We’ve all heard the saying, “you’ve got to make your money work for you.”
We listen, we nod, we promise we will, and then we forget about it and overspend on bar tabs and greasy (but oh so good) pizza.
People understand that making their money work for them is a core principle of personal wealth. Using investments to increase cash inflows while reducing cash outflows is key to creating a life of monetary riches.
However, while many people get it, few people actually know how to do it. But I’m here to tell you that investing is easier – and less risky – than you might think. It all comes down to two principles:
- Buy Appreciating Assets
- Lease Depreciating Assets
It’s as simple as that (in theory, at least). If you follow these two principles you’ll create a life filled with personal wealth. Therefore, in this article, we’ll discuss:
- Assets and their importance
- Appreciating assets
- Depreciating assets
- A simple strategy for wealth building
Alright, let’s go!
What Are Assets?
Ok, before we get into the nitty gritty of personal wealth, it’s important to define an asset as well as its importance. For those who don’t know, an “asset” is something that holds value. Stated differently, it’s a piece of property, either tangible and intangible, that can be purchased and sold.
The most common type of asset is a piece of real estate, i.e. your home or an investment property. It’s easy to conceptualize because it’s tangible. You can run up to the garage door and give it a swift kick. I don’t recommend doing it, but the point is that you can. A car would be another example of a tangible asset. Feel free to kick that, too.
There are other types of assets, however, that are much less tangible. Public stock, for example, is an intangible asset. It still has value and can be bought and sold, but you’ll have a lot more trouble trying to physically kick it. You can kick you investment advisor, maybe, but certainly not a stock.
This is because stock represents ownership in a company. If a public company is divided into 10 million shares and you own 1 million of them, you own 10% of the company. If you own 100 shares, you own 0.001% of the company, and so on and so forth.
Other assets include boats, furniture, commodities, private equity, and almost anything in between. If you own something – regardless of its tangibility – that has value and can be bought and sold, you own an asset.
Why Are Assets Important?
Assets are important because, well, they’re assets! Specifically, they’re important for two reasons:
- Assets act as a store of value
- Assets are often functional
The first reason is the most common when we think about assets, especially when we’re investing. When we invest in an asset, we’re expecting that the value of the asset will increase over time. This means that assets “store value,” i.e., you can purchase an asset and hold onto it before selling it at a later date (hopefully for more money than you bought it).
The second reason is slightly less common but much more necessary. A house, for example, would be a good example of an asset that both stores value and is also functional. It might increase in value, sure, but the most important thing is that you have a roof over your head.
However, a house is an example of an asset that can both increase in value as well as act as something functional. There are other assets, known as depreciating assets, that might be functional, but don’t store their value very well. A car would be a good example of a functional asset that declines in value over time.
So, what gives? Why would someone want to invest in an asset that loses value? Well, I’m glad you asked!
What is an Appreciating Asset?
The best kind of assets are appreciating assets. Appreciating assets are things that can (emphasis on can) increase in value over time. Real estate, public stock, and a multitude of other things are appreciating assets.
Purchasing an appreciating asset is the literal act of making your money work for you. If you take $1,000 and invest in Google stock, for example, and the value of your shares increases to $1,100 after a month, you’ve just made an additional 10% on your money without doing a damn thing. Amazing!
The same thing goes with a home, which is both functional and stores its value well. If you purchase a home for $500,000 and then sell it for $600,000 five years later, you make 20% on your money just by literally living in a house.
Now, when you add in a mortgage, property taxes, and other fees, the math gets a little wonky, but just know that you typically make money on a real estate purchase (2008 willing). If you don’t believe me, read the example in this article I wrote for one of my clients, here.
This is why appreciating assets are so important. You invest in them with your existing dollars with the expectation that your money will grow over the short-, medium-, or long-term. If you want to achieve personal wealth, you have to invest in appreciating assets.
Where to Get Appreciating Assets
Appreciating assets can be sourced from almost anywhere. The types of appreciating assets are many, but the most common are real estate, private companies, and public stocks.
If you’re interested in stocks, you might want to check out Betterment or WealthFront. Both of these companies are “robo advisors” and they use computer algorithms to invest your money for you. They ask you a series of questions to assess your investor profile (desired level of risk, desired return, etc.) and then curate a diversified portfolio that fits your needs.
If you’re interested in real estate…you better start saving. Just kidding, but really though. Real estate assets typically require 20% as a down payment. The rest is covered by a mortgage or loan. However, there are FHA loans and other alternatives that help you purchase a house with as little as 3% – 5% down. For more information on these types of loans, check out Rocket Mortgage or Chase Bank.
Finally, there are other appreciating assets like private equity, commodities, options, swaptions, and almost any other name you can make up in your head. Just know that these appreciating assets aren’t for the feint of heart, and if you’re a beginning investor, stick to public stocks and real estate.
What is a Depreciating Asset?
Remember that a depreciating asset is one that while functional, might not store its value well. In fact, once you purchase the asset, its value will usually decline steadily until you sell it or scrap it.
Well, if appreciating assets are so great, why even bother with depreciating assets then? If the point of buying assets is to increase your personal wealth, it would stand to reason that you don’t want depreciating assets at all.
Well, let’s keep reasoning because that’s not exactly right.
Remember that one of the benefits of an asset is that it’s functional. Think about a car. Yes, it might decline in value over time, but you still get a lot of value out of using it.
So, using a car as an example, you might purchase one for $10,000 and sell it five years later for $5,000. This means that your asset depreciated by 50% and you essentially “lost” $5,000 on the investment. But the point of a car isn’t to make money off of it, but rather to make your life more convenient.
Is the convenience worth $5,000? That’s up to you to decide. For a more detailed example of the cost of car ownership, go here.
The bottom line is that depreciating assets, while working against your personal wealth, typically increase the overall value of your life (i.e. happiness, convenience, etc.).
Where to Get Depreciating Assets
You can find depreciating assets almost anywhere. Cars, boats, furniture, and the rest can be found online, in galleries, at dealerships, etc. I think you get it. Just know that as soon as you drive your new car off that lot, you’ll never be able to sell it for as much as you paid for it.
How to Successfully Manage Your Assets
Ok, so we now understand the difference between appreciating assets and depreciating assets and the reasons why we’d want both.
But remember that personal wealth comes from increasing your cash inflows and decreasing your cash outflows. So, if appreciating assets increase your cash inflows but depreciating assets do the opposite, how can we actually achieve personal wealth?
Well, the key is to purchase appreciating assets and lease depreciating assets.
Let me explain:
Purchase Appreciating Assets and Lease Depreciating Assets
Appreciating assets hold their value well. These are the assets that make your money work for you. These are the assets that result in monetary wealth. Think about it this way. Inflation is roughly 2% a year. This means that every year, a dollar becomes 2% less valuable.
The price of a candy bar in 2000 and the price of a candy bar today is inflation. It’s not necessarily that your dollars become less valuable so much as everything you buy becomes more expensive over time.
So, if you don’t invest your money in appreciating assets, that is, if you keep it sitting in a checking or savings account, you’re effectively losing 2% a year. This means that at the very least, you need to make 2% a year on appreciating assets to remain even. And then if you want to actually get off the rat race-fueled treadmill, you’ll need to make as much as 6% – 10% on your money, on average. Otherwise, you’ll be working your job right past retirement.
It makes sense to purchase appreciating assets. It’s the only way to achieve personal wealth.
But, while depreciating assets aren’t good stores of value, they’re still necessary because of their functionality. Remember the car. So, while it makes sense to purchase appreciating assets, wouldn’t it make sense to NOT own depreciating assets? Instead, why don’t we lease and rent our depreciating assets?
The benefit of leasing a depreciating asset is that you pay for its monthly “functional value” without being stuck with a declining asset. For example, let’s say that you can lease your dream car for $350 / month. Well, is the value derived from the car worth $350 a month? If so, it would make sense to pay the monthly price tag for its life benefits.
But if you were to own the same car, you’d have to worry about the annual depreciation and hope that you’ll be able to sell it at a later date for somewhere close to its sticker price. And if you’re familiar with cars, that’s basically an impossible task.
Therefore, when you lease a depreciating asset, you’re literally paying for the increase in your life’s monthly value. And as soon as that value diminishes, you can break your lease, returning it without having to sell it in the hopes of recouping some of your money.
Let’s not mince words. When you’re trying to build personal wealth, your rule of thumb should be to purchase appreciating assets and lease depreciating assets.
This practice will help you increase your cash inflow and reduce your cash outflow, all without any work from you. Instead, your money will be doing the heavy lifting. Feel free to enjoy the fruits of their labor while you sip your Mai Tai.