Know what your assets and liabilities are
Bad idea to build assets with borrowed money
Understanding what you own - your assets - compared to what you owe - your liabilities, is an important step in your financial journey.
The financial choices you make shape your overall net worth, which is a snapshot of your finances at any given time. Understanding what you own - your assets - compared to what you owe - your liabilities, is an important step in your financial journey.
However, because people have different ideas about how wealth is built, there can be conflicting ideas about what is an asset or liability.
“An asset is defined as something of value which can be used to generate a profit, an income or can be converted into cash. A liability is the debt you take on in the process of acquiring an asset or something of value, which means that there is a duty to repay the debt,” Anelisa Mti, advisory partner at Citadel, explains.
From an accounting perspective, a house, a car and cellphone would be deemed assets, while savings and investments are seen as immediate assets due to the interest earned on savings and dividends on investments, Mti says.
“For most people earning a salary, their biggest asset as well as their biggest liability would be their residence. People want to acquire a house as a form of security but to acquire the property you need to take out a bond or home loan paid over 20 or 30 years; this loan is a liability, she explains.
Keep in mind that it is possible to turn an asset into a liability and vice versa. A property can become a liability if you cannot afford its upkeep and take on additional credit with higher interest rates to maintain it.
Ester Ochse, product head at FNB Money Management explains that understanding the additional cost of owning an asset is important.
“You need to be able to repay the bond, pay rates and electricity as well as furnish the property, pay for insurance and other expenses like maintenance,” Ochse says.
A personal financial statement shows the assets you own as well as your liabilities, which is the money you owe. It’s a great tool to determine your financial standing.Ester Ochse, product head at FNB Money Management
Mti cites life insurance cover on your bond to ensure the bank is repaid in the event of your death as an example of turning a liability into an asset.
“If you keep your life cover even after your bond is repaid, this life insurance policy would become an asset, as the liability of debt it was insuring against would be repaid,” Mti says.
A better option however would be to redirect what you spend on premiums towards savings or investments instead.
Once you have a clear understanding of your assets and liabilities, Ochse suggests draw up a personal financial statement that gives you an idea of your overall net worth.
“A personal financial statement shows the assets you own as well as your liabilities, which is the money you owe. It’s a great tool to determine your financial standing,” she says.
Mutado Mahaba, chief executive officer and co-founder of short-term insurer Solvency says a personal financial statement is usually used when you’re applying for credit - a positive net worth shows your ability to repay the loan.
“Besides applying for credit, a personal financial statement can help you track your net worth over time. It is useful to track whether you are leaning towards more liabilities than assets, so that you can take action to correct this,” says Mahaba.
For example, if you have extra space in your home, you can rent it out to help pay off your bond quicker. If you have a holiday home that you don’t use, you could rent it out for the months that you don’t need it to help repay your bond, Ochse suggests.
Mahaba adds that you should also focus on increasing your cash in hand as well as increasing the value of the assets you already own. He, however, discourages taking the risk of increasing your liabilities in a bid to attain more assets, i.e. borrowing money to buy them.
“You should be careful that in an attempt to increase your assets you do not increase your liabilities. Your net worth increases if the increase in the asset is greater than the increase in liability,” Mahaba cautions.
He suggests you assess your personal financial statement every six months to get a clear picture on whether you need to focus on attaining more assets or decreasing your liability in the year ahead.