To evaluate any business proposal or a Company per se, we always subtract its liabilities from its assets and if the residue is positive, we term it as an income generating proposal or company. On similar note, if we have to evaluate our own financial health, the residue must be positive. So for the residue to be positive our assets must outnumber our liabilities, which later on will create wealth for future. However, many of us can be confused with the definition of assets, so to generalise assets are tangible or intangible items which posses certain amount of exchange value (which exceeds its cost price). Let us explain assets more specifically.
Assets: An asset can be such item whose value keeps on changing but in an appreciable manner. The point of appreciable manner is predominant because every economy suffers from inflation, thus reducing the value of money, therefore if such item whose exchange value keeps on rising can always help us maintain our purchasing power and thereby achieving financial growth aka wealth. An asset always positively impacts our net worth and thereby making the case of positive residue strong. However, each of our expensive purchases are not assets, so let us check out what contributes towards assets.
Shares/mutual fund: Prices of stocks, shares or practically anything related to stock market is ever changing. Although there are numerous factors which may decide the stock market, it is fair to say that stocks or shares have made wealth for many people. This asset creates income in the form of dividend, increment via bonus shares and most importantly if the stock is performing well creates value appreciation. History suggest investment in stocks have provided abundant returns, however this statement must also be read with a pinch of salt because of certain risk which every stock market possesses.
Bonds/Fixed Deposit: Type of asset which generates almost guaranteed returns and also keeps your investment in safe hands. This may or may not give inflation beating returns but will certainly help in wealth creation. Government securities, corporate bonds, bank fixed deposits are some of the examples which not only mitigates the risk of stock market but also shares acceptable returns thereby giving positive impact on your net worth.
Real Estate: Some of us might be confused as to how a real estate can positively impact one’s net worth. The reason being its predominant nature of appreciation along with its capacity to generate income via rent. Real estate can be the safest assets unless you are investing in an unsafe country. There are multiple options such as direct investment in commercial or residential property or one may even consider the REIT option which requires limited cash outflow.
Cash at bank: Since holding liquid cash can be unsafe, we are considering cash at bank. The most liquid asset amongst the list, cash can help you anytime anywhere. Although it may not be profitable to stack money in the bank account, it may be wise to create an emergency fund to avail it in exigencies.
Let us check out what are liabilities
Car: Surprise! Surprise! Have you heard anyone telling they have sold their car higher than their purchase price, apparently not. Polar opposite to any assets, the price of your car starts depleting the moment you take it out of the showroom. Although a car can be termed as a necessity by some on account of family needs or office travels, it is important to note that it is one the money leaking item which includes unavoidable expenses such as maintenance, insurance cost, repairs if any let alone the interest cost of car loan. Even after completing the tenure of car loan, the item may be added to your assets but still it will be termed as depreciating asset.
Housing Loan: Even though real estate is covered in the assets column, it may not be worth it if your buying it while incurring huge debts. Usually, a housing loan term ranges above 15 years to maximum of 30 years. For example, a Rs. 50 lakhs housing loan at 7.5% annual interest rate, the buyer will end up paying more than Rs. 45 lakhs in interest, which is nearly the cost of purchasing the house. Ironically real estate forms part of assets as well as liabilities, thus unless and until the debt is fully paid off, real estate remain part of the liabilities.
Credit card debt: Costliest among all the liabilities is the credit card debt, however the same can be avoided if planned properly. Credit card interest rates are amongst the highest of its peers, thus any part payment or late payment attracts huge interest amounts. Full and timely payment are the only two options to avoid credit card interest and guess what it also positively impacts your credit score.
So why buy assets over liabilities
Appreciation: The most obvious reasons, which helps in not only rising your net worth but also keeping you inflation proof.
Compounding: One of the significant reasons why assets beats inflation and help you create wealth. It happens when the earnings from the assets are reinvested to create additional earnings.
Wealth creation: The ultimate objective which occurs on account of appreciation of assets and compounding of income generated through such assets.
Stop leakages of your income: Liabilities incur debts and debts incur leakages from your income. Buying assets helps you stop these leakages and in fact add ons to your income.
Although some liabilities are inevitable, but wealth building occurs only when your assets grow strong. Therefore keep the liabilities minimum and buy assets to see a happy future.
Viral Bhatt is the Founder of Money Mantra - a personal finance solutions firm.