My first encounter with word asset was in primary school when one team mate said about another “he’s an asset on the team”. Big word to come from a little boy and at the time I didn’t know what it meant. I’ve met that word so many times after and I hope you have too. All the advice is buy assets. It’s great advice, the best advice. Firstly we need to understand what an asset really is.
Oxford and Cambridge
The Oxford dictionary defines an asset as a useful person or thing. While the Cambridge dictionary defines asset as a useful or valuable quality skill or person. This is a sufficient everyday definition until some crazy person runs around shouting “a house is not an asset”! Now we have to question everything we believed about money and assets in the first place. Was my primary school team mate a liar?
So we need to clear up the definition and explain why people can say your beautiful car is not an asset and still be allowed to walk the streets. And we will also look at what this means for your investment decisions.
The International Financial Reporting Standards are the guys who (largely) determine how the world deals with accounting issues. The definition of an asset for the IFRS is a resource controlled by an entity as a result of past events and from which future economic benefits are expected. Let’s break down the key points of this definition and apply it to our personal finances.
While this obvious for resources you own, control can also result in recognition of an asset if the benefits of control can flow to you.
Future economic benefits
This is perhaps the most important part of the definition. Expected future inflows, according to the IFRS future inflows are expected when probable. So when it is reasonable to believe that money will come to you as a result of control.
In contrast to assets are liabilities. According to the IFRS a liability is a present obligation arising from a past event, the settlement of which will result in economic outflows. Something that takes money away from you.
To drop the IFRS and speak plainly assets put money in your pocket, liabilities take money away.. Sounds simple so where’s the confusion? The confusion stems from how we look at money. Let’s look at some purchases people make and separate the wheat from the chaff.
A car is definitely a resource owned or controlled but ownership of a vehicle results in obligations including registration, insurance, maintenance costs. Our test simply put looks at the net position, so if it’s going to bring in more money than it takes out, you have an asset. Nowhere does this make sense than in Zimbabwe
This is perhaps the most controversial one. A quick look using our simplified test reveals that a house that is lived in is not an asset as per our criteria. It in fact better suits a liability as the obligations created such as rates and taxes in addition to running costs are considerable and pretty much forever.
There are exceptions of course. Firstly when the property is leased out and earning an amount sufficient to cover all associated costs and create a surplus. Secondly when it is purchased to be resold and this is where the confusion really comes in . The future economic benefit need only be expected but you really cannot expect the benefit until you at least put the house up for sale. Again consider the volatility of our environment and our relationship with pricing & currency.
Phones and gadgets
Well these should be an automatic no but there are exceptions to the rule. Yes, when you derive income from them. Don’t get too excited, my tablet that I’ve used to reply 3 work emails doesn’t count. I suppose what we need to understand about these objects is because they lose value very fast they are automatically resulting in outflows just by owning them. The same can be said for cars.
Shares and other financial instruments
Finally something that is clear cut. These are quite simply assets by any definition. Whether they are public (like ZSE) or private instruments the expectation of future inflows from their dividends and/or disposal is a reasonable assumption. Their value at any given time can be approximated based on a variety of methods. Contrast this with cars and gadgets which have values that can be best described as fluid.
So next time you are thinking of buying that “asset” apply this simple test;
- Will it bring in money?
- Is it reasonable to expect this money?
- Will it’s ownership result in money going out?
- What is the net position on a monthly basis?
It’s really simple but I’ve seen a lot of people who could’ve been saved by this simple framework had they possessed it at the time of purchase. This doesn’t take into account utility, only you can know that. I hope it helps you make better decisions.