An Engineering Approach to Money

Earlier we talked about totaling up your assets and your liablities on a regular basis to know your net worth. At the time I kind of skipped over exactly what is an Asset and what is a Liability.

What is An Asset

So let’s start with assets. An asset is anything that you can turn into cash. It does not need to be cash, it can simply be something you can sell for cash. It should be valued at its fair market value. But please don’t be overly aggressive, some things can fetch a big premium if you take the time to find exactly the right buyer and get full value. This is not a realistic valuation though. What I try to do is value all my assets at whatever I could get if I needed cash in a hurry. A stock can be sold in a hurry for the market value and the cash will be there in 2 or 3 days. A car is trickier. If you needed to sell it in a hurry you might have to sell it for 10 or 20% below market value to get the cash in a hurry. Houses are the same. Furniture and hosehold items are worse, you might only get 50% if their value if you had to sell them in a hurry.

I think it is important to take this kind of worst case approach to valuing assets for many reasons. Things like household items are crummy assets. This is because they are almost certain to be worth less next year than they are this year. Ideally your assets should all be growing over time.

This is one of the big differences between the wealthy and the middle class. The middle class take their money and buys services or poor assets like cars, boats, furniture and big houses. The wealthy take their money and buy good assets like stocks, bonds, and rental properties. This brings up the important point that…

All Assets are Not Equal

If you truly want to be wealthy you need to buy good assets. Those items that put money in your pocket over time. A good asset will be worth much more over time than you originally spent on it, as well as any costs you spend to maintain it. Most good assets aren’t much fun while you own them. You can’t water ski behind them, you can’t show them off to the neighbors. They don’t make your life much easier today. But the income or capital gains that they generate over time will grow your net worth making life much easier down the road.
In general buying good assets means putting off your gratification until another day. Instead of buying that PS3 you buy 3 shares of Goldman Sachs. Instead of buying that new living room sofa you purchase 100 shares of Cisco Systems. It won’t be very comfortable to sit on while watching TV, but it will grow your net worth over time instead of just filling up your house.

If you want to be wealthy spend your money on good assets, not on simply acquiring more stuff.

This entry was posted on Wednesday, April 25th, 2007 at 3:57 pm and is filed under Theory, Definitions. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.