How To Turn A Liability Into An Asset
My rich dad believed that people struggled financially because they make decisions handed down from parent to child, and most people don’t come from financially sound families.
He often said that most bad financial advice was handed out at home, which is one reason I am an advocate for financial education in the home.
Of course, for most people, while financial advice starts in the home with old rules like go to school, get a good job, save your money, buy a house, and invest for the long term in a diverse portfolio of stocks, bonds, and mutual funds…it doesn’t end there.
Many people also take bad advice their parents give them and compound it with bad advice from financial advisors as they get older.
Many financial advisors will tell you that your house is an asset, but that is untrue. As such, this financial advice becomes a liability because it causes you to make bad assumptions and decisions about your personal wealth and your financial future.
The “Your House is an Asset” Myth
A cultural right of passage is buying your own home. Many people dream of the day when they get the keys to their own front door, imagining the joy that will come with the monumental achievement of taking on hundreds of thousands of dollars in personal debt.
The reality is that many people desire to buy a home because they think of it as a good investment. In terms of a financial statement, they think of their house as an asset. Because of this, in many cases, homeowners expect their house to be a big part of their retirement plan.
The problem is the majority of people who buy houses do so as a primary residence, not as a rental property. So let’s break down what that looks like financially.
On a given month for your personal residence, you need to pay for your mortgage, utilities, maintenance, taxes, insurance, and possibly more. Sometimes these can turn out to be huge costs, for instance, if you need to replace a roof or your main plumbing line collapses.
All of these are things that take money out of your pocket. And as rich dad taught, a liability is something that takes money out of your pocket.
Many so-called experts will point to things like paying down principle, tax breaks from mortgage interest, and appreciation as reasons why the house is an asset.
But paying down principal is simply saving, and savers are losers. The tax breaks for your mortgage do not offset the costs that go out of your pocket each month, and if you’re banking on appreciation, you’re basically gambling, as homeowners in the Great Recession painfully discovered.
This is not to say you shouldn’t buy a house—Kim and I own three houses. I’m simply trying to help you see that it is not an asset. Rather it is your home and should be enjoyed for that, not as your ticket to a secure retirement. Look elsewhere for that.
Truth sets people free, and the truth that your home is not an asset but instead a liability is one of the most important truths you can know.
Understand Where The Cash Is Flowing
One of the reasons why so many people wind up poor at the end of their working lives is simply because they failed to acquire many real assets. For those of you who have read Rich Dad Poor Dad, you already know rich dad’s different definitions of assets and liabilities.
Simply stated, “Assets put money in your pocket and liabilities take money from your pocket.”
The reality that most people think their house is an asset proves most people do not know the difference between their assets and a hole in the ground. It also reflects how poor financial education in our schools is.
To make matters worse, if a person truly understood the relationship between expenses, assets, and liabilities, that person would know that their retirement plan is really a liability, not an asset.
All a person needs to do is look at where the cash is flowing. In most cases with people saving for retirement, the cash is flowing out of their pocket, not into their pocket. In true financial terms, people who are feeding their retirement plan are really feeding an under-funded liability. If and when that retirement plan begins to put money into the person’s pocket, then and only then does that liability become an asset.
Turning a Liability Into An Asset
My friend and publicist, Mona, and her husband had always wanted to own a cabin in the mountains of Arizona.
When the summer heat hits Phoenix, the mountains offer cool relief. They looked at various mountain towns and available properties and came upon a small cabin that would be a “cool” getaway.
They never liked the idea of taking on a mortgage that they had to pay for and, in their research, they found there was a shortage of rental properties in the area. They weren’t the only ones in Phoenix looking for an escape from the heat! Problem solved.
All they needed to do was put a lock on a closet in the cabin that became the “owners closet” where they could lock up their personal items, and they were in the vacation rental business.
Mona and her husband took a property that was a liability—a mortgage that they had to pay—and turned it into an income-producing asset.
Now, Mona can escape the heat while enjoying all the benefits of real estate ownership like tax advantages, cash flow, leverage of OPM, and control.
Why The Rich Are Getting Richer
One of the reasons the rich are getting richer is simply because they know how to use debt to acquire assets, assets that put money into their pocket. They also know how to turn debt into an asset. It takes a higher financial IQ to be able to do this.
Instead of learning how to use debt, the poor and middle-class work and try to save as much money, either in a bank or in their retirement accounts, often stuffed with mutual funds.
Why do they do this?
While there are many reasons, one reason is that it is easy to do. You don’t have to think too hard, you don’t have to study, and you don’t have to work too hard. Just go to work, pay your bills, and if you have any extra money, all you have to do is turn your money over to a total stranger, someone who claims to be an investment expert.
Instead of getting ahead, many people today are working harder, some holding down two and three jobs, but working for the wrong kind of income—earned income. When they get into trouble, they may borrow against the equity in their home (if they have a home) or get a new credit card that appears in the mail.
On a macro-economic scale, not only are blue-collar jobs going overseas, so are white-collar jobs, the jobs of those who went to college. Today, college-educated, white-collar workers in developing nations are competing with white-collar workers in the U.S. Japan, and Europe.
So it is tough to get ahead simply by going back to school, working harder, saving money, and getting out of debt. And that is why today, the U.S. is facing a financial crisis simply because so many millions of people, even college-educated people, do not have enough money to live on once they retire.
The world is filled with assets. Anything—be it a business, a piece of real estate, an oil well, a gas station, a stock, a bond, an insurance policy, a retail store, an airport, or a taxi cab—can be an asset. Cash is always flowing. That is why the saying goes, “Money makes the world go around.”
In order to be rich, all you need to do is find an asset that flows money into your pocket, not out of your pocket.
Editor, Rich Dad Poor Dad Daily