To evaluate any business proposal or a company, we always subtract its liabilities from assets and if the residue is positive, we term it as an income-generating proposal or company. Similarly, if we have to evaluate our financial health, the residue must be positive. For that to happen, our assets must outnumber our liabilities, which later on will create wealth for the future. However, the definition of assets can be confusing. Hence, it is important to categorise generalised assets as tangible or intangible.
An asset can be an item whose value keeps changing but in an appreciable manner. This point is predominant because every economy suffers from inflation, thus reducing the value of money. Therefore, an item whose exchange value keeps on rising can help us maintain our purchasing power and achieve financial growth.
What are assets
Shares/mutual fund: Prices of stocks, shares or practically anything related to the stock market is ever-changing. Although numerous factors may decide the stock market, it is fair to say that stocks or shares have made many people wealthy. This asset creates income in the form of a dividend, increment via bonus shares, and if the stock is performing well, it creates value appreciation.
Bonds/Fixed Deposit: The type of asset which generates guaranteed returns and is a safe investment option. Government securities, corporate bonds, and bank fixed deposits are some of the examples that not only mitigate the risk of the stock market but also share acceptable returns. This has a positive impact on your wealth creation.
Real Estate: Some of us might be confused as to how real estate can positively impact one’s net worth. The reason is its predominant nature of appreciation along with its capacity to generate income via rent. There are multiple options such as direct investment in commercial or residential property or one may even consider REIT that requires limited cash outflow.
Cash at the bank: Since holding liquid cash can be unsafe, we are considering cash at the bank. The most liquid asset on the list, cash can help you at any time. Although it may not be profitable to stack money in the bank account, it may be wise to create an emergency fund.
What are liabilities
Car: 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, it is important to note that it is one of the money-leaking items. It includes unavoidable expenses such as maintenance, insurance cost, repairs, car loan, etc. Even after completing the tenure of a car loan, the item may be added to your assets but still, it will be termed as a depreciating asset.
Housing loan: Even though real estate is covered in the assets column, it may not be worth it if you are buying it while incurring huge debts. Usually, a housing loan term ranges from 15 to 30 years. For example, Rs 50 Lakh housing loan at a 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 is a part of assets as well as liabilities. Thus, unless the debt is fully paid off, real estate remains part of the liabilities.
Credit card debt: Costliest among all the liabilities is credit card debt. However, it can be avoided if planned properly. Credit card interest rates are among the highest among its peers. Hence, any part payment or late payment attracts huge interest amounts. Full and timely payment are the only two options to avoid credit card interest.
Why to buy assets over liabilities
Appreciation: The most obvious reason, which helps in not only rising your net worth but also keeping you inflation-proof.
Compounding: One of the significant reasons why assets beat 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 that 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 help you stop these leakages and add-ons to your income.
Although some liabilities are inevitable, wealth building occurs only when your assets grow strong. Therefore, keep the liabilities minimum and buy assets for a happy future.
(Viral Bhatt is the Founder of Money Mantra — a personal finance solutions firm)