Pull up a chair, friend, and let me draw on the back of our virtual napkin. Since this is a blog about money, we’d better dive right in to the good stuff, right? Consider something for me: Lebron James if rich. But, the guy who writes Lebron James’ paycheck is probably wealthy. Who would you rather be?
Notice, I have absolutely no idea who “the guy who writes Lebron James’ paycheck” is.
Wealth is easily one of the most misunderstood topics in personal finance because most people invest more time analyzing their underpants than analyzing their default accounting decisions. Just so you know, you’re constantly making accounting decisions even if you’re perhaps only dimly aware of it.
The Whole of Accounting in 2 Paragraphs:
I’m going to throw it atcha: Assets = Liabilities + Stockholder’s Equity. That’s right, I went there. Master this basic concept and keep it always present in your mind, and you’ll be on your way toward building real wealth. (And to think, the average salary of a CPA is in the $60k – $85k neighborhood. You’re welcome.)
In our equation, we’ll use “stockholder’s equity” as a synonym for wealth — for now. Since Assets – Liabilities = Wealth (please don’t notify the GAAP police), there are two very basic methods to achieving financial independence:
- Maximize Assets
- Minimize Liabilities
But, wait — not so fast. Fist we have to deconstruct what both of these things really mean, and not what you necessarily think they mean. The term “asset” is generally used incorrectly when speaking to amateurs and even many professional money managers. Assets are a very narrow class of finance, in fact.
What are assets?
Investopedia.com defines it like this:
In personal finance, current assets are all assets that a person can readily convert to cash to pay outstanding debts and cover liabilities without having to sell fixed assets.
Blah, blah, blah. I’ll say that assets are something that repeatedly put cheddar in your back pocket — without you being there. So, by either definition – is your car an asset? No.
Is a motorcycle an asset? No.
Is your home of residence an asset? No’
Is your JOB an asset? Absolutely not.
We could keep going, but do you get the picture? What most people as well as most BANKS consider assets on your personal balance sheet or statement of net worth are not really assets! The reason a bank would call your home is an asset, is because it’s something that puts cheddar in THEIR back pocket.
Securitizing a piece of property with the intent to collect interest is a fantastic way to generate wealth, so long as you’re the one doing the collecting. Bottom line: don’t let it happen to you!
Here’s a big, bold statement that many people either forget, don’t understand, or don’t want to understand. Are you ready?
SECRET #3: INCOME IS NOT AN ASSET!
Income is something that you use to pay expenses in the pursuit of maximizing asset growth, but very few items are true assets. Here are a few:
- income producing real estate
- real estate investment trust
- personal, profitable business
What are liabilities?
Most likely, you’re much more well-versed in the topic of liabilities because Americans LOOOOOVE them some liabilities. Back to our buddies at Investopedia:
Essentially, these are bills that are due to creditors and suppliers within a short period of time. Normally, companies withdraw or cash current assets in order to pay their current liabilities.
I’ll call a liability anything that costs you money. This is not to say that there is no value in the expenditure — there are many things that must be purchased in order to function within a modern economy. However, I’ll submit that we are generally addicted to liabilities that make absolutely no sense and have absolutely no hope of returning let alone retaining a single dime.
And why not? Liabilities are very easy to understand (sign here….). There are countless ways to spend your precious income, yet virtually no outlets to appreciate the impact magnitude of wasting your money. This is a consumption based economy. Yeah – surprise. What you choose to consume will either nourish you or make you sick and poor. This is the spectrum of our daily decision-making.
Temptation and Distraction are the Assasins of Wealth
Temptation and Distraction are everywhere. Just today, I have already passed on 6 opportunties to spend money, and I have a very structured lifestyle that is engineered to avoid temptation and distraction. The way I see it is that we can either choose the long, boring route of methodically devising a strategy and accumulating assets that lead to financial independence… OR, we can start practicing our free throws, hoping to land a NBA contract.
Truth is, you don’t need this lesson. You already know all this, right? What you need is perhaps a compelling reason to maximize your wealth creation or a nice, wholesome kick in the ass.
I can do both.