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CASHFLOW SERIES PART 2 – LIABILITIES
Welcome back!
Hopefully you have already learned about assets through Part 1 of this series! If not, head on over there and brief through the information before continuing.
As a quick reminder, this CashFlow Series is broken down into three parts:
- You have learned about assets and the different types. You know understand what types of items are considered an asset, and why.
- You’re here! In this article we are exploring what liabilities are, why you must understand the difference between a liability and an asset, and how it is involved with cashflow.
- In this article we merge the two categories and delve into how much of assets and liabilities you need, and how it relates to money management and cashflow overall! [COMING SOON]
Like budgeting, understanding cashflow is a foundational topic you need a grasp of before diving into serious investing or passive income.
First, you must overcome the hurdle of budgeting. It takes a few months of serious tracking to fully understand where your money goes and how much you truly spend. It also takes some trial and error to realize how much you can save, how long it will take to pay off all your debt, and to reach financial freedom.
It is a journey, and not a quick one for sure.
However, once you have your grasp on basic money management, you’ll start hearing radical stories of people getting out of debt by selling their cars or even their home.
Can you imagine!?
Debt, especially student loan debt is hard to escape from. It starts with [behavior modification], determination to understand your personal finances, and grit to make it to the end.
But, why sell your “biggest asset”, your home, to become debt free? We’ll explore this within this article!
By understanding the difference between an asset and a liability, you’ll start realizing how you are losing money, and discover how to reach financial independence even faster.
What is a Liability, Anyway?
A liability is something you buy that will not earn you money later on.
Some examples include:
- Cars
- Your home/Mortgages
- Student debt
- Credit card debt
- Boats and RV’s
Cars
As with homes, cars are a touchy subject. Some people love their cars so much and could never think of them as negative. However, for the sake of understanding, it is a liability.
Let’s consider purchasing a $30,000 car vs. a $7,000 car. Which would have a higher loan amount? The answer is obvious. Which would you be paying more for each month? Again, the answer is the $30,000 car.
The loan is the liability. Debt in any form is money you owe, and thus, a liability. The car technically starts as an asset then is depreciates. The loan will forever be a liability!
After you pay off your less expensive car, you still have insurance to pay, and maintenance to spend for it. You must continually pay for gas for it to work. When you eventually sell the car, you may get less than a quarter of what you initially paid for it, not including any extra expenses it took to keep it running!
After 10+ years, your used car may not be worth even selling!
Cars are expensive, but for so many Americans, it is a requirement to own! Especially if you have children, live in the suburbs, or more sparse areas like the Midwest.
For the average individual, cars lose value. You most likely do not own an antique car that could be sold later on for more money.
For many, it would be significantly smarter to own a less expensive car when working toward financial freedom. Yes, many sell their car to get that extra few thousand to pay off credit cards. For some, it is only logical to become a 1-car household for a period of time.
Selling your car to pay off debt would be very difficult, but I know of one couple who did it after going through a Dave Ramsey course, and it drastically changed their behavior around money.
Imagine the money each month you could save and put toward debt or investments if you had to pay less on a car…
The best part: After properly budgeting and saving, you could purchase your next vehicle in cash and not have to worry about a car loan!
RELATED ARTICLES!
Your Home (Mortgage)
For more information regarding this topic, we highly recommend reading Rich Dad Poor Dad!
You probably have heard this one since you were young: Your home is your biggest asset.
However, I’d like you to challenge what you’ve been taught to better understand why it is considered a liability instead!
As with cars, technically a house is an asset if you don’t owe anything on it. If you could buy an inexpensive home and then flip it and earn money from it, then it is an asset! If you use Airbnb to rent rooms, or own a home that is a rental property, you can consider them assets!
Your ordinary family home…is indeed a liability.
Why?
Very, very few people purchase their homes with cash. Obviously, people who are in debt don’t typically carry around over $100,000 in their bank. It is just common to have a mortgage on your home!
However, there is the argument that homes can go up in value with inflation and when economic areas increase in value.
Consider this:
- How much money do you put into your home for outdoor upkeep? This includes lawn care and service, painting, cement fixes, plants, trees, and flowers, and windows.
- How much money do you spend on electric, water, gas, etc.?
- How much money have you put toward renovations, furniture, indoor painting, flooring, and decorations?
If you’ve owned your home for a while, it is probably impossible to put an exact number to these questions.
Now, consider this:
- Since owning your home (or, think about your parent’s home), how much money has been brought in to make up for those expenses?
The answer is most likely very little or none.
Even if you get more money when selling the home than the purchase price, you can thank inflation for part of that. The dollar continues to be worth less, and thus is costs more to buy the same property. Is your home really “worth” more 10 years later, or has it just been following with inflation?
So, Now What?
Remember, the idea of a liability is that it takes money from you, rather than gives you money.
Debt, the most obvious form of liabilities never will give you back money. Whether it is credit card debt or student debt, it is simply you having to pay someone back for what you borrowed.
This is why it is so important to rid of as many liabilities as you can!
To start, you can try a snowball method as Dave Ramsey teaches in his book, Total Money Makeover.
This method will help you to get rid of the smaller debts and work toward the larger debts such as student loans or your home mortgage.
This is why you want to own as many assets as possible! Especially passive income assets.
Imagine paying less bills and earning more. It is definitely greener on the other side, the challenge is figuring out how to do it.
We will explore cash flow and the balance of liabilities and assets in Part 3 of the CashFlow Series. STAY TUNED!
Okay, Let’s Summarize!
- An asset is something you own that will take money from you and not make you money in the future.
- Some common assets include: credit card and student loan debt, homes, boats, and RV’s
- A car depreciates in value fast and quickly becomes a liability.
- A home is commonly referenced as an asset, but there are many reasons why it is actually a liability!
Thanks for reading! Let’s head on over to Part 3 and learn about how assets and liabilities fit together into cashflow!
You’ve made it this far, let’s keep learning!
ThirtyEight
ThirtyEight Investing is in no way affiliated with any possible companies expressed in this article. All advice and opinions provided in this post are reflections on experience and are honest to help readers make appropriate decisions on their path to investing.
