Financial Genome Project – Chapter 6

Chapter 6 – Assets and Liabilities

“I can’t lie, I’m guilty of splurging too man
‘Till I learned the difference between assets and liabilities
Really important man, I swear.” ~Ludacris (American rapper)

As I mentioned in Chapter 5, The Payment System, I placed the payment system outside the genome because we’ll trace out each expense. Before we dive into individual expenses though, I want to discuss assets and liabilities. Every penny we spend is either consumed (e.g., food) or becomes an asset and/or liability.

When we buy food, money is exchanged for a good that, theoretically, is consumed in its entirety. This is true until you have kids, where they claim to be “starving”, eat one bite of the food, suddenly become full, and the rest is thrown away. We’ll consider this waste as totally consumed as well. Entertainment is another consumable expense. When we go see a movie or go to a theme park, the entertainment value is consumed.

When we buy clothes, furniture, consumer technology, etc. they become assets. We spend the money; we receive a good in exchange, and we own the product—it becomes an asset. It’s important not to conceptualize assets as a good thing or a bad thing. When I took my first accounting class in college, the professor told me to wipe all word association with the words credit and debit. It turned out to be sage advice, since the main reason students struggled in the class was because they had a hard time classifying credits and debits. If you’re interested, the confusion comes from assigning items to debit “cards” and credit “cards”. Once you get passed that, accounting gets a lot easier (relatively). If you spend all your discretionary money on clothes, then you may have a lot of assets; however, that’s probably not a good thing. Having a lot of assets, that aren’t generating returns, can become costly.

These same assets can be liabilities when we use money we don’t have (e.g., credit cards) to purchase goods. For example, a shirt may cost $10, but when placed on a credit card, we must pay the whole $10 back and any interest we accrued if we didn’t pay off the whole balance before the next billing cycle. Your debt is a liability. When the debt is paid off, then the good becomes an asset; however, that interest you paid siphoned a portion of your salary. Technically, the $10 shirt is an asset and you have an equal $10 liability; however, clothing has nearly no resale value. A $50 shirt sells for 50 cents at a garage sale just like a $10 shirt does. Additionally, too many consumer assets can generate additional expenses if you need to purchase storage to hold those assets. This is becoming a negative trend in our economy, with nearly 1 in 10 households renting a storage facility, compared to 1 in 17 in 1995.[1] Storage costs, in this case, would be a consumable expense.

Some goods, like houses and cars, can be an asset and a liability at the same time. If you buy a $250,000 house and put $25,000 down, then you have $25,000 as an asset (called equity) and a $225,000 loan—a liability. As you put money towards your mortgage, your liability goes down and your assets/equity go up. An additional tangent—the interest you pay on the mortgage is then siphoned off your salary. We’ll discuss all the intricacies of the home purchasing in a future chapter. If the value of your house rises your equity goes up, but then your liability stays the same.

This is an important concept as we spend our income. The way we choose to spend our money determines our ability to influence the financial genome. There are two ways a single individual can greatly influence the genome. The first and most common is to have a large net worth. Your net worth in calculated by total assets less total liabilities. People with a high net worth, as individuals, yield a large amount of influence on the genome. They can invest their money to influence corporations, non-profit organizations, and governments or they consume a lot more, influencing the success of products. The second way a single individual can influence the financial genome is by having a large amount of power. This is intangible and difficult to calculate. For example, the annual salary of a U.S. Senator (not a majority/minority leader) is $174,000 a year.[2] Assuming the Senator isn’t already a millionaire (a rarity in modern politics), $174K is not considered an ultra-rich salary (upper 1%); however, a U.S. Senator can yield a large amount of influence on the financial genome. In most cases, power and net worth typically go hand-in-hand.

Keeping track of your net worth is a beneficial step in basic personal finance. You total all your liabilities and subtract that from your non-consumer product assets (don’t include clothes, furniture, and electronics). As I mentioned above, your house and car can be both as asset and a liability. The equity of your house or car (estimated value less mortgage or car loan) is an asset. The remaining balance of the mortgage and/or car loan is the liability. It’s recommended you record your net worth twice a year or more frequently.[3] When establishing financial goals, you should aim to increase your net worth each year. I have included an example net worth calculation below.

NET WORTH CALCULATION EXAMPLE

 It’s important not to just track your net worth, but it’s also beneficial to track your monthly expenditures (or expenses). We’ll go into all the different genome connections we make when we spend our money in future chapters. After a couple years of tracking your net worth, you may be surprised to find your net worth stop growing and plateau. A lot of times, this is because your expenditures have increased quicker than your salary; thus quicker than your savings (a.k.a. lifestyle inflation). You can record your expenditures at the same time as your net worth—every six months or sooner. A lot of monthly expenses can be renegotiated to lower your costs. In the last year, I’ve managed to reduce my phone, internet, and cable TV bills by calling each service and asking them to find ways I can lower my bills without reducing services. Some people have found success in reducing expenses/increasing services with shopping around for car, property, and life insurance. With advancements in technology, some people can eliminate classic bills. Some people are foregoing expensive cable plans and going with streaming service which can cost 80% less. Here’s an example of tracking your expenditures. This is not an all-inclusive list and some people may have fewer expenditures.

EXPENDITURE EXAMPLE
If you’re able to lower your monthly expenditures, place this money into savings or invest it to increase your net worth. If you have sufficient emergency savings, are appropriately insured, and invested correctly, you should see your net worth increase year after year. Thanks to the power of compounding interest/returns, and reinvested dividends, your net worth will start to grow exponentially. I remember it took me nearly 5 years to become debt free and to save my first $10K. It took me only 2 years to save my next $10K after that. 3 years after that (10 years total), I was still debt free and my net worth was at $100K. Shortly after, I bought my first house yet still managed to have a positive net worth.

Below is our current genome sequencing. We’ll start to trace out each expense in the next chapters, and when we do, we’ll mark its connection to an asset or a liability (or both). It’s important to note, that while we have some control over the job and income we have, we have significant control on what we do with our money, and how it impacts our net worth. Where we go in the genome from this point depends on your goals in life.

CURRENT GENOME SEQUENCING

[1] http://www.consumerreports.org/personal-finance/the-high-cost-of-self-storage-facility/

[2] https://www.senate.gov/artandhistory/history/common/briefing/senate_salaries.htm

[3] https://www.moneymanagement.org/Budgeting-Tools/Credit-Articles/Money-and-Budgeting/How-To-Create-a-Personal-Balance-Sheet-and-Determine-Your-Net-Worth.aspx

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