What defines an asset? We can go with the Oxford Languages definition of “A useful or valuable thing, person or quality.”
Perhaps you’ve heard corporate management types (if you work at a company with such creatures) describe you or other employees as an asset. Now the interesting thing about that is, they pay you a salary or other form of financial compensation to do what you do for them, so in that sense you are an expense, or a liability.
So what makes you an asset? Not the checks they keep issuing to you. Not your office or cubicle they keep on your behalf, or mileage they pay you when you drive for work related business or expenses they pay when you travel on their behalf. Not the contribution they make to your health care insurance or 401k match.
None of these make you an asset. They are all liabilities, expenses and obligations that take away from the profitability of the company.
So what makes you an asset?
It is what you produce for your employer above and beyond the expenses they incur in employing you that make you an asset.
Profitable companies get more income (or we can also say productivity) out of their assets than it costs them to possess the assets.
So let’s take that observation and carry it into our personal lives. Let’s pretend as individuals we are all mini-corporations. We’d like to be profitable. As such, let’s look at each of the assets we surround ourselves with.
Not all Assets are Created Equal
We can look at assets a couple of ways: Tangible (cars, homes, clothes) and intangible (copyrights, patents, computer software) are one way corporations look at assets, especially when it comes to recording those assets for accounting purposes. Most of us possess mostly tangible assets. Show of hands for a car, clothes, etc? Right, everyone. Show of hands for patents, copyrights, etc? Yes, yes, you have software, so fine, just about everyone. But the value of our tangible assets tends to be higher.
Let’s look at assets another way, one I think more clearly shows us how they can help or hinder our efforts to achieve financial independence. Assets can be productive, that being income producing, or they can be an expense. Anyone else just get chills? Funny, that’s what happened the first time I heard that…must just be me.
Allow me to illustrate:
Your car. A productive asset or an expense? I can arrive at different answers depending on what I use my car for. For instance (1) I drive my car for work as an Uber/Lyft driver and get paid for the use of my car, or (2) I drive my car to work at a job I couldn’t have if I didn't have the car.
In the example above, I would call the car a productive asset in the first case and an expense in the second. Why is that? In the former case, I can clearly identify the car as being the direct cause of my earning income from its use above and beyond the cost of a payment, fuel, repairs and maintenance. I can even know to the dollar, each month, how productive that car has been.
In the latter, I am paying for all those same things, but receive no income from the direct use of the car. You may use the car to get to a job, but how expensive a car do you need to achieve that? Can you ride a bike or take a bus or other public transit to get to work? Where potential substitutions exist, it gets mushy pretty fast.
Substitution as a Solution
But let’s have a look at acquiring an asset as a substitution to reduce expenses. When the asset is not productive, we can instead look at the expense of the asset in relationship to not having that asset. Let’s examine your car once again. Without it, to have that $60,000 salaried job in the city, you’d have to live closer to work, where monthly rents are $2,000. With a car you can live where monthly rents are $1,000. The best salaried job available in walking distance of where you live now pays $30,000 a year. If owning and operating the car costs $8,000 per year, your substitution analysis would be:
If you choose to take the city job and live in the country, you can see by substitution that the car is providing a financial benefit of $4,000 over choosing to live in the city at higher rents. That still doesn't make your car a “productive” asset , but it does allow you to take the higher paying job, so by substitution it more than offsets the higher potential rent expense.
Where substitution reduces your expenses you can do so without setting yourself back on achieving financial independence.
This, however, remains the most important point: To achieve honest to goodness financial independence, where having a job doesn’t matter to you covering your ongoing expenses, you can’t call an asset productive until it makes more money for you than it costs to possess it.
Financial independence comes fast when you become adept at surrounding yourself with productive assets. You can even convert assets that are currently expenses to productive assets. The car example above being a perfect example. Drive it to work, expense (but perhaps a good choice following the rule of substitution). Drive it for work and voila! productive asset.
Does this mean everyone should drive their car for work? Certainly not. But if you do a substitution analysis between the job you have and driving for Uber, Lyft, etc. and find you have more money at the end of the day doing the latter, the answer might be yes.
The discussion above led me to my third investing principle: Always be on the lookout for opportunities to invest in productive assets.
Home Sweet Home?
So let’s test this idea on something else: Where you live. Parents, friends, and culture in general oft repeat the American dream ideal of owning a home. This may have encouraged you to scrap and scrimp and save in the hopes of one day owning a home. One you would live in. So here are two questions I’d like to pose to test your understanding of the ideas I’ve just presented:
Question 1 - If you buy a house to live in, do you have a productive asset or an expense?
Question 2 - If it is an expense, how would you determine if buying a house would still be a good alternative to renting?
Ponder those questions and I’ll devote my next post to the answers.
Until next time, may peace and prosperity be with you.
The Natural Economist
Next up, Buy or Rent? A tale of two cities.