Understanding Money

Money is damn important it seems. In fact out all the tangible superficial things in the world, I would say money is the most important thing to understand out there. What do I mean by “out there?” I mean the real world after graduating high school or college. The real world begins at different times for different people, but that is another blog post. I deal with understanding the monetary value of organization on a daily basis in my profession. With that said I have come to a few conclusions. Putting it extremely simply, value comes from what you own, what you owe, and what you make. These attributes must all be taken into consideration when deriving a value from a company or an individual’s financial value. Let’s assign words to these attributes to further clarify their meaning.

Assets

Assets are economic resources that provide value. From an accounting standpoint assets represent ownership in something that provides a value that could be converted into cash. A lot of people solely value their “social class” on what they own. To them a 3,000 square foot house means they are rich. Or buying a new car every year means that you are rich. A lot of people confuse consumption with assets. Yes your CPA/Broker/Financial Planner will tell you those things are assets, but from a logical standpoint they are liabilities. There is one asset everyone is born with and that it their time.

Liabilities

Liabilities are obligations an individual or organization has made. They are obligations that must be met, but they usually have equal value to the asset. In a perfect world a mortgage balance will equal the value of a house purchased. The only way to reduce the net liability is to acquire more assets (ie. cash) to service the debt. Your asset may also grow in value as well due to inflation or speculative appreciation.

Income/Expenses

Income and expenses come from what you make. Income is a derivative of assets and expenses are derivatives of liabilities. In order to assess whether something is indeed an Asset or liability, one needs to determine if the net of the attributes attached whatever you purchase falls in the Asset class or Liability class. For example if you have a house that is worth 200K with a loan of (180k), for the current year your interest expense/property tax expense was (12k), your regular housing expenses were (15k) and you rent a room for an annual cash flow of 3.6k. The calculation would look something like this:

200,000-180,000-12,000-15,000+3,600=-3,400

As you can see the number is negative, therefore from a logical perspective, this house is a liability. This does not following Accounting regulations, but from an operational standpoint this is true. After viewing money from this perspective it has changed my wants and needs.

When I initially started my profession I felt the need to go out in the world and buy things based on how others would perceive me. This continued until I realized through a sort of morbid epiphany that buying all those things would not make me happy. In fact that lifestyle would enslave me to my career with the extra pressure to raise my income in a significant incremental manner each year in order to maintain the false lifestyle that others expected me to engage in. I think it is very hard to divert from this line of thinking due to the incredible influence advertisers and society exhibit on the average person. My moment of clarity came when I realized that most people save less than 10% of their income and therefore have to work until their sixties or later.

While I do enjoy my profession due to the learning opportunity it provides me, I do not want to work 40 years only to have the last decade or two of my life available for my true passions. I realized that I have control over this outcome. All I have to do is increase my rate of savings in order to experience true financial freedom. When the passive income of my investments covers my expenses I am free to pursue whatever interest despite its economic rewards. Also I can be aggressive and engage in actual business ventures that are risky, but I have always wanted to do. This can only happen in a capitalist society, which we happen to live in for the time being. I feel that the general inclination society feeds us is to be a cog in the wheel and never be the person who set the wheel in motion.