013, Mortgaging a House

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So, we covered ratios in the last post. The focus of that post was to show you the basics of a ratio for buying a house. Now you know and understand the ratios that are recommended in relation to your income. You understand that the 20% recommended down payment is the minimum you should put down on a house. Let’s run through a few examples to show you the impacts of a few scenarios. Sometimes a picture is worth a lot of words. In this case, the picture will be a spreadsheet. Before we get started, here are some of the areas we’ll cover.

I ran all of the calculations through Mortgagecalculator.org. It has the most complete variables necessary to truly capture all of the costs. Be wary of the bank calculators that only show principle and interest. While that’s a big portion of your monthly rate, it’s not the whole picture. So, I’m going to lay out a few things in this post to help you truly capture the total costs you can expect.

First, there’s the purchase price. You may hear people say things like “I paid $200,000 for the house”. They are referring to the purchase price. By the end of this post, you will know the cost of the house will be much more than the purchase price… unless you pay in cash.

Then there’s the down payment. You’ll want to put 20% or more down on a house so you avoid paying PMI (Private Mortgage Insurance). Remember that’s where you get to pay for the bank’s insurance in case you don’t make good on your money. That 20% should be your minimum. You can put down as much more as you want.

Next comes taxes. You can’t get away from taxes. Taxes can be a considerable expense…especially in Texas, where I’m writing this post. What Texas loses in income tax, they make up for in property taxes.

You’ll also want to have insurance. This isn’t the PMI insurance. This is the homeowner’s insurance that you pay for things like a hail storm that trashes your roof, fence, etc. The bank will require you to have insurance if you finance. If you pay in cash, it’s a good idea to pay just to protect your home from an unexpected diseaster.

What we’ve covered above is referred to as PMTI. PITI is simply Principle, Interest, Taxes and Insurance. Everyone will pay those when financing a home. But don’t forget or confuse PITI with PMI. Remember PMI is that insurance for the bank that you get to pay. So, the total monthly cost will be PMTI plus PMI. The less you put down the more PMI’s cost goes up.

In order to show the differences in PMTI plus PMI, I’ll set a few variables so you can see the impact of the changes. I’ll also randomly choose Grand Prairie, Tx as our city of choice to nail down the exact taxes for a property. Limiting the variables should help you see the long term impacts to your finances for the choices you make.

The house will be a $200,000 house in Grand Prairie, Tx. The interest rate is going to be set to 4.33% which is fairly close to the current rate. Your rate will likely vary somewhat based on down payment and your credit score. So, 4.33% is good for illustration purposes. The property taxes for Grand Prairie are 2.921736% of your home value or $5,843.47 every year. That amount will be divided by twelve and added to your monthly payment. Homeowner’s insurance is set at $1,000 per year. Again this will be broken down and spread across your monthly payments. The three scenarios will be putting 5%, 10%, 20% down for your down payment.  The Term will also be either a 30 year or 15 year fixed rate mortgage.

Price Down Pmt % Down Term (yrs) # PMI Pmts Montly Pmt Total PMI Pd Total Int Paid Cost for House
$200,000.00 $10,000.00 5% 30 79 $1,592.98 $7,679.17 $149,698.07 $357,377.24
$200,000.00 $20,000.00 10% 30 71 $1,539.23 $5,325.00 $141,819.22 $347,144.22
$200,000.00 $30,000.00 15% 30 40 $1,485.40 $2,833.33 $133,940.37 $336,773.70
$200,000.00 $40,000.00 20% 30 0 $1,364.90 $0.00 $126,061.53 $326,061.53
$200,000.00 $10,000.00 5% 15 37 $2,086.49 $2,929.17 $68,666.11 $271,595.28
$200,000.00 $20,000.00 10% 15 26 $2,006.69 $1,950.00 $65,052.11 $267,002.11
$200,000.00 $30,000.00 15% 15 14 $1,926.89 $916.70 $61,438.10 $262,354.80
$200,000.00 $40,000.00 20% 15 0 $1,780.42 $0.00 $57,824.10 $257,824.10

Take a good look at the chart.  Study it for a bit and see if you can find the Big Rocks.

The first thing I see is that the final cost for the house could be anywhere from $257,824.10 to $357,377.24.  So, depending on how you set up financing for your house, you could pay a lot more.  Maybe this would help with some perspective on just how much that is.  Let’s say you make $57,000 per year.  If you are inefficient you would work for more than 3 years just to pay for the interest and PMI if you put minimal down and finance for 30 years.  You’d only have to work for one year to pay for the interest if you put 20% down and got a 15 year mortgage.

The second thing I see is that by far, the biggest difference in what you pay in interest is determined by the length of financing.  The longer you finance, the more you pay in interest.  Many folks say that they will finance for 30 years and pay early.  Statistically, they don’t though.  So, if you are in that small percentage, you’re likely not. I tried that and didn’t do well.  It wasn’t until I locked myself into the 15 year mortgage that I actually stuck to it.

The last thing I see is more of a reflection.  Being in the military, I’ve never truly owned any houses. I mortgaged them.  So, I’ve pretty much have been paying interest for most of my adult life.  While I did make money on every house I’ve mortgaged, it was done through improvements, etc.  I’ve never run the numbers, but I’d be lucky to break even considering all the interest I paid.  I wonder if I would have come out cheaper if I only rented and paid cash for a house.

So, as you can see from the chart above, there’s a lot of ways you can buy a house. This post points out a few different ways and for many different lengths of time.  Use this information and the thoughts to do it as efficiently as you possible can.  In just this one example, it could mean you save about $100,000.  What can you do with $100,000????

You now have the tools to make an efficient decision. Don’t be Average!

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011, Enough Already

How much is enough?  Since a home and vehicles can be such a large part of your expenses, especially when you are young, let’s address that first. You surely don’t need the excessive stuff above. You may want it, but you don’t need it.

How much house is enough? Warren Buffet is a extremely rich guy. If you don’t know him, take a few minutes on google and check him out. He lives in house that’s .001 Percent of his Net Worth. Think about that for a second to let it sink in. For some perspective, if your net worth was $1,000,000 your house would be $10 ($1,000,000 X .00001). Yep, that’s ten dollars. The $10 represents how difficult it would be to purchase the house from your cash or investments. This house he bought in the 1950s is an insignificant part of his wealth. He could afford a way more expensive house if he wanted. He’s said he’s happy where he lives. If he felt he could be happier in another house, he would move. But he’s content. There’s no need for him to spend any more to chase a bigger house to keep up with others. He has what he needs and wants.

Granted, he’s worth $60-80 billion, so he’d need a massive house to even begin to approach 1% of his net worth. But that’s not the point necessarily. When you have enough, you don’t need more. When you are content, you don’t need more. When you are happy, you don’t need more. That’s my point.

You’ve often heard things like “your home is your biggest investment”. While your house is an appreciating asset, it doesn’t generate any income. Money is tied up in your house where you can’t spend it or truly invest it. Practically, that means that if your home is your biggest investment, more than half of your net worth isn’t going to generate income. Having that much of your net worth inaccessible and tied up means that you can’t spend it. It also means that it’s not generating income. So, you’ll have to work longer to build assets that can actually generate cash either now or in retirement. That’s the classic house rich, money poor scenario. You have an expensive house, but you don’t have much money for other things like properly investing for your future. Being house rich can severely limit your flexibility to get ahead financially.

This is really amplified when you are young. Your young years can have the most impact on your wealth in retirement when you invest efficiently. When you neglect your retirement in your early years, it’s much harder to catch up due to the time that has passed. The compounding interest from these early years really help to build up an investment nest egg of investments to carry you through your retirement years. Don’t become house rich and cash poor.

Here’s a great article looking at home ownership in total. Avoid the Dream House Trap. It talks about how an expensive house can strap you with large expenses. Those expenses, if not properly balanced against your income, will be felt financially a lot more. It will limit your ability to have flexibility to properly invest in other income generating assets to help you through retirement. The Average people in America frequently overlook how a house can trap you in the rat race just to stay afloat.

You need a roof over your head to shelter yourself from the elements. People do live in grass huts, modest homes and mansions. They all provide the basic requirements of shelter to keep you alive. People are also happy in each of those examples. Each example is also more costly. Grass huts are cheap, modest homes are reasonable, and mansions are extremely expensive. So, choose your housing carefully without overestimating your needs.

Next, let’s talk about cars.  We’ve touched on those before.  This is likely the second biggest expense that can cost lots of money if not done smartly. Since I’ve been into Choose FI a lot lately, here is an article about new cars and here’s a podcast if you listen to those.  The bottom line is that your transportation costs can eat up quite a bit of your income.

Over the course of your, at least 40 years of driving, decisions you make can literally cost you hundreds of thousands of dollars if you are not wise in your choices.  Those hundreds of thousands of dollars can either boost your income during retirement or drag you down.  The choice is yours. If you haven’t read my article about the brand new car I bought, please go back and read my post.  Buying a new car was not a good financial move for me.

You do need transportation. Most will drive cars or trucks versus mopeds or bicycles. Just as in houses, the choices vary widely. They will impact your finances one way or another. Make well informed decision on how your choices will impact your finances. A cheap used car can get you from point A to point B just as well as a brand new high dollar sports car. So, it’s truly up to you which path you choose. Choose wisely and position yourself for success in retirement.

These two major expenses can make or break your finances in the long run. They are the Big Rocks. So, make wise decisions based on facts and solid information that will meet your financial goals. Don’t overestimate your needs and max out your wants. Find the sweet spot that can work for you. If you have to have the cat’s pajamas, you’ll pay more for things at the expense of your financial security in your later years.

Make finding contentment a goal with whatever you have.

006, Always “Bee” Learning

In the first five blog posts we’ve covered the basics. As was mentioned you can literally get advanced degrees on this stuff. The degrees don’t guarantee that you’ll be successful. Nothing really does. However, once you have a solid understanding of the basics, continue to learn. Strive to learn new things throughout your life. The more you know, the more likely you’ll make a well informed decision. The more you make well informed decisions, the higher your chances of success will be.

In today’s fast paced environment continuously learning is more accessible than ever before. Frequently, that learning doesn’t even have the high cost of a college education. There are websites for almost any topic you can think of to learn about. Granted, not all are great. But a website that doesn’t deliver will quickly be left in the dust by good ones. With the advancements in equipment and the ease of publishing something on the internet, a crowd of followers will point out any mistakes or poorly supported ideas presented as facts quickly. So, if you search for educational based websites that have a large following you’ll generally wind up with sound advice. When something is presented, you can cross check facts with another website quickly as well. Sitting in uncomfortable chairs listening to an instructor is not the only way to get educated today.

Podcasts are another development in recent years. Yes, I’ve been learning before podcasts were available. But you don’t have to even read websites if reading isn’t your thing. Some people learn from reading and some from listening. Many of the websites out there on financial independence and personal finance have both websites and podcasts. The podcasts range from just the host’s opinion, experiences, or advice to discussions among a group of people. Often times the guest hosts will either be someone who has achieved success or are well on their way. The guest could also be the authors of books, other podcasts, or other experts in the topic of the day.

Audio Books are another option to learn. While websites and podcasts can be very educational, the author needs a little more room to explore or explain the topics. Podcasts and websites tend to be more focused on a particular topic in a format that’s a quick read or listen. But a book isn’t limited to those formats. They can be as detailed as necessary to fully explain complex topics, stories, or ideas.

By now, you may be questioning the amount of time required to actually learn personal finance and financial independence. Everyone is working these days. Generally married couples both work too. So, how can you get to advance your education? When will you find the time?

My morning commute is about 45 minutes. During that time, I’m usually listening to a podcast of some kind to learn something new. Over the years there have been many topics I’ve leaned about on this commute. Dave Ramsey Podcasts about how to get out of debt when in debt. Choose FI and the Mad FIentist are podcasts about personal finance. Bigger Pockets is about real estate investing. I’ve also listened to many podcasts about deer hunting, turkey hunting, and even cooking. So, rather than just listen to the latest song by a random artist, I’m learning new stuff on the podcasts. If you can think of a topic, chances are there is a podcast about it.

Podcasts can also be listened to during other times. Anytime you can wear headphones, you can learn. Instead of being that person bobbing his head up and down in ignorance, learn something. You can learn while exercising, while your partner is watching TV, or even sneak in a quick topic in a waiting room. You may even be able to listen to a podcast in a deer stand! Just make sure you download it first if there’s no cell coverage in the woods.

I’m also an early riser. Maybe you’re a night owl. Whatever your schedule is, carve some time out to better yourself either before the kids or wife get up or after he or she goes to bed. If you are going to get ahead in life, you need to spend some time educating yourself. Early or late in the day is generally a good time to sit alone and learn.

Almost all of this information is available for free, in many formats, and pretty much hassle free. Just as you want your finances to be efficient, so should your learning. It isn’t necessary to lock yourself in a classroom, office, or basement to learn. Don’t be stung by wasting your time being idle, learn something. Look for opportunities to be efficient with your time and always be learning.

Resources, Stepping Stones for Success

If you just skim things, click on the books to be taken to Amazon and you can buy the book directly from the link and have it delivered straight to you door.

Here are a few of the many books I’ve read over the years. They are very good books that have had an impact on me and my personal finances. I wouldn’t recommend them if I didn’t read them and they were worth every penny. I assure you that if you buy, read and apply the books, they are worth more than the cover price. You won’t get a check, you can’t sell them, and they aren’t going to magically turn into money. But when you understand the ideas in them, you’ll make more on interest, dividends, or growth of your investments. You will also save many more times their value by reducing how much you pay in interest over your life. Remember, you don’t have to do everything exactly correct in every detail. You only have to get the Big Rocks right to reap significant financial benefits from them.

I also explain a little bit of each book to help guide your through them. Depending on what you are seeking, one may be more right for wherever you are in your financial standing.

I’ll update these books periodically when a book or something catches my attention.

Total Money Makeover, Dave Ramsey

This is a tried and true guide to getting out of debt. Dave explains in simple terms the quickest way to pay down, and eventually pay off your lenders. It’s a 7 step program. I highly recommend tackling the first three as fast as possible.

The Wealthy Barber, David Chilton

The core of this book is getting the Big Rocks right. It shows shows that you don’t have to have a big income to become wealthy. It covers debt, investing, and even keeping living costs efficient. This is a quick and easy read.

The Millionaire Next Door, Thomas Stanley and William Danko

The authors studied self made millionaires for over 20 years. They explain several common characteristics of what made the millionaires, well millionaires. You may be shocked that many self made millionaires may look like every other person in your neighborhood. He or she was just better and more efficient with their personal finances. It’s a really good read too.

Your Money or Your Life, Vicky Robin

Vicky takes a very unique look at the value placed on time and money. The first several chapters are a bit loose for me. But then it gets into some really interesting topics explaining how money and time are intertwined. It goes into quite some detail to guide you the true payment for your time from your employer or business. There are examples that lay out the details to get the true monetary benefit of working. It’s worth a read or two.

Full disclosure notice: The above books are links from the Amazon Affiliate advertiser program. I do get a small percentage if of the sale if you use the links above to purchase the book or books.

004, Liabilities

Liabilities…Do you want to be Average in your Financial Progress? The little cutie above is Emilee. She’s above average in my book. She doesn’t have any liabilities. Liabilities are like the alligator she’s riding. If you don’t stay on top of them, then can drag you down.

Liabilities are simply what you owe. Everyone is trying to get into your pocket to get your hard earned money. In the traditional sense, liabilities are thought of as loans. But I argue that in personal finance, liabilities cover a broader range of obligations that require them to pay them every month. These are those seemingly small “I can afford it” things that really take a toll on you over the long haul. These are very important to get right. The idea behind these transactions is that the company wants you to think these obligations are a small insignificant thing. Don’t be fooled. This is financial death by a thousand cuts. They only want no or a small down payment and for a low monthly payment. Those really add up over the years.

I’ve personally experienced this in car buying more than anywhere. Unfortunately for me, I didn’t realize I was being taken to the cleaners in enough detail to act accordingly. I’m a slow learner and being in the military can be a bad influence when it comes to finances. Banks know your income is secure. They know if you are late on payments they can call your commander to put pressure on you. They also know “giving the car back” is not an option unless the military guy wants disciplinary action. It may have changed a little today with not being able to call someone’s commander, but there are still very real consequences to not paying on time. Anyway, early on I would buy a car and then trade it in before I paid it off. I did that several times before I finally made it to the big time! I could “afford” a brand new car they said. It was a 1990 Pontiac Grand Prix. The new V-6 model. You know, I’m going to get the small rocks right and save gas! But boy did I miss the big rocks on this one. I financed it with the 5 year plan to keep the payments affordable. I took it hook, line, and sinker. They smelled this sucker a mile away.

My numbers will likely be a little off, but in the ball park. I bought it for say $25,000. By the time I was done with the “easy” payments which really weren’t easy for me, I’d paid like $35,000. So at the end of the 5 years I was finally the proud OWNER of a 5 year old car that was driven daily by a young father with two kids. It was scratched and dented on the outside. The inside was not any better. Carpet was stained, headliner was stained from when someone opened a can of Coke and was starting to come loose and hang down. I would be lucky to get $10,000 for it on a good day. So, bam. In 5 years I turned $35,000 into $10,000 by buying that car. But I had a nice car for about 2 years and saved some gas! I got the little rock right, but missed the big rock. I never bought a new car again. I’ve reached the pinnacle of the financing sucker with cars. If I would have burned my Honda Accord to the ground in the parking lot of Greenville Dodge as soon as I wrote the check for it, I would have lost less money! If I would have invested that $25,000 I lost in the new car deal in an appreciating asset that got 10% interest, today that $25,000 would be worth approximately $223,857 today (23 years later). The car dealer doesn’t tell you that. That’s compounding interest. It works both ways. I lost $25,000 on 1995. The bank has $223,857 today. Who won? I guess that’s why banks have awesome buildings and I don’t. I got the numbers from here: http://www.moneychimp.com/calculator/compound_interest_calculator.htm. The picture below is from the EZ Calculator app you can download for free dollars. The numbers are not exactly the same, but close enough to prove my point. That difference is a small rock. I missed the boat with that purchase.

When you get the big rocks of assets, liabilities, and net worth right, you’ll win. Instead of death by a thousand cuts, you’ll be successful by a thousand small wins! The average consumer will spend hundreds of thousands of dollars during a lifetime bleeding money (and compounding interest) to finance charges, administrative fees, and interest. They will pay some on cars, some on consumer goods, maybe some college loans, and a bunch on a 30 year mortgage. These folks don’t pay all the interest and fees up front or at once. Doing so would highlight just how crazy expensive financing costs right in your face. Instead, they keep their hand in your pockets, and just take just a little, for a long time causing you to loose opportunities to invest.

Now, armed with how this stuff works, think about reversing it. Now you are aware. So, let’s say Average Joe spends $400,000 towards servicing liabilities. The $400,000 is a low number for average folks, but just trust me for now. Smokey Joe on the other hand at least gets the big rocks right. He will cut this figure drastically. He still messes up on some small stuff, but gets the big rocks right. Smokey will likely save say 80% of the $400,000 in interest and fees over his lifetime. Yes, I made up the 80%, but it surely isn’t unrealistic. That 80% will keep $320,000 in his family’s pocket. Or use a more conservative figure of 50%. He’s keep $200,000 in his family’s finances. He doesn’t get a large pile of cash up front or long down the road some day. By efficiently using his hard earned money, he still buys what his family needs. He doesn’t give 50% – 80% of his money away to liabilities, and instead invests it in a slowly growing appreciating asset. Over time, he’s sitting back receiving dividends from from the money he invested in appreciating assets, or letting it continue to grow for his family’s legacy. Or whatever he wants, he did well by spending wisely to accumulate a nice pile of money.

I’m sure most know that loans are an expensive way to buy things. The only worse way, in personal finance, to finance a car is to lease it. But, there’s even more to the story than just an expensive way to spend your valuable money. You can make financing something good a very bad deal. Remember the appreciating and depreciating asset discussion? Average Joe finances only depreciating assets. So, when he’s done paying the purchase price, fees, and interest, he looses big time. Whatever he purchases, is worth less than the original purchase price. So, he pays more and ends up with less. Now Smokey messed up a few times along the way. But he remembered the difference in assets. He would only finance things that are appreciating assets. While he still paid more than he could have by being inefficient, at least Smokey Joe was left with an asset that was worth more than the day he bought it.

Let’s math this up a little.

Average bought a $1,000 flat screen TV, sofa, bed, or something like that. He financed it. Say he financed the TV at 10%. Since he has great credit, he gets the premium 10% interest rate versus the more common 18-21% on the folks with jacked up credit. Say it takes him 2 years to pay off the credit card or loan. He would pay $1,107 for the TV or 10.7% more than if he had paid cash. You can check it here: https://www.bankrate.com/calculators/mortgages/loan-calculator.aspx. Let’s also assume that 5 years later, Average wants to buy a new TV. He lists it on Craig’s List and sells it for $200. The cost of this deal is what he paid for the asset, minus the cost of selling the TV. Running the numbers, he bought the TV for $1000 plus the $107 in interest. His cost is $1,107 minus the selling price of $200. His ultimate cost is $907 in real dollars. Of course, Average repeats this over and over again throughout his life and can’t seem to get “get ahead”.

Smokey financed $1,000 of investment grade gold, silver, or maybe he just got a great deal on a small business. He got the same 10% interest rate for the same 2 years. He financed the $1000 for the appreciating asset. At the end of the finance terms Smokey’s paid $1,107 just as Average did above. Now fast forward 5 years as Average did in his TV purchase. Smokey’s asset appreciated a measly 10% in 5 years. It didn’t do nearly as well as he had hoped since he knows when buying low cost index mutual funds historically return more than 7+ percent over time. So, basically his asset’s growth and the interest he paid cancel each other out. When Smokey decides to sell his asset at 5 years, he gets 10% more than he paid for it. But the interest wipes out his gains. While this doesn’t seem good, he’s still in way better financial shape as Average. The value to his financial position from this transaction is zero dollars. Not good, but remember Smokey makes mistakes too. If he would have paid cash at least he would have about $107 dollars more. Why not $100? Compounding interest is the reason. More on that later. Smokey could use that $1000 to buy a TV for cash or try investing again. He has $1000 in in pocket. But for Average to buy a $1000 TV for cash, he would have to use his $200 from the sale of his TV and also come up with another $800!

These aren’t huge numbers. Both were only doing a $1,000 deal. Let’s look at percentages.

Average spent $1,107 and sold it for $200. That amounts to a $907 loss or approximately an 82% loss of position or 18% efficiency. Smokey broke even at zero percent. So, Smokey achieved an 82% higher efficiency of his valuable money.

You’ll have hundreds or even thousands of transactions like this over your lifetime. If you can be 80% more efficient on every purchase, how far do you think you can go? Let’s see the kind of difference makes over a lifetime. Average Joe and his wife make $45,000 per year, the average American income. Smokey’s family makes the same $45,000. To bring it back to some math and numbers let’s say Average worked 30 years and earned $1,350,000. Average’s efficiency is 18% from the numbers above. So, his $1,350,000 will yield approximately $243,000 of value. He finally OWNS his home, but he’s still financing his car. Sounds like the average American right?

Smokey worked right next to Average and earned the same $1,350,000. But since his efficiency is even, his $1,350,000 is worth $1,350,000. That’s $1,107,000 ($1,350,000 – $243,000) more! His money is much more efficient. That’s assuming Average JOE continues to finance things and Smokey never has investments that make money. He owns the house next door worth $243,000, both the family’s $30,000 cars, and has the remaining and has the rest is invested in $1,043,000 in gold, silver or a business that never appreciated. His lifelong investment broke even too. The more money you put into appreciating assets the better off you will be over the long haul. It’s pretty hard to invest in conservative appreciating assets and do as poorly as Smokey did. But he still has over $1,000,000 in assets. This is a simplistic view of two transactions extrapolated as if all transactions were the same. The big rock is that the percentages very different and are significant enough to make a large difference in your personal finance.

That’s the power of knowing the big rocks. Numerous small decisions like Average made above over an extended period of time can really drag your financial independence down. Most people are Average Joes.

Don’t be Average.

003, Get off Your Assets!

img_0303Assets

Assets are simply what you own. Don’t just blow by that last sentence. Go back and look again. The last word is key. To this date, I still don’t own my home. From the first time you are asked to fill in your address for a credit card, bank account, etc., you’ll be asked if you rent or own your house. There’s no box to check or explanation that your house is financed. It’s just rent or own. Looking back, the first time after I financed my first house I thought I was making great progress because finally the “own” box could be checked on credit applications. I can remember thinking it’s weird because the house was deeply financed. But I was told that’s the normal and correct thing to do. Somehow that little interaction was the first step down the crap line of BS that the financial world sells, the ones that pick your pocket anyway. I knew it wasn’t technically correct. But I played along and somehow felt better, more comfortable, and maybe even a little more successful. Their strategy to underplay debt had worked. The language that’s the norm in our society today is wrong. I don’t “own” my house. I have equity in the bank’s house. That’s the true situation from a financial perspective. Assets are what you own.

Assets are something that someone else will pay you money or trade you something else of value to get. Things like owning stocks, bonds, profitable businesses, and investments. A house, a car, a motorcycle, a travel trailer, motor home, and land are all assets. Those are things that have value. Other people will pay you in exchange for those type of things.

This word asset is used frequently, but not always correctly from a financial perspective. People say your looks are an asset, but that’s not true. Maybe they said your brains, or work ethic, or some other characteristic was an asset. Those are not assets. They are characteristics. These days folks seem to use incorrect words to describe things. Maybe they are just using it for emphasis, but it’s still wrong. Words matter. If you repeat things long enough you get more comfortable with what you are saying. You may even start believing it. Don’t fall into that trap.

Assets are generally categorized into one of two types. Appreciating assets and depreciating assets. It’s a little more complicated that that, but if these two categories are understood and used properly, large gains can be made over time. Even the investors with the fancy degrees don’t get every move right. Just keep playing and moving forward.

Appreciating and depreciating assets are the two big rocks in this post. All assets are not created equal. Some assets go up in value in certain situations. Others go down in the same situation. Some things change rapidly and some slowly. Some stay stagnant over time. While there are numerous variables that can effect assets, usually they are just affecting the rate that the asset appreciates or depreciates. Generally they go in the direction described above over a long time. That’s what we’re playing for here. The long game is what we want to win.

An example of an appreciating asset is PepsiCo Stock that I own. When I was young, one of the things I explored was something called a DRIP. DRIP stands for Dividends Re-Investment Plan. Under the plan small numbers of stocks can be bought. Once you own the stocks, the dividends are used to buy stocks instead of receiving a check for the dividend. If you haven’t figured it out yet, dividends is money a stock sends its investors. That’s one of the benefits of OWNING stock. So, back in like 2000 or so, I purchased $500 of PepsiCo Stock. It was only like 5.2 shares. Not much at all. I’ve never added a penny to the stock. So, for like the last 18 years the dividends were reinvested back into PepsiCo stock buying more shares. When I checked the value of the account today my $500 investment is now worth $2,734.09. That’s more then 5 times my initial investment. You can argue details about PepsiCo isn’t a great stock, DRIPs are too expensive with fees, or whatever. But can’t argue that it increased in value more than 5 times my original investment of $500. Assets like that are what you should be after. The Big Rock here is you have to do something. Anything is better than nothing.

Appreciating assets is where you want most of your effort to go to achieve forward progress. Simply put, it increases in value over time. They are worth more tomorrow than they are today. Some examples are low cost index based mutual fund, stocks, a savings bond, savings account in a bank. Over time, your assets will allow you to achieve the financial freedom to do the things you value most in your life. The more appreciating assets you own, the harder they will work for you. Compounding interest also works in your favor to multiply the positive affects over time. When your assets are providing more income than your expenses, you are financially free, financially independent, retired, or whatever you would like to call it. Generating income from clocking in at a job, going to work at your business, or looking for new jobs to create income to cover your expenses can be over!

Depreciating assets are the opposite. They are worth less and less over time and may even eventually have no value. Just about anything with a motor would fall into this category. A boat, car, motorcycle, or even a weed eater. RARELY can you purchase one of these items and then sell them for more after a short time of use. These are major drains on your valuable resources, mainly money. Rather than creating more value at a later date they drain your resources as they decrease in value. Then, as in the car, when it no longer works it is usually replaced. Then the cycle of bleeding value repeats.

The key here is to limit your losses on depreciating assets and maximize the acquiring appreciating assets. When looking at future purchases, ask yourself which type of asset are you buying. Will it lose value and have to be replaced? Will it be worth more in the future? It’s obvious that the depreciating assets are holding you back from forward progress. Appreciating assets tend to grow or provide dividends (money). If they are producing dividends, reinvesting those dividends to buy more appreciating assets will push you forward towards a financial goal. If you are investment is in a business, say a coffee shop, profit you make thatis invested back into the business is similar in that you would do that in order make the business more valuable.

My little granddaughter (in the picture) may or may not become a great fisherman one day. Of course, she’ll never know if she can unless she fishes. She has to cast her line in the water to find out. Are you fishing for the type of fish that will be worth more than the minnow you bought for bait? It’s never too late, or too early, to get off your assets and purposely cast your line in the water.