When most people classify their assets and liabilities, they include all their possessions in their asset category and any debts in their liabilities. This might technically be correct from an accounting standpoint. However, unless you are planning on selling everything you have tomorrow, I don’t think this is helpful from a personal finance perspective. Many of your possessions are a weight on your financial situation. Rather than considering everything you own an asset, consider things that cost you money while you own them as a liabilities. On the flip side, anything that earns or saves you money during its lifetime is an asset.
The purpose of doing this is to clarify what purchases help and what purchases hurt your financial situation. Increasing your assets and reducing your liabilities frees up your budget and improves your financial stability and security. The diagram below is one way to picture your budget. Your assets and income should outweigh your liabilities and expenses. The lighter you keep your liabilities and expenses, the more your finances are able to absorb an unexpected expense or drop in income.
Some liabilities are obvious. Debt is a liability because the payments you have to make on it are a weight on your budget. Classifying possessions as liabilities is a little harder, however. The money you spent on them will make you want to throw them in the asset column. However, most possessions continue to cost us over their life time, making them liabilities.
Cars are one of the best examples of this. Even if you buy your car with cash, your car means you owe an ongoing insurance premium, maintenance, gas expenses, depreciation and licensing expenses. And if you’ve financed it, it also has an interest expense. However most of us would have a hard time counting our cars as liabilities. It’s true that in many cases, you won’t be able to completely eliminate owning a car, but you can reduce how much of a liability your car is. When you’re in the market for a car, be conscious of how much a new car will cost you in each category. And if you have multiple cars, consider eliminating one.
These considerations should not be exclusive to car buying, but rather become second nature for all purchases (and freebies). Get in the habit of recognizing what something will cost you not only up front, but also in the long term.
Assets are typically easier to identify. Any investments you have are assets because of current or future income that they provide. Rental properties would likely fall under investments, and under assets, assuming that the rent that you are collecting is covering the costs of owning and maintaining the property.
If you own a home, it has some characteristics of both an asset and a liability. On one hand, you owe property taxes and insurance premiums because of your house. Your house also incurs maintenance and utility costs. As long as you have a mortgage, your house is also costing you interest. On the other hand, owning a house saves you rent expenses. If you want to determine whether your house is an asset or liability, tally up all the costs of owning your home and compare it to the costs of renting.
Homes typically start falling on the liability side of things when they start getting larger and more expensive than you need. The larger the home, the more maintenance you’ll need to do on it, and the more you pay in utilities. The more expensive the home, the more you’ll be paying in property tax and in mortgage interest.
Finding your Balance
Barring moving to the wilderness and living off the land, it is impossible to completely eliminate liabilities. Furthermore, you may decide that certain liabilities are worth it for the non-monetary benefits they provide. Don’t drive yourself crazy purging every liability from your life and accumulating assets until you die a miserly scrooge. However, simply get in the habit of considering the true cost of things and making more informed decisions. You might realize that the perpetual cost of something far outweighs the benefits it provides. Recognizing this before you make the purchase may save you lots of headache down the road. And when your budget feels a little too tight, take an honest look at your liabilities and consider getting rid of some.
While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.