Start With the Basics
When you are searching for information to improve you financial situation or build your wealth, you may come across hundreds of articles with their own take on the solution. These solutions may be very helpful when it comes to solving a very specific situation.
Some of them will provide you with a lot of very useful information. That is great! You may need a detailed walk through of your issue and their solution.
Very few of these articles take a step back and explain some of the principles involved in understanding these situations. You will not be able to build wealth for you and your family until you have a solid understanding of these core principles.
This one seems pretty obvious, but it’s not what you think. The Income Statement is not where you report how much money you make. It a report of how much you keep.
The amount of money you earn is either called earnings or revenue. The other side of that is expenses. This one is pretty straight forward. Expenses are how much money you spend.
When you are looking to control your financial situation, those are the two levers that you have. Revenues and Expenses. You can either increase revenue or you can decrease expenses.
The suggestions that are offered by your personal finance experts will affect either one or the other. Creating a budget is a good way to decrease the Expense side. Beginning a side hustle works on improving the Revenue side.
In the business world, the Balance Sheet is the financial report that contains Assets, Liabilities and Equity. This is relatively the same when looking at it from a personal financial perspective, however, the terms are being defined incorrectly.
Businesses consider Assets as items that are used to produce Revenue. Liabilities were the debt leveraged against these Assets. Businesses use Liabilities to purchase Assets.
When you are thinking about your financial situation, you have been taught to think of these terms in a different way. You may have classified Assets as items that had value. Any debt was considered a Liability and Equity was the difference between Assets and Liabilities or Net Worth.
This relationship is fundamentally flawed. Because of these definitions, you may have the wrong things in the Asset column. Your house, car, valuables are not really Assets. They do not generate any income and, except for your house, they decrease in value.
Something that you buy that does not generate income and loses value, is a liability. What is even more troubling, is that you probably have used debt to purchase these liabilities.
We have been confusing these terms and it is the cause of a lot of the financial troubles that we have now. Spending money on things that are losing value is a guaranteed way to lose the game.
Typically, your mindset says that when you begin to earn more money that it is ok to buy more things. What is happening is many people are buying the wrong things.
You have to learn how to invest your money in things that continue to grow in value. Understanding what is truly an Asset is the first step in that process.
Rental Real Estate is usually the first thing you think of when looking for cash generating Assets. Another popular one is dividend paying stocks. Both of these Assets increase in value while generating cash flow.
You may not have the desire to be a landlord, I sure don’t. What you can do is purchase shares in a REIT, Real Estate Investment Trust. This is an investment vehicle where the investment manager buys and is responsible for managing the real estate. You can then buy shares in the REIT and you benefit from the cash flow and the Asset growth.
Assets are things that provide cash flow and grow in value.
Liabilities are things that decline in value.
Also published on Medium.