The financial industry uses jargon and words that people in their normal day-to-day lives don’t use and are not fully conversant in. People simply don’t understand the meaning of words used. People do not have an up-to-date picture of their finances and make decisions on incomplete information and get themselves into deeper trouble.
Can you relate to this?
What exactly is income and wealth, and is there a difference?
What is an asset and what is a liability really? Do you know what you are worth financially?
First, let’s talk about taxable and non-taxable income.
Firstly, there is taxable income. Most countries allow some form of deductions, exemptions, and other allowances taken from your gross income. Your gross income, or gross earnings, refers to your total income before deducting anything.
In short, your taxable income is the amount of your gross income that is subject to income tax. Check with your tax office what they consider as taxable income.
Normally, the following counts towards your taxable income: your salary, wages, or any job-related income, tips, profits from stocks or real estate sales, winnings from the lottery and gambling, and even the cash value of bartered items.
In some countries cancelled debt counts as taxable income, which means you will pay tax on any debt forgiven.
Secondly, there is non-taxable income which is income that may be part of your gross income but your government does not tax you on it.
This includes income such as child support, proceeds from life insurance policies, inheritances, workers’ compensation payments, welfare benefits, compensation awarded as a result of physical injury, education scholarships or grants, and income paid to your retirement account.
Now, let’s talk about expenses.
Expenses will include items such as the cost of maintaining a home, rent or mortgage payments, utility bills, property insurance, and groceries.
Other expenses can include items such as personal care, clothing, medical costs, education costs, travel or vacations, money spent caring for pets, personal insurance such as life insurance.
This may further include buying and maintaining a vehicle and paying for insurance on it, or paying for public transportation.
It also includes buying items, such as decorations, for your home, going out for entertainment purposes, to the movies for instance, or eating at a restaurant.
Any money put into a savings account or a retirement plan is part of household expenses as well.
In other words, everything flowing out of your account is an expense.
Some of the above expenses are necessities but others are non-essential and wasteful and may get you into financial trouble. Perhaps you’re not even aware of all the money going to waste.
Do you know where every dollar you earn goes? Yes, or no?
When your expenses are less than your earnings, you have positive cash flow. You have negative cash flow when you spend more than what you earn.
The fact is that you will never be financially free if you do not have positive cash flow.
Even if your inflow and outflow only match, you are living from pay cheque to pay cheque. You must spend less than what you earn – you must live below your means.
The first thing you need to do to become financially free is to get positive cash flow!
How does your cash flow look? How much money do you have left at the end of the month?
Let us now turn our attention to assets and liabilities.
First, let us look at how an insurance company or your accountant would classify assets, i.e. “something you own”.
By bookkeeping standards, assets fall into two broad classes, namely financial and non-financial assets.
Financial assets include money held in savings and cheque accounts, negotiable certificates of deposit (NCD), savings bonds, stocks, retirement accounts, cash value of life insurance policies, trusts, annuities, commodity futures, royalties, awards from lawsuits and cash on hand.
Non-financial assets typically include residential and business properties, land and buildings, vehicles of all types, electronic equipment, art, jewellery, furniture, appliances, and collectibles.
By bookkeeping standards, liabilities include everything you owe someone else, i.e. the regular bills that you have to pay, including real estate loans, car loans, student loans, revolving charge accounts, such as credit cards and store cards, and lines of credit. For you to build your wealth you need to eliminate liabilities.
A mountain of debt in combination with the power of compound interest will destroy all your dreams about wealth and may lead to bankruptcy and foreclosure.
Now comes the interesting part. Bookkeeping standards are good and needed, but for bookkeeping, not for growing wealth.
I am in favour of, Rich-Dad-Poor-Dad author, Robert Kiyosaki’s view of assets and liabilities.
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In short, Rich Dad considers an asset as something that makes you money and a liability as something that costs you money.
For the purpose of creating wealth you too should adopt this view. This definition of an asset will exclude your car and your residence because they cause an outflow of cash. Certain other consumer items such as clothing, a stereo, TV, and so forth also do not count as assets because you can’t live off them unless you plan to sell them.
“True” assets are assets that bring you an income – that is money working for you.
How many “true” assets do you have that are increasing your earnings? Are you sure all your assets are “true” assets?
The next important concept is net worth. It is easy to calculate your net worth. Add all of your assets and subtract all your liabilities and you get your net worth.
To Win The Wealth Game, you need this number to be positive and to grow each year.
Having this knowledge is good. Applying this knowledge is great. But let me leave you with the following thoughts:
Wealth is much more than money. It includes things that money can never buy.
People without money are often happier than those with tons of money. Some people with an average income do great things, while others squander their money.
Real wealth allows you to live the life you want; to pursue your passions and spend time on what is important in your life. Financial freedom is about having choices; it is about living life on your terms.