Last update: 17.09.2024 08:35
“Wow, great piece! That must have cost you a fortune?” Well, just because something costs a lot doesn’t mean it’s a fortune. It’s not just the post-corona shopping queues at luxury stores in Zurich that show that many people don’t know the difference between assets and liabilities. We show the difference and why you need to accumulate assets, not liabilities, to become financially independent.
(5 minutes reading time)
Onslaught at the Louis Vuitton store on Zurich’s Bahnhofstrasse in mid-May, shortly after the coronavirus measures were eased. A long queue forms outside the store. A young man talks about his motivation: “We need to get rid of some money, more than 2,000 francs.” He wants to buy shoes, a bag and a belt. Another customer says she is there because of her friend: “It’s her birthday tomorrow and she wants to buy a bag. She also has one that needs to be repaired.” Two examples that also show that many people don’t know the difference between assets and liabilities.
Six out of ten Swiss employees are financially unstable
A recent study shows that only 40% of Swiss employees have their spending well under control and do not have to live paycheck to paycheck thanks to their savings (green category). Although 20% have savings, they struggle to control their spending (orange category). The remaining 40% live paycheck to paycheck and many regularly overspend (purple and red categories). These mainly include millennials (i.e. people born in the early 1980s to late 1990s), recently divorced or sick people. It is to be expected that the financial situation will continue to worsen as a result of the coronavirus pandemic.
Financial stability of Swiss employees in 2020
Financial instability also has a negative effect on other areas of life: almost a third report this. In contrast to financially stable employees, those who live from paycheck to paycheck and have no savings are sick 8 1/2 more days per year in Switzerland, enjoy their work only half as much and have four times more stress, anxiety or depression. Time to get out of this!
Assets and liabilities differ
One possible reason for financial instability is a lack of understanding of the difference between assets and liabilities.
Difference between assets and liabilities
| Assets | Obligations (liabilities) |
|---|---|
| are values that earn you money | are something that costs you money |
| ensure an inflow of funds to you | ensure an outflow of funds from you |
| create additional income for you | take further income out of your pocket; not only to buy them, but also to receive them afterwards |
| increase in value over time | lose value over time |
| e.g. shares, bonds, rented real estate | e.g. owner-occupied real estate, cars, consumer goods such as smartphones, clothing, credit cards and consumer loans, |
The value of assets increases more and more over time due to the compound interest effect. Your FI engine runs faster and faster. On the other hand, the value of purchased liabilities decreases over time: your house loses value continuously without maintenance, renovation and care, your car is worth a third less as soon as you drive it off the dealer’s lot, your cell phone is unsaleable after two years. Contrary to popular belief, cars are not assets, but commodities with a rapidly declining current value and you won’t be able to pay any bills from your property next month.
What makes you financially successful
Virtually everyone receives income every month, usually in return for working hours (wage income as an employee or self-employed person) or as a transfer payment (e.g. in the event of unemployment).
Financially successful people use their income first to buy assets and only then for necessary expenses. In contrast, less financially successful people spend their income on things first. They often accumulate debts or obligations for the future with their consumption. Take the Louis Vuitton bag as an example: not only does it cost a fortune and is not an asset, but it also causes follow-up costs when it is due for repair. And we hope that the young man with the CHF 2,000 credit card belongs to the green category.
How your cash flow develops on the way to financial independence
If you want to improve your financial situation, your cash flow cycle will change on the way to financial independence. The cycle describes how you generate income to finance your lifestyle.
In level 1, you only live off your salary income. You need all of this to finance your consumption. A simple cycle: work, spend money. You have no assets or liabilities.
In stage 2 , you start to finance your consumer wishes. This may be through an overdraft on your personal account or credit card, a consumer loan, a leased car or a fancy apartment with a fat mortgage. You need your earned income to service the obligations you have entered into for consumption. The cycle consists of working, incurring debt and consuming. Strictly speaking, there is still a small hole in the cycle: others, e.g. banks, take their share of the debt and live off the fact that you are in debt.
Cash flow cycle stages 1 and 2 on the road to financial independence
In stage 3 , you take control of your personal finances. You first use your wage income to acquire assets. You are motivated by the urge to escape the “money versus time” equation and build up an income independent of your work input. You use the rest of your wages to buy what you need or what is really important to you. The cycle then looks like this: work, invest, consume. As soon as you own assets, they also bring you additional income that you can use to finance your lifestyle. You rely on assets and liabilities are part of your past.
Cash flow cycle stages 3, 4 and 5 on the way to financial independence
In stage 4 , you generate enough income from assets to finance a good part of your lifestyle. However, you do not yet have enough or a cushion and are therefore still dependent on additional income from work.
At level 5 , you are financially independent: your assets generate so much income that you can finance 100% of your lifestyle. You can do without income that depends on your working hours. Instead, others work for you:
- Governments or companies pay you interest because you have lent them money by buying their bonds. They have obligations to you.
- or employees work for you in all companies from which you have bought shares and whose profits you collect as dividends.
- or tenants paid you because they live in properties that belong to you.
Please note that you have only reached level 5 when you really generate enough funds from your free assets to finance your current expenses. Tied assets in an owner-occupied house or pension assets (in AHV, pension fund or pillar 3a) are there, but do not yet provide you with an income stream to finance your everyday life.
Summary of assets and liabilities
The quote from Robert Kiyosaki puts it in a nutshell: “If you want to be rich, simply spend your life buying assets. If you want to be poor or middle class, spend your life buying liabilities.” Assets increase in value and bring you income. Liabilities decrease in value and take away your income. Financially stable people spend part of their income buying assets. People with the goal of financial independence maximize this part of their income.
Mach den ersten Schritt zur finanziellen Unabhängigkeit
In einer Minute siehst du deine Vermögensentwicklung und dein Einkommen während der Rente.
