The Difference Between an Asset and a Liability – Personal Finance

By | October 1, 2014

The key to wealth accumulation is knowing the difference between an asset and a liability. If you know this difference, you can identify all the things that are making you poorer every month so that you can decrease it while focusing on things that will make you richer.

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So what is an asset? An asset is something that has economic value that can be owned or controlled to produce value. Assets make the owner richer over time, and many types of assets produce cash flow periodically. Examples of assets include stocks, bonds, CDs, rental property, patents, intellectual property, or a trademark. Anything that makes you richer every month is an asset while anything that makes you poorer is a liability. Using this definition, any asset that is losing you money turns into a liability and conversely, any liability that makes you money turns into an asset.

Examples of assets include stocks, bonds, certificates of deposit, rental properties, businesses, patents, and intellectual property. For stocks, you can profit in two ways: capital appreciation and income. First you can own shares of a stock and profit by selling it later at a higher price, (capital gains). For many shareholders, you also receive a dividend for just owning the stock (income). Bonds and CD’s are sources of income and you receive interest for lending out your money. For rental properties and businesses, you receive income from you tenants or your customers. The key to this is to make these operations passive, thus not requiring your physical presence for these assets to function, or you find yourself with another job. For other assets such as patents and intellectual property, you receive income from other people using your assets. I think this is one of the most powerful examples of an asset.

Liabilities put a drain on your cash as you are required to pay periodically. Say you have a nice brand new car, a big house, and credit card debt. All those things are liabilities as car payments, mortgage, and credit card bills require monthly payments and put a drain on your finances. The key is to minimize your liabilities and maximize your assets. Order is key so first invest your money in assets, and when you are rich enough then load up on liabilities that suit your lifestyle. Often times though, people do the opposite.

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