Difference between ‘assets’ and real assets

June 30th, 2008

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From our previous article, How do we prepare for a possible economic crisis?, one of our readers asked:

A lot of us, simply do not have free floating (saved) money to worry about. What we have, instead, are huge debts that are closely tied to the so-called, and as yet unrealised, ?equity? we are supposed to have in the assets that we borrowed against.

But for the rest, all I see is a sea of debt with an island in the hazy distance that is supposed to be my ?equity? in assets held hostage by banks as security. So, to simplify it to the bare bones, the first question for many is, not whether one should buy gold or silver, but whether one should liquidate assets in which one supposedly has some equity.

Before we continue, we must stress again that we are not providing financial advice of any sorts in this web publication. All views expressed are merely our own personal opinions. With this disclaimer, we can now proceed to what we think…

This question from our reader requires a long and thoughtful answer. Therefore, we will answer it over the course of a few articles.

First, we must be sure of the meaning of “asset.” This word is often misused and misunderstood, leading people to make the wrong investment decisions. We will use Rich Dad, Poor Dad‘s definition- an asset is something that puts money into your pocket regularly.

That definition may sound too simple, but many people do not really understand this concept, thinking that an ‘asset’ is something that can go up in price. That is why there are property speculators ‘investing’ in houses that are far overvalued and getting caught out in a property price bubble when the business cycle turns. In essence, the property price bubble is a Ponzi scheme that collapses when the economy runs out of money through a credit contraction brought about by the credit crisis or rising interest rates. If you read the newspapers today, you will find ‘investors’ bemoaning the horrible superannuation returns of the past financial year because the stock prices were ‘performing’ very badly. Fund managers are judged according to how prices of ‘assets’ under management ‘performs.’ As we said before in Harmful effects of inflation,

The surging asset prices (e.g. stocks, bonds, properties, commodities and yes, even artwork!) of the past several years are not signs of a strong economy. Rather, they are symptoms of inflation, brought about by speculation.

Without a proper understanding of what an asset is, many people mistook rising prices for wealth and could not see them for what they truly are- inflation. If an asset is something that can go up in price, then in this time of commodity price inflation, a sack of rice (or a bottle of vegetable oil, or a can of petrol, etc) is also an asset! In fact, there are plenty of ‘assets’ in Zimbabwe today, with the prices of stuffs going up exponentially.

If we return to the fundamental definition of an asset being something that puts money into your pocket periodically, then we put ourselves in the right frame of mind in evaluating the value of assets. Next article, we will talk about the value of assets.

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  • ckb

    Good start, but even that definition has too much potential for slip-and-slide.

    First, we should get clear about whether the ‘money in your pocket’ means some sort of gross income, or net icome. The difference between those possibilities can be huge.

    Second, even if we opt for the latter, the net, or positive cashflow definition of an asset, in the case of leverage, an asset can turn into a liability if interest rates go up. So, the investment property that produces you a positive cashflow at 7% interest, can easily turn into an ever worsening liability as you approch, say, 12%, or higher. So, this seems far from satisfactory.

    And, if we take, instead, what initially seemed even less attractive, the weaker meaning whereby any sort of income generation would qualify an investment an asset, the threshold for the problem starts even lower.

    I do not mean to be difficult, but I have always found the dichotomy of assets and liabilities vague and the line between them arbitrary. One could, of course, adopt a forgiving and flexible attitude towards these concepts and accept that what is an asset today can turn into a liability tomorrow, and vice versa, and simply live with it. This, in fact, is quite OK with me, but it would be futile to convince my bookkeeper and my accountant, let alone the Tax Office, of taking this as a working definition.

  • ckb

    Good start, but even that definition has too much potential for slip-and-slide.

    First, we should get clear about whether the ‘money in your pocket’ means some sort of gross income, or net icome. The difference between those possibilities can be huge.

    Second, even if we opt for the latter, the net, or positive cashflow definition of an asset, in the case of leverage, an asset can turn into a liability if interest rates go up. So, the investment property that produces you a positive cashflow at 7% interest, can easily turn into an ever worsening liability as you approch, say, 12%, or higher. So, this seems far from satisfactory.

    And, if we take, instead, what initially seemed even less attractive, the weaker meaning whereby any sort of income generation would qualify an investment an asset, the threshold for the problem starts even lower.

    I do not mean to be difficult, but I have always found the dichotomy of assets and liabilities vague and the line between them arbitrary. One could, of course, adopt a forgiving and flexible attitude towards these concepts and accept that what is an asset today can turn into a liability tomorrow, and vice versa, and simply live with it. This, in fact, is quite OK with me, but it would be futile to convince my bookkeeper and my accountant, let alone the Tax Office, of taking this as a working definition.

  • Hi ckb!

    First, we should get clear about whether the ?money in your pocket? means some sort of gross income, or net icome. The difference between those possibilities can be huge.

    That’s what we are about to talk about in the next article.

    The concept of net income (vs gross income) implies co-mingling of assets and liabilities together into a third concept called “equity”. The net income is the combined net cashflow of “equity” The problem is that this is the accounting definition of assets (accounting assets = liabilities + equity), which is not the definition used here. The accounting definition of asset causes confusion in our thinking. We hope that our readers will clear the deck of confusion here.

    Notice that a mortgage loan, that loan is a liability to you because it sucks money out of your pocket AND it is an asset to the bank because it puts money into its pocket.

  • Hi ckb!

    First, we should get clear about whether the ?money in your pocket? means some sort of gross income, or net icome. The difference between those possibilities can be huge.

    That’s what we are about to talk about in the next article.

    The concept of net income (vs gross income) implies co-mingling of assets and liabilities together into a third concept called “equity”. The net income is the combined net cashflow of “equity” The problem is that this is the accounting definition of assets (accounting assets = liabilities + equity), which is not the definition used here. The accounting definition of asset causes confusion in our thinking. We hope that our readers will clear the deck of confusion here.

    Notice that a mortgage loan, that loan is a liability to you because it sucks money out of your pocket AND it is an asset to the bank because it puts money into its pocket.