Your Home Is Not An Asset
Back in high school accounting (urgh) I was told that an asset is something that you own and a liability is something that you owe.
I accepted that as fact. After all, who was I to question the powers that be?
But that little “fact” neglects one crucial factor – a vital distinction that makes all the difference.
An asset is something you own that creates value for you. Merely owning something doesn’t necessarily mean that it’s expanding your wealth or making you money.
This critical distinction is one of the primary reason that so many people spend their lives filling up their wealth pantry with liabilities (things that cause money to flow out of their lives) believing they are filling their lives with “assets” – and only discovering too late that they are effectively broke.
It’s absolutely key, when you create your wealth plan, that you understand this distinction.
A real asset brings money
into your life. Anything that
makes money flow out
is a liability.
With this understanding you can start putting things in the correct drawer – you can figure out precisely whether the things you are spending your money on are taking you to wealth heaven or money hell.
The most common area where people get this wrong – and incorrectly sum up their perceived wealth – is around the house they live in.
➤ Here’s the truth bomb…
Your Home Is Not An Asset
Owning your own home can be a whole bunch of things… but “an asset that contributes to your financial freedom” is NOT one of them.
Mostly, a home is a big liability.
Even when it’s paid off, as long as it does not generate any income for you (and costs you every month in council taxes, utilities, insurances and maintenance) – it is absolutely not an asset.
Remember, a liability is something that makes money flow out of your life.
Your home is NOT a wealth-generating asset because…
- Income test: as long as you live in your home, you cannot earn income from it
- Utility test: while you stay in your house (and you need a roof over your head) you can’t sell it to access any value growth
- Capital growth test: assuming you want to maintain the lifestyle and level of home you live in when you achieve your financial freedom, any home equivalent to the one you are in will cost you the same or more
Your home is a liability because…
- If you have a mortgage on your home you are paying interest on the loan
- Your house costs you every month in rates, taxes, maintenance and insurance
- It costs you significant sums to buy and sell (property transaction costs are high)
One of the most insidious wealth destroyers is people not understanding this and believing that a bigger house is a key part of a wealth strategy.
Unfortunately, there is also an underlying societal belief that it’s a sign of success.
The allure of a bigger, better house
Many people are seduced by the idea that progressing to a more expensive house means they are securing a bigger asset. However, they are actually digging themselves into a bigger financial problem.
The poverty cycle looks something like this…
You keep moving up, from a one bedroom flat to a terrace, to a free-standing bungalow, to a better suburb. Due to complete naivety, your money is flowing into something which you believe is an asset. But actually you are now trapped, because unless you sell that property and downgrade, you have nothing that can bring income into your life. So you have to keep earning money the hard way.
➤ This is the trap of the aspiring middle class.
The norm might be a 20 or 25 year mortgage, but the scary reality is that after 20 years of being home owners most people still owe huge amounts on their home loans because of this pattern of “upgrading” (and sometimes refinancing to fund consumption spending).
In most of the western world, people move on average every seven years – upgrading each time to a new house. With each move they get a new mortgage – not realising that even though they have a bigger property, a “better” asset, all they are really doing is expanding their liability drawer.
This is because if you’re moving every seven years, you have barely reduced the capital on the mortgage debt. Mostly, you’ve just been paying off interest.
The availability of interest-only mortgages on principal residences has made this ever scarier. Back in 2017, tens of thousands of buyers who had opted for interest-only mortgages when property prices peaked in 2007, discovered their properties were not only worth less than they paid for them – ten years later – they actually still owed more than their homes were worth!
This is what happens when you don’t understand the fundamental difference between a real asset and a liability.
Back in 2017, many people were forced to sell their properties and use other money to pay the shortfall still owed to the bank. They were left with no home and no assets – possibly still more debt. All they achieved was paying exceptionally expensive “rent” for 10 years – while also being responsible for all the costs on the house, like maintenance (which the landlord pays for if you are actually renting). And, naively, they thought they were buying an asset.
Don’t get me wrong – I love owning my own home. Just don’t be misled into believing your home is a key wealth-creating asset.
Having the security of a roof over your head that nobody can take away is also a vital part of your financial well-being. And I encourage people to buy and pay off their homes.
Don’t believe your house is something that goes into your asset pot as part of your wealth strategy.
Don’t keep upgrading to a bigger and bigger house unless, at the same time, you’re putting money at a greater rate towards proper wealth generating assets that can bring income into your life and feed you when you no longer feel like working to earn.
If you believe your home is a key asset you could end up with a fancy home but no food on the table.
Investment property
Investment property is something entirely different. This is indeed an asset that can bring in income.
Property is such a great investment because it’s the easiest asset class in which to use leverage. In other words, you can use debt in a way that expands your wealth rather than destroys it.
Leveraging – using debt to accelerate your wealth – is not something that should be entered into lightly. You have to research what you are buying and what the investment return will be.
The key with investment property is to understand that everything is in the numbers. Put aside all your beliefs and emotions and just look at whether it makes financial sense.
Many owners of investment property don’t understand the importance of running this asset like a business – and this is because many become “property investors” by accident.
For instance, they start renting out the apartment they couldn’t sell when they got married or they inherited from great aunt Mabel when she died, but they never really understood the numbers.
Just owning a property doesn't make you a property investor, let alone a good one.
The most important parts of being a good property investor are:
- understanding what you are want from a specific investment and how it will contribute to your financial freedom plan
- knowing how to achieve that requirement (skills)
- ensuring the financial rewards significantly outpace the risk of taking on debt to leverage wealth expansion
The most important part of being a good property investor is understanding the risk and reward balance of taking on debt.
Leverage is like fire
It can burn you… or it can warm and protect you. You must understand how to direct it and manage it to ensure it is a positive force in your life.
