The term ‘asset’ gets thrown around in multiple contexts and quite frequently it is misidentified. So let’s first define what an asset is.
“An asset is a resource with economic value that one owns with the expectation that it will provide a future benefit.”
Investopedia
One key thing to take away from this definition is the expectation to provide future benefit. That benefit can be captured through various methods, collecting regular income (such as dividends or rent), selling the asset at a later date as it appreciates in value, or something that allows you to generate a cashflow (i.e. a piece of machinery that allows you to be in business).
Now that we understand what an asset is, let’s highlight some items that are NOT assets.
- A car that you own for personal needs is not an asset.
- A home that you live in is not an asset.
- Your job is not an asset.
- Cash is not an asset.
The first two are quickly disqualified as they do not generate a cashflow. A personal home (provided that none of it is rented out), although it may appreciate in value, is not an asset because you need to live somewhere. If you move out and rent the property out, then it becomes an asset.
The third item, your job, although it does provide a steady cashflow. It does not generate value on its own. You get paid only if you work.
Finally, cash does not generate income, it does not grow in value. Instead its value is slowly eroded by a well-known but poorly understood thing called inflation. However, cash is the easiest thing that can be converted into an asset!
Reasons why you should own assets
1. Assets generate value while you sleep
An asset will continue to generate value while you own it with little to no intervention. A stock position in a company will continue to create value as the underlying company continues to grow sales and deliver product and/or services. A rental property will generate rental revenue on a monthly basis. If you are spending hours supporting your asset(s), please reassess the situation to ensure that it is not a job in disguise.
2. Asset value increases faster than your salary
Asset values usually trend up. In short cycles they may actually lose value, however over the long run smart assets always go up. For example, the stock market (e.g. S&P 500) is unpredictable, yet over the long run it has averaged returns of 8-10% on an annual basis. This was achieved even with the dot com bubble and the great recession taken into account.
If you’re not convinced, just think how much the average home increased in value over the last 12 months? Now compare that against how much your salary has increased.
3. The gains compound
Compound interest is a powerful thing. Every dollar that you invest will generate value, and next year that gained value will generate value of its own. This perpetual cycle is compound interest. Play this scenario over 5, 10, 20, 30 year periods and you will begin to appreciate its effect. Given enough time, your portfolio growth will outpace your initial investment, and hopefully your current salary.
Bonus – favorable taxation
Everyone has to pay taxes. But wouldn’t it be nice if we could keep more? Holding assets can help. Your salary on the other hand is taxed at 22% (plus state tax) and higher for any income above ($41,775 [2022]). Long term assets (capital gains) are taxed at a 15% federal tax rate (plus state tax); short term capital gains are treated as regular income. Long term assets are those held for a year or longer, anything less than that is a short term asset. Qualified dividends are an exception to the rule, as they do not require the 365 day seasoning. Qualified dividends are taxed a little differently as well as they do take into account your income. However, for most readers that tax rate will be 15%, provided you make between $41,675 and $459,750.
In conclusion, an asset must be something that you own which has economic value and is expected to generate value over time. There is large spectrum of assets that vary in risk, attainability, and complexity. However, a diversified smart set of assets will always generate value over a long term, outperform your salary, and help generate wealth instead of lose value sitting in your bank account as cash.