Build Wealth by Buying Assets, not Liabilities
What do you spend your money on?
I want you to stop for a second and actually ask yourself this question. Think about the most recent major purchases you've spent money on. Go all the way back a few months if you have to, consider everything - new TV, new bike, fancy dinner, new shoes, gifts, movie tickets, plane tickets, vacation etc... Think about all the things you've spent money on over the last few days.
How many of those things will make you money in the future?
Some of them? Most of them? None of them?
Most people spend money on material things. Which is the act of taking 'money' which has buying power (which means you can buy all kinds of things), and reducing it to one thing. After you've bought that one thing, the money is gone forever.
Unless you re-sell it, but like most material things, they deteriorate over time, get old and lose their luster. We call this depreciation; they depreciate in value. This is the problem with material possessions, they depreciate in value over time.
Assets vs Liabilities
Assets are something you can own that bring you future economic benefit.
Liabilities are your obligations that must be paid or services that must be performed.
It really all comes down to this - think about your most recent purchases have you been spending more money on liabilities or assets?
For most people, dollars spent on liabilities far outweigh the amount spent on assets.
The critical difference in the basic spending habits of wealthy people, is that they spend the vast majority of their money on buying assets.
Some examples of assets are:
- Exchange traded funds (stock market)
- Diversified dividend paying investments
- Shares in a business (private or public) / or the whole business itself
- Ventures that generate semi-passive income (website, blog, youtube, instagram, affiliate marketing)
Rich vs Wealthy
While you may read these two words as having the same meaning, there is a subtle yet important difference between being rich and being wealthy. To explain the difference I'm going to quote a good book by Robert Kiyosaki - Rich Dad Poor Dad:
"The rich have lots of money but the wealthy don’t worry about money.”
The rich are seen to have a lot of money - they’re the people you probably see who have high paying jobs, drive nice cars around town, eat at fancy restaurants and spend their summers at the cottage. But the wealthy are so beyond, that they don’t have to worry about money, ever. They're truly financially free to go wherever and do whatever they want.
The wealthy are on a whole separate level. The wealthy are masters of finance, they understand the value of owning assets, having cash flow, and how to invest their money wisely.
It's ok to spend money on liabilities, just as long as you have a disproportionate amount spent on assets beforehand. Recall the wealth pyramid as a guide for how money should be spent, have a solid cash base that feeds into your investments as priority number one. Buying liabilities isn't even on the pyramid because it should only come as a luxury after you're financially taken care of. When the cost of a liability becomes trivial - that's when you should buy them.
How the wealthy... get wealthy
Wealthy people spend their money on things that generate more wealth. At the top of this post I asked you to think of your last major purchases. If the majority of your dollars ($) were spend on things that make you money (assets), then you're on the path to building wealth. If most were material items or things that cost you money down the road, I encourage you to read this section again - it just may change the way you fundamentally think about spending money.
The size of the arrows in the diagram above are very significant. Notice how much larger the asset purchasing and reinvesting is (blue arrows) compared to the purchase of liabilities (black arrow). When your nest egg is growing like a well oiled machine, it will spin off enough money to buy the luxuries in life. But it is all in proportion to how much you keep re-investing. As a beginner this may mean being able to buy coffee whenever you want without it impacting your finances. Soon it may be a new cell phone every year, some day it will be the sports car of your dreams. It all depends how much you're reinvesting, and the more you re-invest without cashing out, the larger your nest egg will grow. So if you can forgo these luxuries, you will greatly accelerate the growth of your nest egg. Eventually it will pay for your entire retirement (100% of your cost of living).
Simply put, if you spend your money on assets that generate more income for you right now, there is a compounding effect that will provide you with good returns as time goes on. For every dollar you pour into income generating assets, you will receive a return on your investment as time goes on. To read more about how powerful this compounding effect really is, check out this post on compound interest.
On the flip side, for every dollar you don't use to buy assets, you're losing out on the earning potential of that dollar over time.
If you're looking for a great resource to get started investing, I recommend this book. A lot of the concepts I use originated from this book way back in the day. I'm now primarily a passive investor, which means I sleep well at night knowing my money is growing without my constant attention.