Many believe that earnings equal wealth. It does not.
Many also believe that assets equal wealth. It does not.
So, what is wealth? And if an asset is not an asset, what is an asset? Confused?
Well, you are not alone. Many get this wrong and until they really understand it, becoming financially free or planning for your financial future becomes a bit tricky. How tricky? Try treading a needle while being tickled. That tricky.
But before I answer that let’s look at Nicolas Cage. Because he worked out that earnings do not equal wealth. And it is a painful lesson.
His career earnings are US$200M. By 2021, he had debts owed to the IRS (ATO) of $13m and he could not pay it. He basically ran out of money. How is that even possible? How do you spend US$200M?
Well, when income increases, we find exotic ways to spend it. And boy did Mr Cage find exotic things to spend his money on.
US$380,000 on an octopus and 2 cobras. A stolen dinosaur skull costs US$412,000. His 4 divorces would not have been cheap either. One of his marriages lasted 4 days.
US$21M on castles. US$5m on a haunted house, US$40M on other homes and US$12M on Islands. Now add a Gulfstream jet, 50 cars, 30 motorbikes and four yachts. Why do you need 4 yachts? But then again, I don’t ‘need’ 4 cars so I shouldn’t be talking.
These are all ‘assets’ in the traditional sense. And as these ‘assets’ equal wealth he should be wealthy. So how did he run out of money?
Well, according to him it was all his accountant’s fault. They sent him “down a path toward financial ruin.” Crap….. I am now feeling the heat.
So, before you all decide to sue the pants off me for sending you down the ‘wrong path towards financial ruin’ I will try to explain how two people with the same income can go in totally opposite directions.
One thing I have learnt from research and from observing high-income clients is that none have become wealthy or are able to reach financial freedom based on their earnings. That is because as we earn more, we spend more. And this is true for you, me and Mr Cage.
When I observe those who have become wealthy, they become wealthy by investing in real assets.
When it comes to ‘assets’ traditional accounting and the banks are to blame. I tend to blame the banks for everything nowadays. When you buy a home the first thing we are told is that it is an asset. When you go for finance, our home is considered the largest ‘asset.’ But banks must do that because if they told you your home was not an asset you would not borrow from them. And then they lose big time.
But as Mr Cage found out none of what he bought are ‘assets’. Everything he owned was actually a liability.
Ok now you think I have lost my marbles. You will get plenty of support from my wife, so you are not alone. But hear me out for a minute and I will try to explain my logic.
My view is that an asset is only an asset if:
- It brings money to you with no expenses
- It brings net money to you after paying to keep it.
If you look at all the ‘assets’ Nicolas Cage purchased, none brought income to him. In fact, they all cost him money to keep. And that is why he ran out of money.
But you may say that these ‘assets’ would have gone up in value.
Maybe. But did they go up in value after paying for the cost of keeping them? Probably not.
Using this definition, you may find that your house is not an asset. It may be an asset with current crazy pricing but prior to that probably not.
Here’s why.
You buy a home for $1M and take out a mortgage of 80% ($800K).
After 10 years the price of your home has doubled to $2M. This makes you feel $1M richer. But are you?
Well, for starters you paid stamp duty, legal fees, loan fees to buy and the deposit. That’s about $250K. After 10 years you would have paid $500K in interest and repayments on the loan. Now add repairs, the new kitchen and new bathroom which will eventually happen, the new shed, landscaping and the electrical costs when the mice chewed through the electrical system. The average kitchen is $30K. The average bathroom is $15K.
And do not underestimate the damage kids can do to a home. Oh, and don’t forget swimming pool maintenance. Over the last 12 years, I convinced my pool has stolen $40K from my wallet.
As you can see your $1M profit has become a lot less.
What I am saying is that our homes cost money year in and year out which we do not factor in. If I rented a home with a pool I would never have to worry about a broken window, pool maintenance, a new kitchen and I would not give to hoots about any mice in the attic. Would my rent be more than the cost of owning a home? I’m not so sure.
Yes, renting costs money but so does owning a home. They are both liabilities. You just need to decide which is the lesser evil.
Are investment homes assets? In the beginning probably not because there is a chance it will be negatively geared. But over time they start producing an income. A rental property only becomes an asset when the cost of keeping it is less than the income you generate from it plus the increase in the value of the rental property.
Let’s take Will Smith. He also has career earnings of US$200M. He also has a few homes but no yacht. He prefers to charter them because that costs less than owning one. He also invests his money in assets that generate income via his Investment fund. He lives the same lifestyle as Mr Cage, but Will Smith is worth US$350M.
To be wealthy, you need to be an owner of assets that generate an income or increases in value. Nicholas Cage was a consumer. He bought iPhones whereas, Will Smith also bought iPhones but holds shares in Apple so that when you and I buy an iPhone, yes you guessed it, Will Smith benefits.
The key to wealth building is not to buy any asset. It’s about buying assets that make sense.
But as Will Smith has proved you can still have the luxuries and be wealthy.
And that is why I will keep my 4 cars even though they cost me my right arm. And then my left leg too.