Learn how to differentiate between assets and liabilities in personal finance before making your first investment.

• An asset is something that has value and/or puts money in your pocket because it generates income and/or cash flow
• A liability moves money out of your pocket and causing costs for you
• Healthy financial planning means to increase your assets and keep your liabilities to a minimum
• By budgeting a set amount of your income each month towards investing, you can begin to generate more income and assets

In this lesson, you are going to learn about assets and liabilities.

Knowing about assets and liabilities is essential before you start investing, so in this lesson, we give you an overview of why they are important.

What are assets and liabilities?

In the widest sense, an asset is something of value that you own and that ideally puts money in your pocket because it generates income and/or cash flow. Like you learned in lesson one of the Personal Finance section of the Newera Academy, income is important when it comes to budgeting. Income is basically money you receive. Therefore, an asset brings you money.

Assets may appreciate in the long term, meaning that their value increases - an example of this could be a small house or some stocks that you own. However, assets may also depreciate in value, meaning they become less valuable over time - such as a computer or a car (unless it’s a rare vintage model).

Some types of assets that generate income include dividend-paying stocks, royalties and patents. You may also find definitions of assets that include high-end items that belong to you and that you don’t owe any money for - such as your house or your car.

Assets may appreciate in the long term, meaning that their value increases - an example of this could be a small house or some stocks that you own.

A liability, on the other hand, moves money out of your pocket - liabilities are things and ventures that cost you money. Liabilities don’t generate income, but create constant, regular expenses for you.

Examples of liabilities include any type of loan you are paying back, such as for real estate or student loans. But it could also be that you make use of your bank account’s overdraft on a regular basis which also causes unnecessary costs.

What do assets and liabilities have to do with budgeting and investing?

Let’s take a look at some popular misconceptions involving the concepts of assets and liabilities. Let’s say you have borrowed money to buy a car, this car is now a liability for you for the duration of time you pay off the debt for your car. However, if you use your car (that has been paid off and belongs to you) to generate income by offering other people rides for money, you could then make more money than you need to upkeep the car, so it would now be considered an asset. The same is true for real estate: In order to afford a flat or house, you take on a mortgage. This mortgage is a liability, while the real estate eventually becomes an asset when you have paid off the loan. Keep in mind though that a property and your car will keep incurring expenses such as taxes and maintenance even once you have paid off any related debt.

Your basic objective in setting up your personal financial plan is to increase your assets while reducing your liabilities.

Increasing your assets

Your basic objective in setting up your personal financial plan is to increase your assets and keep your liabilities to a minimum. Setting up such a plan includes closely analysing your income as well as your expenses. What creates income for you and what creates expenses? How can you start generating additional income?

Budgeting for investing

For instance, by budgeting a set amount of your income each month towards investing, you can begin to generate more income and assets. Investing your money means that you put this money towards a cause with the expectation that this cause will generate more money (a profit) later.

Become financially literate

Getting into the habit of regularly educating yourself on finance is possible at any stage in your life. Learning about finances itself is an essential investment in your financial future. Therefore, the next step after analysing your income and your expenses is to learn how to make the right financial decisions and to generate cash flow - incoming money - towards your income by investing.

To find out how you can take the first steps towards investing, read our next article on setting up a household budget.  

FURTHER READING

BOOKS

• Cagan, Michele CPA and Lariviere, Elisabeth - The Infographic Guide to Personal Finance: A Visual Reference for Everything You Need to Know
• Collins, Matthew - Personal Finance for Beginners - A Simple Guide to Take Control of Your Financial Situation