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Start making the right financial decisions by understanding your assets and liabilities.
Blogger: Cam McLellan, CEO, OpenCorp
I believe there is one reason why the majority of Australians are not financially wealthy and never will be. I want to share a rule with you today, which will put you ahead of the majority if you apply it.
At OpenCorp we have a team of accountants who work for us full-time and have a very important role. So I hope you don’t take what I’m going to say next the wrong way. I find that a lot of people immediately turn to their accountants for financial advice. The majority of accountants aren’t licensed to give financial advice and are not financially independent themselves. I think the main reason people turn to their accountants to see what they think before making financial decisions, is because there are numbers involved. The reality is that while accountants understand the rules I’m going to go through, they don’t apply them to general life, which is why they’re not financially independent.
Forget about property or any kind of investment until you understand this rule and live by it day-to-day. I want to talk about assets and liabilities. Most people think of assets and liabilities as two different things. If you instead understand them as four very distinct things, you are going to be so far ahead of the game when you think about money or taking on debt.
Assets can be broken down into appreciating assets and depreciating assets, which are two very different areas. An appreciating asset goes up in value while a depreciating asset goes down. Likewise, liabilities can be broken down into beneficial and non-beneficial categories. A liability is a debt of any kind. There are more types of debt than just a house loan.
A lot of people say that your family home is your biggest asset and it is an asset, an appreciating asset because it goes up in value. However, even if it is your largest asset and you buy it today and wait 10 years for it to double in value, every other property on the market will also have doubled in value. In my book, you therefore aren’t any better off. Even though you will have some usable equity you won’t have built your true wealth. A beneficial liability is related to wealth creation and the family home loan is not related to wealth creation.
Most people would say that an investment property is an appreciating asset and it is, but we need to break it into land and building components. It is not your own home so you’re able to depreciate its value. The Australian Taxation Office deems that a home has a 40-year lifespan and, after that, theoretically it won’t be worth anything. The land however, goes up in value and makes money. The building’s only purpose is to provide rental income for the land’s holding cost. The investment property loan is a beneficial liability related to wealth creation.
We travel to secondary schools and talk to a lot of kids about the way they are going to transition from a world where they are protected by mum and dad, to a big, bad, financial world. If these kids have a good understanding of the assets and liability rules when they are making decisions over the following five transition years, their financial health will be a lot better when they hit 30. If they are slightly set up by 30, then they are going to have a comfortable retirement. We hope that by 30 they won’t face financial setbacks because they acquired depreciating assets by using non-beneficial liabilities – cars which depreciate in value, phones and credit cards, for example.
We talk to the kids about choices or pathways in life, like choosing between a credit and debit card and broader issues like whether or not to get in a car with a drunk driver. We also talk about the majority of Australians who don’t understand these rules and work their entire lives away only to end up with nothing when they retire.
We use the example of AFL players. AFL players live in a fishbowl; everyone looks in from the outside and judges how they go. A lot of people deem that AFL players have short careers and earn huge money. They have to transition like the kids, going from having a huge income and not managing it very well, into the real world where they might not have a trade or profession to fall back on. We tell the kids, “At least the AFL players followed their dreams. From a very young age, if you follow your dreams and make smart investment choices and smart decisions about assets and liabilities, you’re going to be in a better position.”
We give the kids daily life examples of the four asset and liability categories. We talk about mobile phones and ask the kids, “Is a phone worth more or less when you walk out of the store? Are the calls making you money or not?”
We talk about friends, “Is your friend a good person? Are they an asset to you or a liability? Are they a loser who is dragging you down?”
This happens with adults as well. You might start hanging around people just because you like them but do their personality traits make you a better person? If they’re a real loser, they’re probably scabbing money off you... so they’re probably a liability as well!
If you understand assets and liabilities and truly apply this knowledge to your life, you will have a much better outcome and find it a lot easier to make financial decisions.
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