Why measure your assets and liabilities?
Put simply, your assets can help you to achieve your future financial goals, and your liabilities will hold you back. Assets can help you grow your income, and liabilities will grow your expenditure. Not only that, but your liabilities could also hold back your ability to grow your future assets, and thenby affect your future income!
What are your assets?
You should be able to list all your assets. This would include the following, but could be anything of value: Property, pensions, investments, bank accounts, and businesses.
Therefore, it should be reliably easy for you to estimate how much each of these categories are worth.
Good assets and bad assets
This is where a lot of people fall down in their planning. You need to think about how your assets affect the rest of your financial life.
When we ask most people what is their biggest asset, what do you think is their response? You would probably say your house. Well, as far as we are concerned, your house is your largest liability.
OK, we realize that a house is an asset in the traditional sense, but it is also a huge drain on your resources. Think about it for a minute. If you have a mortgage, where do you think your bank puts your mortgage / house? That's right, in their assets. That makes it a liability for you. Also, if you want to cash in that asset, where will you live? Well, you will need to buy another house, so it does not really count for financial planning purposes. Of course, if you downsize you could release some equity, but how many people actually choose to do this? Along with a house comes a lot of expenditure – council tax, mortgage, utilities, maintenance etc.
Another big asset for many people are their pension funds. The trouble with pensions is that the Government tells you what you can and can not do with them. You can not take benefits until at least age 55, and only 25% can be taken back from the fund; the rest buys and income. For some people this inflexibility means that pensions are not as desirable as other asset types. Of course, pensions do have a place in your plan, with excellent benefits such as tax relief.
Your business may have a value (although how much depends on what someone else may be prepared to pay for it). However, it can be dangerous to assume that your business will grow at a uniform rate until you come to sell. Your business may be worth a lot less than you think. We prefer to think of businesses as cash generation tools for income, which can go towards creating more of the correct asset types below.
Readily realizable, income producing assets
These assets are the holy grail of financial planning. You need to work on building up assets which could be cashed in at any point and spent on your lifestyle. This gives them flexibility to be used when you might need them, and also diversifies away from less flexible assets as outlined above.
If you then combine these assets with income generating capacity, this will only serve to increase your future income, then growing your future assets. This is the power of compound interest in action, working for your benefit. Good examples of such assets might be:
– Rented investment property
– Shares / ISAs / other investments
– Bank accounts
What are your liabilities?
In modern times is essentially unheard of to be completely debt free, and indeed this can come with some problems. The trouble is that this affects your ability to grow enough assets (of the right type) to be able to fund your future lifestyle without having to work.
Typical liabilities include mortgages, credit cards and loans.
What to do about (bad) liabilities
Our suggestion is that you should always aim to pay off debts as quickly as possible. This will serve you well in the long term as the interest saved can be put towards your lifestyle now in the form of expenditure, or to building assets for your financial future. Generally speaking, debt costs more than the gains from savings or investments.
Remember that your liabilities are someone else's assets. The sooner you pay off your debts the better off you will be.
In certain cases, it can be good to have debts. If someone else is paying that debt (such as a rental property) then this can be a good long term strategy towards capital growth. However, this does come with risks so be careful to understand them.
You should put together a list of all your assets, plus all your liabilities. Then you can break these down into good and bad types, focusing on reducing debts, and increasing readily realizable income producing assets.