could be outdated?
Let's have a look at it. You'll know what I'm trying to say as we move further.
First, we need to recall the traditional meaning of what we call an ASSET and a LIABILITY.
WHAT WE KNOW
Basically, an asset is anything you own such as your mobile phone you are using right now. Your mobile is your asset because it is your property. And liability is something which you are going to pay off, for instance, your bills that you need to pay or simply EMIs of your loan.
THIS IS ALL WE KNOW ABOUT ASSETS & LIABILITIES, RIGHT?
Well, this information is not incorrect but yeah, this is not how it goes when the things get personal.
When we talk about personal finance, we are not going to hold the perspective of an ACCOUNTANT. Let's think more like an 'INVESTOR'.
An investor is not exactly the person who invests money but it's more of having a mindset. So how does an investor define these terms?
Modified definition of ASSETS.
For us, an asset is something that we own but for an investor, its understanding is quite different & more interesting.
They define assets as something that puts money into your pocket.
To be more specific, an asset is anything from which you will earn something, which will generate future cash inflows for you and whose value will increase over time.
So going by that, most of your personal things which you own are not your assets because they don't generate cash inflows for you.
The asset could be something such as stocks, real estate or any business which can give you positive cash flows in the future.
Moreover, an asset could be anything as simple as you learning some skills that will help you in the future to earn, it will generate income for you if you put the same in use.
Now, what is a LIABILITY?
Basically, liability is all your 'WANTS', simply all those things which will take money out from your pocket. All your 'wants' are just a form of liabilities that takes money out of your pocket. Also, it will never generate a positive cash flow and whose value will decrease over time.
Your desire of owning an expensive or trendy stuff which doesn't add up to your net worth & whose value decreases by time is nothing but a liability in disguise of ASSETS.
The mobile phone you are using right now, what was its purchase price? Whatever would be the amount you paid, it will not fetch you the same value now.
Well, that doesn't mean all such things are liabilities as long as you are using them to increase your productivity & efficiency.
Having a phone is a need, it is an asset but having an expensive one which you really didn't require & you spend extra money on it than you should, then it becomes a liability for you.
So how will you know what is an asset for you & what is a liability?
Well, there's no preferred way to find out the difference because you can't generalize this thing. It's unique for every individual.
All you need to do is change your perception when you buy anything because you are the best judge for yourself.
(I have explained in detail how to differentiate between your NEEDS & WANTS. You can read here.)
For now, let's sum up this article here.
The asset is anything that puts money into your pocket & liability is something that takes money out from your pocket.
The asset is something whose value increases by time & liability is something whose value decreases.
Assets generate cash inflows in the future but liability cash outflows.
This article is inspired by a book Rich Dad Poor Dad. I am so fascinated by this perspective that I think everyone should know this. No matter from which background you are or what you do, you are going to deal with money. It's just a matter of time.
So that is it from my side, see ya.
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