Before we dive deeper into the different types of assets you could potentially buy throughout life, I wanted to first discuss and breakdown what an asset actually is as well as provide a valuable framework on the smart way to analyse and acquire assets.
How The Accountants Define An Asset?
An asset is either a tangible (something you can hold/touch) or intangible (something you can’t hold/touch) economic resource that can be owned or controlled to produce future positive value. Simply stated, in financial accounting terms, assets represent value of ownership that can be converted into cash.
What An Asset Actually Is..
Put simply, an asset is something that makes you feel MORE secure, not less.
Acquiring an asset is personal. The same asset can make you feel more secure or less secure depending on your personal circumstances. For example, the same physical asset of a house can be an asset or a liability depending on how much money you owe on the house. If you have paid off your loan and own your house outright, this is an asset to you as it provides you security and a lifestyle benefit of living in your own house with no rent or loan repayments. Conversely, the same house could be a liability to you if you have a high loan to value ratio (e.g. 90% loan to 10% equity) at the same time as losing your job (ability to service the debt is gone) and/or interest rates rise (having to pay more interest on the same amount of debt).
PIE Assets (Your Smart Asset Framework)
MMMMHHHH PIE – who doesn’t love a good old Aussie pie!
Wealth PIE Asset Framework: Having different assets and classifying assets based on their benefit is very important. The three main ways for an asset to make you feel more secure include:
- Assets for lifestyle (Personal (P) Assets) – Provide a lifestyle benefit (personal use, enjoyment or benefit) such as a house, furniture, clothing, luxuries/toys or a car. Personal assets are wanted for security and to live your life. They are not going to provide any income, and if they go up in value, it doesn’t mean much as they are generally assets not to be sold. Your aim for the Personal (P) asset component of your Wealth PIE is for no debt owed on these assets over your lifetime.
- Assets for cash flow (Income (I) Assets) – Cash flow income includes interest from bank accounts, dividends/distributions from shares/bonds, profits from a business or rental income from a commercial property. These assets are your most important assets. They are key for financial freedom as they allow you to earn passive income which allow you to own your time (The World’s Most Valuable Commodity: Time). Unfortunately, most people spend their whole working life avoiding thinking about income assets and then upon retirement, suddenly want an income from their investments to sustain them in retirement. For example, a residential investment property, while often being a good way to grow your wealth, is rarely a good income investment. This brings us to the final component of the Wealth PIE..
- Assets for capital gain (Equity (E) Assets) – An equity asset is something you buy today because you expect it to grow in value in the future. As the value of the asset grows, your equity increases (the increased value minus debt owed) and thereby increases your wealth e.g. investment property, land/development or superannuation. These equity assets do not provide you with an income now. These assets are for capital gain. Sometimes equity assets can cost you money to hold e.g. negatively geared investment properties cost to hold (interest repayments > rental income) each year with the hope that they go up in value overtime. Your goal for Equity Assets in the Wealth PIE is not to hold too much debt with the aim of holding them roughly at neutral cost. This allows you to never be in a position where your forced to sell, thereby allowing them time to grow in value.
- Understanding the Wealth PIE enables you to determine why you are buying an asset and what you hope to achieve by making that purchase.
- Think about assets based on their benefit to you. Don’t let your circumstances turn an asset into a liability.
- You want security from your personal assets, cash flow from your income assets to eventually replace income from your job and growth from equity assets to increase your wealth. Aim for something in each sector throughout your life.
- Cash flow income assets are the most important of all the asset types, not just at retirement, but throughout your life. It is these assets that allow you to own your own time, and to not have to exchange your time for money.
- If you can buy an asset that has good cash flow, good capital growth and has underlying quality/security, then you have all bases covered.
- The Wealth PIE model is a logical framework to analyse and acquire assets for financial security and freedom as you move through life.