As Darlene pointed out in the comments of my last post, assets add to your wealth while liabilities steal your wealth away. So, why is this at the heart of every intelligent investment decision? I believe it is because most people have a misconception of what the tangible difference is between the two. Assets, at some point or another, but preferably sooner, actually deposit more cash into your bank account than they take out. Liabilities require more cash to maintain than they provide. For example, according to a recent Gallup poll, most people in the United States believe that their house is their greatest asset. In fact, from an investment standpoint, you don’t stand to make much money, if any, after you account for interest on your mortgage, and repairs and maintenance to the house and property. Does that make home ownership a bad idea? Probably not, but that also doesn’t mean it is an asset that is putting money into your pocket.
The point is that many Americans have precious few assets that provide any reliable wealth appreciation or income and maintain a heavy amount of liabilities. The U.S. Census Bureau keeps a somewhat up-to-date database on who owns what in the United States. A little research reveals that a massive portion of the United States population has more liabilities than assets and the picture gets worse when you leave equity in the home out of the equation. This article by the Motley Fool does an excellent job pointing out just how much of our net worth on average is tied up in housing.
The real problem is that so few people own any interest in stocks or bonds, and if they do, they are likely investing through a mutual fund that is eating them alive in fees. But to really understand just how bad you are getting taken advantage of by your “trusted” financial adviser you have to understand the power of compound interest (The topic of my next post). The Federal Reserve notes in one publication (page 16) that approximately 15% of Americans own individual stocks and bonds. I’ll let you guess where that 15% lands in their net worth percentile ranking.
So, what is the difference between someone who can escape the rat race and someone who can’t? Well I’m not entirely certain, but a big factor is having much more of your money tied up in assets (the real kind that actually return money to you) and much less debt owed to others that you have to pay out every month.
If you are interested in really improving your net worth situation and beginning to live a financially worry free life, I would implore you to start focusing on how you can spend less and save more. the fact is that you can’t start making investments, or paying off debt, until you have the free cash flow to do so. It is that free cash flow that allows you to tip the balance of debt-to-equity in your personal finances.
Question: What effective ways have you found to lower your expenses and save money?