I hope the title of this post didn’t resurrect nightmares from accounting classes. And I’ll try to keep this post from being as boring as said classes. However, understanding your assets and liabilities is critical to your overall financial plan.
Reframing how you view Assets and Liabilities
If most people were to tally up their assets and liabilities, they would include all their possessions in their asset category. Unless you are planning on selling everything you have tomorrow, I don’t think this is helpful from a personal finance standpoint. Rather, consider anything that costs you money while you own it as a liability. Anything that earns or saves you money during its lifetime is an asset. Increasing your assets and reducing your liabilities frees up your budget and improves your financial stability and security.
The diagram above 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. Any debt is a liability because of the payments you have to make on it. Classifying possessions as liabilities is a little harder, however. You might have an emotional attachment to possessions. Possessions have cash value, so you’ll be tempted to throw them in the asset column. However, most possessions cost us quite a bit over their life time.
Your car, for example, comes with an insurance premium, maintenance, gas expenses, depreciation and licensing expenses. And if you’ve financed it, it also has an interest expense. In most 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. If you have multiple cars, you can also consider eliminating one. These considerations should not be exclusive to car buying, but rather become second nature to you whenever you are considering any purchase or acquisition. Get in the habit of recognizing what something will cost you not only up front, but also in the long term.
Assets are typically much easier to identify. Any investments you have are assets because of the 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 your own house, 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 utilities are going to cost. The more expensive the home, the more you’ll be paying in property tax and in mortgage interest, not to mention in the purchase price.
Finding your Balance
Barring moving to the wilderness and living off the land, it is impossible to eliminate all your liabilities. Furthermore, you may decide that certain un-necessary liabilities are worth it to you 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, considering the true cost of things helps you make more informed decisions. You might realize that the perpetual cost of something far outweighs the benefits it provides. And when your budget feels a little too tight, remember that you might have more liabilities than you initially thought.
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.