I’ve often noticed how some people incorrectly use the word “invest.” The real word they were looking for was “purchase.” Nobody has ever invested in a new pair of shoes - no matter how good the sale was :-) Yet, I’ve heard that line far too many times. What is a true investment? How do we define an asset, and how does it differ from a liability? Stick around as we dissect the words invest, asset, and liability.
As a general word, an asset is used to define something positive, beneficial, or advantageous. A talented addition to a sports team is commonly referred to as an asset. We can also look at assets from an accounting point of view. Accountants term assets as anything that has a store of value and can be liquidated if necessary; this includes cash. The business balance sheet typically lists equipment such as vehicles and electronics under the asset column. All of the aforementioned interpretations of an asset are legit, and contextual in meaning. Let us explre the word “asset” as defined by InvestAssetWealth.
An asset is any purchase by which the net total of capital appreciation + (plus) generated income - (minus) necessary associated expenses increases over a realistic period of time.
Typically the “realistic timeframe” is much less than 10 years, but can be up to a maximum of 50 years thus allowing the investor to “realize” the increased value within their own lifetime. Necessary associated expenses are incurred as a direct result of the asset purchase, and may exist for the entire life of the asset.
So, lets talk about some examples of assets.
1) A stock is purchased for $10. Commission to buy or sell the stock is $5. The stock pays a yield of 15%. 1 year later the stock is worth $30. The net value is $30 (value of stock) + $1.50 (yield) - $5 (commission to buy) - $5 (commission to sell) = $21.50. This is indeed greater than the original value of $10, thus confirming the stock was an asset. Selling would be necessary in order for the investor to realize the profits.
Important: Obviously there could have been points in time during the year the stock was held in which the net value had decreased (for example, if the stock price dipped down within the first couple days of the purchase). During this depressed period of time, the stock would not have been an asset to the investor. However since the net value of the stock had increased by the time it was sold, it was indeed a solid asset.
2) A business is purchased for $10000. During the course of 1 year, the business generates $5000 in profits. At the end of the year, the business is sold for $7500 due to a recession in the economy. The net value of the asset at the time of sale is $7500 (value of business) + $5000 (profits generated by business and paid to the investor) - $0 (no additional expenses to the investor) = $12500. We have a net value that has increased by $2500; an asset to the investor.
An investment is simply the purchase of an asset.
Investments are made with the expectation of returns. Investors assess the risk vs. reward of every purchase they make with the expectation of a net value increase, while understanding the possibility of a net value decrease. There are no guarantees in life, but the intent of all true investments is to simply make money. And what makes money? Assets make money!
A liability is any purchase by which the net value decreases over time. It is essentially the opposite of an asset.
Liabilities are often items which depreciate quickly - things such as vehicles and computers. An accountant see’s an asset, yet an investor see’s a liability. Not convinced that your new vehicle is a liability? I know its shiny, goes fast, and looks expensive. But just add up the insurance, maintenance, and fuel expenses alone. Did I mention that your new car depreciated 25% when your drove it out of the dealership parking lot? Ouch!
Note: Some liabilities are further classified by InvestAssetWealth as necessities. A modestly priced base-model vehicle is understandably seen as necessary in North American society. Conversely, a $500000 Ferrari Millechili would do serious damage to ones net worth! Unnecessary liability!
In closing, lets think back to those new shoes that we’ve all bought on impulse. Did they increase in value? Not a chance (although they may have increased in smell :D). Did they generate income by themselves? I’d wager a bet of “no”. So were the shoes an asset? Nope. Therefore, the purchase of the shoes was not an investment; it was simply a purchase. That being said, if you walked into the store barefoot, the shoes would be a necessity. Necessary liabilities are unavoidable, and we all must purchase them from time to time. But make no mistake, we never invest in liabilities. An investment is the purchase of an asset, with the intention of making money.
Investing (in) Assets = Wealth
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