The word asset gets used differently in different circles. If you want to be financially independent, then you should use the following definition. An asset is something which generates income or at the very least can be sold at a profit.
The general public in Australia deem an asset to be something of value. The typical example of this is calling your car an asset because if you did decide to sell it, you would actually receive a somewhat substantial amount of money. That's a problem however if you're working towards financial freedom. Unless you're driving Uber on the weekends, your car is a cost, not an asset.
Change your focus from looking at the current value of the car to looking at the lifetime cost of the vehicle. Let's run through an example, you buy a new Holden Captiva (I'm not trying to promote Holden, I just own one myself and it's an average Australian car), what's the cost over 5 years?
| Item | Item Price | Running Total |
|---|---|---|
| 2017 Holden Captiva | -$34,420 | -$34,420 |
| Insurance | -$3,000 | -$37,420 |
| Petrol | -$8,450 | -$45,870 |
| Rego | -$3,740 | -$49,610 |
| Repairs | -$500 | -$50,110 |
| Re-sale | $15,000 | -$35,110 |
So after 5 years of owning a new car, it costs you $35k and that is including the re-sale value. This isn't an asset, it's an expense. (See the links at the end of the article for a car cost calculator.)
A car is a cost, it doesn't generate income. There are some exceptions, as mentioned earlier, but for most Australians, this is the reality. So what about your home?
An asset generates income or can be sold at a higher price. Owning gold, for example, won't earn you income, but if you trade it at the right times you will make money from it by selling it at a higher price than you paid. So whether or not your home is an asset can get even more complicated than the car example above. Most houses will be sold at a profit when you hold them for an extended period of time. This fits the definition of an asset. But if you have a mortgage, then you may have made a bad choice. There is a plethora of research out there about whether renting or paying a mortgage is better in the long-run. Most people never sit down and do the maths, they just look at the purchasing price and the resale price. In most research, the mortgage works out as the better option, but not as much as you might think, some research has come out saying renting works better. See the video below for an in-depth breakdown of the rent vs. mortgage debate from Money School.
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That being said, while the mortgage payments are going out, it's not an asset, it's only when you sell the house and calculate all the costs, from mortgage payments to rates and house repairs, that you'll know if you've made a profit. A smart investor will consider the economic cost of the mortgage. For those of you who have studied economics, you'll know I'm talking about the opportunity cost. That is, what could you have done with all the mortgage payments, or what's the next best choice. It may well be true, that for a smart investor, they will earn more money by paying rent and investing the difference. The book Rich Dad Poor Dad has a great chapter dealing with this issue of what an asset actually is. If you're just starting out on the journey to financial independence, this is one of those books which makes clear the fundamental ideas and concepts of being smart with money. That's the goal always, be smart with your money and escape the 9-5 grind. To do this you need to know the concepts before you get down to work on the technical analysis of financial markets.
The purpose of this article was to push the idea that an asset is something which generates income or can be sold at a profit. It's a fundamental change some people will have to make in their thinking to become smart with money.
Car estimate calculation:
Price of a new Holden Captiva as of September 2017: $34,420.
On my car, I pay about $550 per year, but it's not a new car, so let's just round that up to $600 per year for 5 years. 600x5= $3000
The average Australian travels around 13,000 km per year (http://www.abs.gov.au/ausstats/[email protected]/mf/9208.0), with the average passenger car fuel efficiency around 10L/100km. The Captiva is around this for fuel efficiency, but it really does depend on how you drive, with inner city use being more costly per km. Let's average the price of pertol at $1.30 per litre. So 10x 1.30= $13 per 100km. 13,000/100x13 = $1690 per year for fuel. Just to give you an idea, that would be spending about $33 a week on petrol. 1690x5= $8450 for five years of petrol.
Don't forget registration, mine is due soon and it's going to cost me $748. Let's stick with that for the 5 years. 748x5= $3740 for your rego.
A new car and in this case a new Holden, does come with a three year warranty, so you won't be spending anything on repairs and services until the last 2 years. Hard to calculate, so let's just say $250 per year if you only do the servicing. $500.
At the end of all this, you can sell that car, the average price of a five year old Captiva is around $15,000.
Further Reading:
- Rent or Buy? The evidence is in
http://www.smh.com.au/comment/rent-or-buy-the-evidence-is-in-20170107-gtnj2a.html
- A total car cost calculator
https://www.nerdwallet.com/blog/loans/total-cost-owning-car/
- Rich Dad Poor Dad
https://www.amazon.com/dp/B0175P82RA/ref=dp-kindle-redirect?_encoding=UTF8&btkr=1
my plan is to rent a room and buy a moped until i achieve financial freedom
The sacrifices now are well worth it for the future.
We are building a house right now on land we own out right, we are taking a mortgage out on the build but our mortgage payment will be less than we are currently paying in rent. And way less that current rent prices. I got sticker shot recently when looking at what it cost to rent a 3 bedroom home in my area now.
Outright ownership of land would certainly be a safe investment over any considerable period of time. If you've researched and have a mortgage at a lower price than renting, you're being quite financially responsible.
I am pretty cheap @drewkin actually it isn't that I am really cheap I am just frugal. Rent currently in the area where we live for a 3 bedroom is $800-$1000 a month our mortgage will be around $600, the house we are renting right now that we have to move from soon we are renting for $675 so it is a no brainer to build on our land.
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STOPThis is very interesting how things vary in the accounting sense form your country to the US. I really enjoyed your article and found it well put together and enjoyable Thanks for sharing. Most worthy of a resteem and upvote