Is your home an asset or a liability?
In traditional accounting, houses are classed as assets (as are cars, computers, boats and other "things" you buy).
However, in Rich Dad Poor Dad, Robert Kiyosaki popularized the following definition of assets and liabilities when it comes to creating wealth:
An ASSET produces income (puts money into your pocket)
A LIABILITY produces expenses (takes money out of your pocket)
This raised the idea that for most people, their home is a liability rather than an asset.
This completely changed every investing decision I've made since reading his book 20+ years ago.
Your Home: Asset vs Liability
Ask yourself:
Is YOUR home an ASSET?
(does it put money into your pocket?)
Or is it a LIABILITY?
(does it take money out of your pocket?)
Ways a house puts money into your pocket | Ways a house takes money out of your pocket |
|---|---|
Rental income | Mortgage payments |
Cell | Repairs and maintenance |
Insurance | |
Cell | Rates |
Cell | Renovations |
Cell | Utilities |
Cell | Legal fees |
How Your Home May Be Keeping You Poor
This misunderstanding of assets and liabilities is why the average person finds it difficult to generate wealth.
For most people, buying a home is the biggest "investment" of their life.
They buy the biggest house the bank allows and commit 30 or 40 years of income to it.
However, the house produces no income and has weekly or daily expenses, meaning they are actually "investing" in a liability that is draining cash instead of producing it.
This is also why most people who put all their resources and income into owning their "dream home" are not financially free, work 50 weeks per year, do not retire early and often live check to check.
You might ask, what if I sell my house for a profit in a few years?
That is great, but not for the reasons you're thinking.
If the only way to produce income with your asset is by selling it, then it is not an asset (the fact it couldn't produce income while you owned it actually proves it's a liability).
In many cases, the real benefit of selling a house will be you are offloading a large liability and freeing yourself of all the expenses.
The second problem with this mindset is you assume your house is guaranteed to rise in value.
One reason for the entire 2008 global recession (and others) was due to houses going down in value.
An important rule in investing is to understand that gains are never guaranteed, and that nothing goes up forever.
Tim Ferriss, who authored the bestseller "4 Hour Work Week" told the story of a billionaire he knew who owned 8 houses in different cities and countries.
Of course, the billionaire could only be living in one house on any given night, but he still had security, cleaners and gardeners at each house 24/7/365.
Eventually he came to the realisation that having all these houses was a liability, and he had basically "spent millions on houses just so he could pay gardeners and cleaners to live in them."
This is a classic example of how houses are just another consumer product and usually not assets, because they produce a lot of expenses and don't often produce income.
Emotion and wealth don't mix!
One of the reasons we don't make financially sound decisions about houses is because home ownership is an emotional issue.
A "dream home" is something we spend our whole life aspiring to, so we don't care if expenses start getting out if hand or we need to take on 30 years of debt.
In fact, some people are probably getting emotional just reading this article.
However, removing emotion is a golden rule in investing.
Emotions are why people panic sell and FOMO into stocks at all time highs.
It is also the reason they pay too much for houses just because of a nice kitchen or porch or because they simply "want" this particular dream house.
The lesson is to treat your house just like your other investment decisions.
.How much income will the house produce?
How much will it cost you?
If a stock were to cost you $2,000 to insure every year, and you had to pay government rates on it, and you could only buy them $700,000 at a time, and you had to repair them constantly, and the only "income" you would get is from maybe selling it for a profit after 5 years, you would simply say "bad investment!"
You wouldn't even waste a second thinking about it.
When Houses Are Assets
The good news is houses aren't always liabilities.
They can be assets too, as can other common liabilities such as cars and boats
(e.g. a car is a liability, but if you use it to drive Uber, it becomes an asset).
Having a better understanding of assets and liabilities and the cash inflows/outflows of a house, you can make better decisions about home ownership.
As an example, most people buy a house, then after a few years, get a bigger mortgage and move into a nicer house, and after a few years, do the same with an even bigger house.
All they are doing is acquiring bigger and bigger liabilities.
What would be a better approach?
Remember, the goal is not necessarily to avoid liabilities, but to ensure your asset list is much larger than your liability list.
Most people spend far too much on their home.
If you have a $800k budget, most people would try and find the nicest home they can for $800k.
Result: $800k liability.
A more financially sensible strategy would be to buy a $400k house to live in, and a second $400k house as an investment property.
Result: $400k assets, $400k liabilities.
The income from your $400k investment property will help pay off your $400k home, and in a few years you could acquire a third property.
Result: $800k assets, $400k liabilities.
This is a much better position than you would have been in had you just bought an $800k home.
Result: $0 assets, $800k liabilities.
Summary
Try to think rationally instead of emotionally about home ownership.
- A house you live in is a liability.
- A house you rent out is an asset.
- You want small liabilities, and big assets!
- If you own multiple houses, make the cheapest one your liability (live in it) and make the expensive ones your assets (rent them out). Most do the opposite.
- If you're buying a home to live in, don't buy the most expensive house you can (do the opposite, buy the cheapest house you can, why would you want to buy a big liability?)
-If you're buying an investment property (an asset), the opposite applies.
Remember, if it produces income, it's an asset!
If it produces expenses, it's a liability!
WEALTH IS BUILT BY ACQUIRING ASSETS.
