When it comes to building wealth, there is one secret that stands apart from the crowd. That secret is to buy assets not liabilities! Although this advice may seem straightforward, it’s easy for your balance sheet to get out of whack.
Let’s explore the differences between assets and liabilities. Plus, dive into the reasons why you should buy assets not liabilities.
What’s an asset?
The U.S. Securities and Exchange Commission says that an asset is “any tangible or intangible item that has value in an exchange.”
Essentially, an asset is an item that holds value. An asset positively impacts your wealth-building by adding to your net worth, that's why it's important to buy assets not liabilities. Here’s a closer look at a few types of assets.
Stocks are individual pieces of a company that investors can buy for their investment portfolio. The stock of a company can hold value.
The final piece of value provided through stocks is the ability to sell them in exchange for monetary value.
Bonds are instruments of debt issued by governments and companies. As an investor, you can buy a bond to receive interest on the principal at the end of the bond’s term.
Real estate is a type of physical asset, and it's one of your best options when you want to buy assets not liabilities. When you purchase a property, the financial rewards can be two-fold.
If you choose to rent out the property, you can generate cash flow from your investment. Additionally, you can sell the property to capitalize on its growing value.
If you don’t want to commit to an entire property, you can invest in real estate through real estate investment trusts (REITs). Through a REIT, you can buy a share as an asset that has underlying value in its real estate investments.
And of course, cash falls firmly in the assets column. Although you cannot buy cash, you can choose to build up cash savings instead of spending the funds on liabilities.
Cash is the most liquid asset out there. You can tap into this value to cover costs whenever the need arises. But with this easy access, you miss out on the earning opportunities provided through investments.
Even still, it’s a good idea to keep a robust emergency fund on hand with enough cash to cover three to six months' worth of expenses.
What’s a liability?
An asset can earn you money. On the flip side, a liability can cost you money.
Although some liabilities are unavoidable, it’s ideal to focus your efforts on accumulating assets and limiting your liabilities. That's why you should buy assets not liabilities, or your finances can suffer.
Here’s a look at a few common liabilities:
Although you likely need a vehicle to manage your responsibilities, taking out a car loan puts your vehicle in the liabilities column.
The average monthly car payment when you get a new car is $648. Unfortunately, this will take a big bite out of any budget. If you have a high car payment, that’s money you cannot put towards saving or investing.
When you pay off the car loan, your car will turn into an asset. But it’s still a depreciating asset. That’s because vehicles lose value over time.
Of course, this doesn’t mean you should skip a vehicle to get around. But you might decide to pick a more affordable set of wheels.
When you take out a mortgage loan, you’ll sign up for a monthly payment for the duration of your loan term. Since many homebuyers take out a 30-year mortgage, the expense will likely sit in your budget for decades.
Ironically, real estate comes in the form of assets and liabilities. When you have a mortgage attached to your home, it’s a liability. When you pay off your mortgage, your home will truly become an asset.
Credit card debt
Debt of any kind is a liability, but credit card debt is one of the most significant liabilities. That’s because credit cards come with notoriously high interest rates. It could cost you thousands just to get out of debt.
If you have credit card debt in your budget, paying it down is a smart move. Although digging out of this debt is easier said than done, it’s possible. Here’s a full guide on getting out of credit card debt.
4 Reasons to buy assets not liabilities
So, why should you buy assets not liabilities? Here’s a look at how choosing assets can make a positive impact on your finances.
Appreciation is when the value of an asset grows.
For example, let’s say you buy a single-family home as a rental for $100,000. After 10 years, you’ve paid off the mortgage and the house is now worth $150,000. With that, you’ve seen an appreciation of $50,000.
Another example is when you buy a stock that increases in value. In either case, the appreciation will add to your net worth. When you buy assets not liabilities, appreciation can help your net worth soar.
Compounding is a process that can help you significantly grow your wealth over time. Essentially, compounding occurs when the interest earnings from an asset are reinvested to create additional earnings over time.
For example, let’s say that you invest $5,000. If you earn a 5% interest rate that compounds daily, the funds could grow to $8,243.32 in ten years. That’s without any extra effort on your part.
Explore the power of compounding by using a calculator to see how much your money will grow.
When an asset grows through either compounding or appreciation, your net worth will grow. That’s in sharp contrast to adding liabilities to your plate.
With liabilities, your net worth will shrink. When you choose to buy assets not liabilities, your net worth has a chance of increasing over time.
Building wealth looks different for everyone. But at the end of the day, you’ll want to increase your net worth.
Use our free calculator to find out where your net worth stands.
Avoid drains on your finances
When you buy assets not liabilities, you are avoiding any drains on your finances. Since liabilities cost you money, they can drain your finances with each and every paycheck.
Although some liabilities are unavoidable, limiting the presence of liabilities in your budget will pay off in the long term.
Buy assets not liabilities: A net worth battle
To calculate your net worth, you subtract the sum of your liabilities from the sum of your assets. So if you have $100,000 in assets and $20,000 in liabilities, then your net worth would be $80,000.
Every purchase you make comes in the form of assets and liabilities. As you buy assets, you can grow your net worth. When you buy liabilities, you may stall your net worth growth or even push it in the wrong direction.
The bottom line: Buy assets not liabilities!
If you want to build wealth, that starts with buying assets, not liabilities. Although some liabilities can be incredibly tempting, your future self will thank you if you stick to assets.