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Liabilities vs Assets and Breaking out of the Middle Class: a Response to Kiyosaki
🕑 Added 2020-03-13 18:40:01 +0000 UTCtl;dr: Things that make or save you money after you own them are called “assets.” Things that cost you money while you own them are called “liabilities.” The middle class tends to accumulate liabilities while the wealthy focus on accumulating assets. The ideal configuration is to have asset income that covers one’s liabilities and expenses. The focus of the middle class should shift toward accumulation of assets through the Pay-Yourself-First model to break into the upper class. See below for diagrams of cash flow among classes (keep in mind that the means of production will not seize themselves). This post takes inspiration from Robert Kiyosaki’s book, Rich Dad, Poor Dad.
This book should be required reading for every new investor: https://amzn.to/3c3ajxI
Why do I need to know about assets and liabilities?
You can trade stocks and options without knowing what an asset is versus a liability. However, assets are the key to lifelong and generational wealth, and they are easier to accumulate if you can identify them.
Loosely, their definitions are as follows:
Asset: Something that makes or saves you money once you have it.
Liability: Something that costs you money once you have it.
Some assets are easy to identify. Unless you invest like shit, your stocks, ETFs, patents, and annuities are all examples of assets. If you are lucky enough to own bonds that outpace inflation, those are also assets. Firearms in the US tend to be assets because they usually increase in value and are surprisingly liquid (stay strapped).
Some liabilities are also easy to identify. You dog is a liability. Loans are liabilities. Long-term contract expenses (like Comcast) can quickly become liabilities as soon as something cheaper opens up. US Steel stock is a liability (I'm kidding, but not really).
We also have income, like a salary, dividend, or social security. But these are not assets because the dollars you receive are not worth more than their face value. And, of course, we have expenses like food, clothes, and entertainment. These are not liabilities because you do not have to spend money on food after you buy it; it's just an expense that closes when you are done paying for it.
Above: a liability, so you'd better enjoy it.
Who is Kiyosaki and what does he have to say?
Robert Kiyosaki is the author of Rich Dad, Poor Dad. You should absolutely read this book. Kiyosaki describes assets versus liabilities and challenges some commonly held views. However, he stops short of drawing the line where something becomes an asset versus a liability. I wish to take his assessment further to describe when these common items act as liabilities versus assets.
Car: Cars are often cited as liabilities because they cost money in gas, insurance, and repairs. Sometimes, you have a car payment too. Kiyosaki agrees that a car is a liability. I generally agree with his point of view, but I want to present three caveats:
1) If you are lucky enough to have a collector's car that is increasing in value faster than the expense of keeping it running, then it is an asset;
2) Remember that saving you money can also make something an asset. If the alternative to driving is expensive ride-sharing or public transportation, and your car costs less than those things, then your car is an asset;
3) If you get a self-driving car in 2030 that drives Uber by itself, and that Uber income exceeds the cost of upkeep, you have an asset (being a regular Uber driver is just income since you are working for it).
Cash: We define "cash" as money in savings, not just actual cash in your wallet. Intuitively, cash is an asset because you earn interest on it. However, we must consider inflation. Most banks pay well under 0.5% interest. Meanwhile, inflation is around 2%. If you have a stack of cash in the bank, you are literally paying the bank to hold your money for you. Granted, you get FDIC insurance and have access to ATMs, but you lose money on cash every year inflation is positive. Therefore, except for the once-in-a-blue-moon deflationary period, cash is a liability because its buying power (its value) drops annually. You might be able to mitigate this by putting your money in a high-yield account like Ally, provided the interest rate is higher than inflation.
House: Commonly cited as an asset because real estate tends to increase in value, there are some expenses associated with home ownership that determine if yours is a liability or asset. Is your home value increasing faster than your mortgage interest, tax, upkeep, and insurance cost? If yes, then I agree your home is an asset. If your home equity is increasing by 1% annually but your mortgage rate is 4% and you're paying a bunch of bills and taxes, then your home is a liability. However, there is a caveat: you have to live somewhere. Assets make or save you money once you have it, so if the alternative to owning a home is renting and doing so would cost more than what you are losing on the house, then your house is an asset, just not an ideal one.
To live normally, you need to have SOME liabilities. You need a way to get around. You need a place to live, and a cardboard box won't get it done. Also, we tend to enjoy our liabilities more than our assets. You probably like playing with your dog more than your silverware collection that gathers dust. And even though some of us are degenerates who like playing options, most people don't "enjoy" day-trading SPY puts. Despite liabilities being more fun than assets, our goal should be to accumulate assets instead of liabilities.
What do assets and liabilities have to do with socioeconomic class?
This section is derived from the views of Robert Kiyosaki. It expands on his analysis and offers a new look at how money management habits keep people locked into socioeconomic classes, other factors not withstanding. It may appear callous, but it is my honest attempt to describe observations without passing judgments while reserving my desire to storm mansions.
The Lower Class:
The lower class likely has income from a job and from some sort of assistance, whether SNAP benefits or Earned Income Tax Credits. The people in the lower class typically do not have many assets, if any, and are generally priced out of material liabilities. What income is left over goes to savings, which loses money to inflation.
The Middle Class:
The middle class has a level of income that exceeds the threshold for most public assistance like SNAP, but still qualifies for FICA loans, etc. People in the middle class prioritize accumulation of liabilities that they may mistake for assets, such as an expensive car. When people in the middle class acquire more income, the excess goes toward more expensive liabilities; this is why much of the middle class lives paycheck-to-paycheck regardless of salary. The middle class tends to purchase some assets, but they are mostly passive 401(K)s and IRAs that have relatively low caps and are inaccessible until retirement. The middle class saves large amounts of income in cash despite having debt on liabilities and in spite of inflation risk.
The Upper Class:
The upper class has income from employment and appreciable income from assets, whether they be annuities, dividend, rental property, or something else. The rich prioritize accumulation of additional assets with the Pay-Yourself-First (PYF) model (discussed later) and then pay their expenses. They use the remainder for liabilities they can afford (because why be rich if you act poor?). The upper class focuses on asset accumulation rather than liability accumulation, which is why the upper class tends to grow more wealthy over time while the middle class does not. The upper class maintains an emergency savings fund in cash, but does not overfund it due to inflation risk.
The Rich:
The rich have enough assets that they no longer require normal employment income. Income from assets follows the PYF model and is used to acquire additional assets, and the remainder covers their expenses and liabilities. Since the rich maintain an emergency cash fund, they no longer need to make additional contributions to it and instead redirect the remainder of their income into additional assets. This is obviously the ideal configuration and ensures the rich stay rich until a spoiled heir blows the family fortune and goes to jail for securities fraud.
How do we advance? Pay Yourself First.
Utilizing the Pay-Yourself-First (PYF) model is the best way I know to accumulate assets without feeling the crunch of reduced spending money. The PYF model describes establishing a dollar value, within one's budget, and setting it aside each pay-period to go straight toward accumulation of assets. While most people (especially the middle class) tend to spend first and invest the remainder, the PYF model preaches the opposite by forcing you to invest first and spend the remainder. In this way, it takes a page out of the Rich's playbook. Don't think you can afford to put money away? Take money off the top of your paycheck, instead of the bottom, and you will surprise yourself.
1) To get from the lower class to the middle class, I cannot give the best advice because I was born into a middle class family and so cannot assess firsthand. My best advice is that one seek the maximum value they are eligible to attain from government assistance, minimize expenses, and seek opportunities to increase income through job training. There are also some money-making opportunities like selling blood plasma that can cover expenses. Obviously, these are easier to pursue when the individual has the free time to do these things. People in the lower class should seek to set aside an adequate emergency fund and then begin using the Pay-Yourself-First model to accumulate assets, however meager. This will discourage purchases of liabilities and eventually compound. But again, I was privileged enough to be born in the middle class and so cannot speak from experience on how to get out of poverty.
EDIT: According to DarkHorseNeigh, who does have personal experience in going from lower to middle class, the keys to advancing are income and education, with military service being an opportunity that affords both.
Income: DarkHorseNeigh recognizes that income among the lower class has less buying power than it does for the upper classes. For example, while the upper class can buy quality, dividend-paying stocks, that is likely out of reach for the lower class, who will likely dine on ACB and F. Likewise, being poor charges interest. Can't afford dental cleaning? Be prepared to pay for fillings later. Can't afford a decent car? Be prepared to pay for extensive repair later. These issues add up, so the next section is even more important.
Education: DarkHorseNeigh recommends prioritizing low-cost education to increase income. Except for the most gifted academics and athletes, college is likely out of the question. However, there are a number of jobs that do not require college education but pay well, such as air traffic controllers. If that sounds too difficult to get into, he offers another option. He recommends looking into JobCorps for those 18-24, which offers free housing and education to those interested in working trades. www.jobcorps.gov : this is HUGE!
Military: Being in the military does not mean sucking down MRE pork fat and slogging through mud every day (but it can if you want). Enter the military fully demanding a job that you want but is not as challenging as airborne infantry, such as dental hygienist or radiologist, and you are almost guaranteed a straightforward job that will keep you out of Egyptistan while teaching you valuable job skills that make you marketable. Military service will also qualify you for free 4-year colleges and provides a better salary than most people are led to believe. Tell your recruiter you want to be a radiologist and nothing else, and I guarantee you will get that job. Don't let them talk you into "being infantry for a few years and then switching later." It's lies.
2) Breaking out of the middle class requires a change of habit. Use the PYF model to take money off the top of your paycheck and invest it into assets. This means more than just matching your employer's contribution to your 401(K). This means investing in your equity by paying off your home faster, avoiding car loans, and establishing a non-retirement investment account in addition to tax-advantaged accounts. The middle class should not hoard money in savings accounts that lose money to inflation. Instead, they should set aside 6 months of funding in a savings account, and then use the excess to pay off debt; there is no reason to carry a $20,000 car loan at 5% interest when you have $55,000 in a bank account losing money to inflation. Kill the debt as soon as possible, minimize liabilities, and prioritize the accumulation of assets with the PYF model.
3) People in the upper class are in a good position to attain wealth. The goal of the upper class should be to avoid excessive liabilities and reduce tax burdens. The upper class is likely to already observe solid PYF habits, but must ensure they do not stray from this policy in favor of acquiring liabilities like lambos, failing investment properties, or spoiled children. The upper class should stick to the formula that got them there: attaining assets, not trying to start a sports bar with a $11mil loan, and building financial literacy among children.
4) The rich should seek to stay rich by ensuring heirs understand the time value of money, are literate in financial matters, and are not overly entitled. The greatest threat to a wealthy family, besides disruption of non-diversified assets, is uneducated heirs who believe their money is unlimited and can be blown on extravagances that get them in legal trouble or bring on debt. Money should be enjoyed responsibly, just like alcohol, weed, or sex.
Summary
Understanding how to identify liabilities versus assets is essential for ensuring individuals make the right purchases to build wealth rather than squander it. Managing your money begins with adopting useful habits. This means focusing on the accumulation of assets to generate appreciable income. This is most easily achieved with the Pay-Yourself-First (PYF) model, in which one takes money off the top of his paycheck to invest and then spends the rest. This contrasts with the common but faulty habit of spending first and investing the rest. Using the PYF model and attaining assets is the key to advancing socioeconomically.
Disclaimer
Mikey really likes money and encourages others to attain assets and minimize expenses. However, Mikey is not a financial adviser. If you are unsure how to create a budget to utilize the PYF model, consult a licensed adviser for assistance.
Comments
Chris Buchheit
Just my point of view, but if the value (bluebook and/or trade-in) of my current transportation (car/truck) is worth more than what I owe then it is an asset. Once that flips to worth less than what is owed it is a liability. Also assuming I could liquidate it quickly and gain cash in hand equal(ish) to what I paid for it...it's an asset. If that is more than negative 10%, it's a liability.
Mikey Millions
Hmm, interesting. I think that’s largely true. But my response is this: if you have an inexpensive liability that is cheaper than all alternatives, then while it is still a liability, you should protect it like an asset until another opportunity arrives. Calling it a cheap liability is a good observation. But we’ve also got to look out for the liability that is cutting our costs down and filling that necessary function. We’ve got to get around, and unless we are carpooling and getting paid to do it, cars will always be a liability. How much money can we save before we treat our required liabilities like assets? I haven’t thought about that before.
Bud Leiser
Small nitpick 2) Remember that saving you money can also make something an asset. If the alternative to driving is expensive ride-sharing or public transportation, and your car costs less than those things, then your car is an asset; I don't agree with this statement because you haven't gone into cashflow positive territory. It's just a less expensive liability, it's still a liability.
