As new investors start to enter the world of investing, it may be hard to visualize exactly how you make money by investing. Is it just a machine that you input a one-dollar bill, and it spits out a five-dollar bill? Or worse, you get only three quarters back? But what investing is really about, is not the price you pay for something and what you get back, but it’s that something you initially bought. That something, is an Asset.
Assets are investments that put money in your pockets. The simplest example of an Asset is investing in the Stock Market, where a stock will pay you a dividend. Dividends are payments a stock/company will pay out to their shareholders regularly: you own 1 stock of Apple; you’ll receive $0.92 every year. That is an Asset, you bought something and now it is paying you back.
What is an Asset?
Assets are things that help you build wealth. Earlier, I described one Asset as a stock, ownership of a company, where you will get some type of return on your investment. That is the key to an Asset, where eventually, the return you get back from an Asset will be of greater value than the initial investment. More Assets equal more cash flowing into the investor’s net worth.
Asset Examples
If Assets generate money for an investor, what are examples of Assets?
- Stocks/Equities
- Purchasing shares of a company or business is a classic way of purchasing Assets. These companies can reward their shareholders via direct payments (dividends) or by share appreciation (share price increase).
- Fixed Income/Bonds
- A bond is like a loan that investors can provide to a company and even the government. By giving money out this way, investors can receive payments based on interest rates.
- Real Estate
- Some people choose to buy land or properties as an Asset class. I’m not talking about buying a house to live in, but properties that can generate cash flow. Residential rentals, commercial properties, land, etc. There’s more upfront cost when build Real Estate compared to Stocks, but Real Estate investors can generate passive income by renting their properties to tenants.
- Cash
- While cash alone cannot make you money, it is still valuable and considered an Asset because the liquidity allows investors to be flexible and nimble enough to make money off of it.
- Intellectual Property
- There are four types of intellectual property (IP): patents, trademarks, copyrights, and trade secrets. These are valuable assets to businesses because while they do not directly make money, they are what help a business stand out from others. One of my favorite IPs would be Coca-Cola’s secret formula. This secret formula gives their product a unique flavor and taste. Safe to say, the secret formula is very valuable to the company.
- Physical Assets
- While a majority of the time it is a product that drives sales and makes money, the actual physical plant or production of a product can be an Asset. Companies will own their manufacturing plants that develop and produce the goods they sell. Therefore, the manufacturing plant has value and can be treated as an Asset.
Assets can be associated with the term, Value. If there is a part of a business that helps produce value for the business to make money, we can call that an Asset. For a deep dive into different types of Assets and sub-types of Assets, read this great article here.
Opposite of an Asset, Liabilities
We’ll cover Liabilities in a later topic, but I would be remised if I ignored them completely.
Since a Liabilities is the opposite of an Asset, then we could define a Liability as something that takes money out of your pocket.
I like to think of Liabilities as “payments to others.” The biggest Liabilities would therefore be debt. You might “own” something, but need to pay the value of it, and usually interest is involved with it.
One quick example would be a car.
Previously I stated that something that has value could be considered an Asset, and a car does have value. We buy and sell cars all the time. However, unless you bought a car with cash, you’d have a loan where you pay someone for the value of the car plus the interest. Not to mention how quickly a car loses its value, or anytime there is maintenance.
Why are they Important?
Understanding why Assets are important is key to both personal finances, as well as when analyzing a business.
Overall, the amount of money coming in needs to be higher than the money coming out. Income versus Expenses. What puts money into your pocket versus what takes things out of your pocket.
Business Asset
When a business grows, expenses grow. Let’s imagine a grocery store. It starts small with one store and a few employees. But as the business grows, more employees are needed to get hired, more inventory is needed, and possibly opening new stores. These are all expenses needed to operate the business. To accommodate that expansion, more avenues of income (Assets) are needed.
Personal Asset
Businesses need Assets to grow their business, but as an individual investor, you need Assets to build wealth, which is referred to as Net Worth.
Net Worth is defined as your total Assets minus your total Liabilities. You can have a positive or negative net worth. Obviously a negative net worth is not ideal, you owe more or have more debt, than the money you are bringing in.
This is why Assets are important. Once these are greater than your Liabilities, your net worth, and your wealth will start to grow.
We highlighted some examples of Assets above, but typically the first form of Asset you will have is a job. Your job provides income which you use to pay expenses for everyday life. As you budget and start to save money (when your income > expenses) you can take that money and start to invest it.
Investing those savings into the Assets define above, will provide additional sources of income. And as those investments make more money, you can put that money into even more investments. This is compounding wealth, when the money you make from investing, starts making money on its own.
Summary
Assets put money in your pocket.
This is an important distinction. People believe that the house they own and live in is an Asset because they’re paying off a mortgage and they’ll eventually live payment free. But think about the definition of an Asset, does your house put money in your pocket? No. Think of all the maintenance and renovations and typical upkeep like lawn care, landscaping, utilities, etc.
Assets like stocks, dividends, rental homes, etc. are examples of Assets that put money into your pocket.
Liabilities are things we own that remove money from our pockets. In the example of owning a home, well that sounds a lot like a Liabilities because of all the maintenance it takes to keep up the house.
A business/company has different types of Assets than an individual investor would. Yes, a company can invest its earnings into the Stock Market, but they also need to use its earnings to reinvest back into its business to grow and expand (which we like to see as individual investors). More plants or facilities or stores or employees will work to bring the business more money. It is good for an investor to analyze a company and determine what Assets they own and how they are making money, adding cash flow, to the business.
Lastly, wealth is created when the money coming in is greater than the money going out. As investors, we want to focus on growing our Assets, not our Liabilities.
Assets > Liabilities
Thanks for reading about Assets! Hopefully, this gives a good introduction to Assets and how we should view them as beginning investors. Any questions or comments, please feel free to add or reach out if you want to discuss.
Disclaimer
Levelzeroinvestor.com is not a registered investment, legal or tax advisor or a broker/dealer. All investments / financial opinions expressed by Levelzeroinvestor.com are from the personal research and experience of the owner of the site and are intended as educational material. Although best efforts are made to ensure that all information is accurate and up to date, occasionally unintended errors and misprints may occur.
