Editors Note – this article is part of our series “Best financial advice I’ve ever received.” People frequently ask bankers the best piece of advice they have ever gotten. So for this series, we’re asking MidWestOne employees to share the best money management tips they’ve ever gotten.
One of the most important things to remember when it comes to personal finance is to:
Know the difference between an asset and a liability.
Assets create income, while liabilities create expenses. In order to cultivate financial security, you need to invest your money in true assets and not liabilities.
Many people think they are buying assets, when in actuality they are buying liabilities. Let’s take a closer look at the differences.
What is an asset?
Simply stated, an asset is an economic resource. It is something of value that generates passive income and can be converted into cash. Examples include cash, stocks, bonds, real estate or business inventory.
From an accounting perspective, assets are often divided into four categories: current assets (such as cash), long-term assets (like real estate), deferred assets (such as insurance) and intangible assets (for example trademarks or patents.)
What is a liability?
At its simplest, a liability is something you are responsible for. A liability has an assigned monetary value that you are obligated to repay in the future. Examples include loans, accounts payable, mortgages, deferred revenues and accrued expenses.
If you invest money in liabilities, you create more expenses in the long term. However, if you are investing money in assets, you create an income stream. It can take some discipline to adopt this mindset. Here are some tips to get you started.
When you are considering a purchase or investment, make sure you evaluate the long-term effects of that purchase. Will the investment cost you more money in the future? Or will you receive a return on your investment. Don’t be tempted to make a purchase that may be attractive in the short term if you don’t reap any benefits in the long term.
Distinguish between wants and needs.
Adapting the assets vs. liabilities mindset can be as simple as saving money as opposed to spending it. Before you make a purchase, determine whether the item is a “need” or a “want.” If it’s an item that you don’t actually need, consider saving the money instead. In doing so, you just created an asset, as well as the ability to act on other investment opportunities as you identify them.
Keep an eye on the big picture.
It’s likely you are not going to be able to avoid spending some money on liabilities (such as car loans or a mortgage). However, make sure you keep an eye on your balance sheet to ensure your liabilities don’t outweigh your assets. Otherwise you might fall into a dangerous cycle where the maintenance, upkeep and expense of your liabilities will eliminate your financial security.
Building prosperity is a long process that takes restraint and patience. Adapting the assets vs. liabilities mindset will help you develop the self discipline needed to achieve financial independence.