2 Important Ideas

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There are 2 ideas that are fairly basic when it comes to personal finance - but they're also really powerful. And chances are, you weren't taught these ideas in school or at home. So let's catch up:

Idea #1 — Think in Terms of Assets

Think in terms of assets... what does that mean? Let's look at a model where we think of money as being in different states. Kind of like water can be frozen, liquid or vapor, money or wealth can be in these different states.

The first 2 states are bad for wealth building. In these states, money is going away from you:

State 1: Debt

  • This is the worst state your money can be in.
  • You owe money to someone or some institution.
  • You're paying interest on your debt. Meaning your debt increases over time.
  • This is negative money that keeps becoming more negative money over time.

State 2: Expense

  • In simple terms, it's when you buy something and the value of your money basically disappears.
  • For example: you pay rent, which is an expense. Next month, the value of last month's payment has disappeared and you have to pay again.
  • Example: food: you convert money into food and then consume that food, making the value disappear.

Debt and expenses aren't always and unequivocally bad. Debt can be used responsibly. And expenses are a normal part of your financial life - it's not like spending money on food is a bad thing to be avoided at all costs.

However, if debt and expenses make up all the money in your financial life, that's a real problem. Ideally, debt is kept at a minimum and expenses are in a good balance with the other 2 states of money:

State 3: Asset

  • An asset is something that either holds its value or increases in value over time.
  • An asset that increases in value over time is called an appreciating asset.
  • An asset that decreases in value over time is called a depreciating asset.
  • A house is (often) an appreciating asset. The price tends to go up over time.
  • A car is (usually) a depreciating asset. The value of the car goes down with age and mileage.

State 4: Productive Asset

  • This is the ultimate thing to own: a productive asset doesn't only appreciate or hold in value, it also generates income for you.
  • For example: if you own an apartment block, you own real estate that may appreciate in value and it generates rental income for you.
  • Dividend paying stocks are another example of a productive asset.

One of My First Aha! Moments...

...was when I realized this key difference between how to stay poor and how to build wealth.

How to Stay Poor

  • The way to stay poor is to spend all the money you make on stuff (bonus points if it's stuff you don't need).
  • The most effective way to stay poor is to build up a lot of debt.

How to Build Wealth

  • The way to build wealth is to invest your money into assets while keeping expenses and debt low.
  • The most effective way to build wealth is to own productive assets.

Idea #2 — Incorporate

For anything that you do as an entrepreneur or creator, it's usually a good idea to incorporate.

This means that there is you and there is your business: 'The Company' — a separate legal entity.

You own 'The Company'.

It is generally advantageous to have a Limited Liability Corporation (LLC) that you do business through.

It's advantageous in terms of:

  1. Taxation.
  2. Your personal liability (a corporation protects your personal wealth).

This protection allows you to take more risks than you normally would. Nobody can come in and seize your personal assets to pay the debts of your company.

Quick Note on Personal vs. Business Finance

Keep your Personal Accounting separate.

Personal finance can be imperfect. But every single cent has to be accounted for in your business.

Bonus Idea — A Business is a Productive Asset.

When you start a business, you're doing most of the work.

The goal is to turn your business into a productive asset that you own. Building a business is one of the greatest and most accessible ways in which anyone can end up owning a highly valuable, highly productive asset.

But to do this, it's important not to get stuck in "employee mode". Don't just build a business that's a job for you. Build a business that is an asset that you own and don't need to be involved in the day-to-day operations of (unless you want to).

Please Note: Personal Wealth Building Sheet

This sheet is mentioned here but is introduced in the next lesson.

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