Yesterday, I wrote about an individual’s desire to be like everyone else and buy expensive assets because other people buy them.

An underlying point in that post that I left out is that most, if not all, of those assets–the HDTV’s, the luxury cars, the stereo systems, the swimming pools–are horrible investments.  They aren’t “assets” at all.  Instead, they are fake “assets.”  Better yet, they are liabilities.  (Robert Kiyosaki likes to call them “doodads.”) 

Liabilities, Not Assets

They are liabilities because they take money out of your pocket.  If you look at a balance sheet, your debts and expenses–the items that take money out of your pocket–are listed under “liabilities.”  When you subtract the value of these items from your assets, you subtract value from your net worth.  (In accounting, assets - liabilities = net worth.)

Let’s apply this concept to one of those luxury purchases.

If you walk into Circuit City and buy a widescreen TV, what have you done exactly?  You certainly bought a great viewing experience.  But how did you pay for it?  You did one of three things: (1) you paid cash for it (unlikely); (2) you financed it through the store’s financing plan (likely); or (3) you put it on your credit card (likely).  The large majority of people use methods (2) and (3) to pay for such items.  This method of payment allows you to buy the item now and pay for it later.  You pay for the item through a set number of future monthly payments with interest.  In other words, these monthly payments take money out of your pocket every month.  Thus, it is a liability, not an asset.

The same is even true if you were able to pay cash for it.  By doing so, you still sink $2,000+ into an “asset” that depreciates over time.  The minute you walk out of Circuit City with that TV, it loses value.  (The best example of depreciation is a car.  The moment you drive that car off the lot, it loses value.)  In six months, that TV will be worth only $1,500, not $2,000.  (If you don’t believe me, try selling it for $2,000 after six months.  Good luck.)  That depreciation subtracts value from your initial $2,000 investment.  Even if you owe nothing on that purchase (because you paid cash), the fact that it loses value over time subtracts from the asset’s value.  That, in turn, subtracts from your net worth.  In short, it takes money out of your pocket.  In that sense, it can be construed as a liability.

The same goes for cars, stereo systems, expensive gadgets, or any other item that you finance or that depreciates in value over time.  These items truly belong in the liability column of your balance sheet.

Real Assets    

Unlike these fake assets, a real asset puts money in your pocket.  Obviously, a car, a TV, and a swimming pool do not put anything in your pocket other than more bills.  On the other hands, rent from a real estate investment, dividends from a stock, capital gains, distribution from a business, and interest from an investment put money in your pocket on a regular basis.  These items are real assets that do not take anything out of your pocket and, thus, do not subtract from your net worth.  

What You Should Do

I need to make clear that I am not saying that we should refrain from buying anything that doesn’t produce income for us.  We obviously have fundamental purchases we need to make, such as groceries, utilities, hardware needs, repairs, etc.  What I am advocating, however, is that we refrain from buying expensive items we can’t afford.  If you can’t pay cash for something, don’t buy it!  Instead, the best approach to take is to make that expensive item–that HDTV, that luxury car, that swimming pool–a motivation for acquiring an asset that produces income.  In other words, that luxury item should represent the motivation for developing some stream of passive income that, when that income accumulates, can pay for that luxury item. 

If I want a new 50-inch widescreen plasma TV that I can’t afford with cash, I should tape a picture of that TV on my wall, and I should use it as motivation for developing some source of passive income that I can rely on for buying that TV.  Perhaps, I should start an online business whose revenue I can use to buy that TV.  Maybe I can invest in silver or oil stocks and use the gains from those investments to buy that TV.  The point is that, instead of not buying these expensive assets altogether, I should use them as motivation for achieving some form of financial independence.  And that independence should, in turn, help me buy those coveted items.

Instead of buying assets that do not produce income and end up being liabilities, invest your money in assets that produce income that, in turn, can help you buy those expensive, luxury items. 

If you like this post, please consider subscribing to my RSS feed.

If you like this post, please bookmark it: These icons link to social bookmarking sites where readers can share and discover new web pages.
  • del.icio.us
  • StumbleUpon
  • Propeller
  • Digg
  • Technorati
  • Reddit