A wonderful point along the financial empowerment journey is realizing that, for the most part, money coming is greater than money going out. This is a phenomenal accomplishment that everyone should be very proud of. The point of sustained positive cash flow is mostly attributable to hard work, motivation, and fortitude to establish healthy money habits. Now you will find yourself facing another important financial decision – what do I do with all this extra money? It is time to start buying some assets! Here are two important rules to help guide your decision
- Not All Assets are created equal
- Income Producing Assets > Income Consuming Assets
One of the most important choices you’ll make once you’ve mastered personal cash flow is prioritizing income-producing assets over income-consuming assets. Income-producing assets generate cash flow for you, while income-consuming assets require cash flow from you.
Let’s take my second rule: Income Producing Assets > Income Consuming Assets. The reason for this is simple – income-producing assets have the potential to increase wealth over time, while income-consuming assets decrease wealth over time. Income consuming assets should not be completely disregarded – after all, the hard work and effort you put in to earn income and live fiscally responsible also includes buying assets that provide enjoyment and pleasure. With that in mind, let’s explore the difference between these two asset types and some tips to help strike a healthy financial and personal balance.
What are income-producing assets?
Income-producing assets are investments that generate cash flow for you. Examples of income-producing assets include rental properties, dividend-paying stocks, bonds, and mutual funds. When you invest in an income-producing asset, you can expect to receive a regular stream of income from that investment.
One of the biggest advantages of income-producing assets is that they can provide a source of passive income. That means you can earn money without having to actively work for it. If you’re looking to build wealth over the long term, having a source of passive income can be a huge help.
Another advantage of income-producing assets is that they can provide a hedge against inflation. When prices rise over time, the value of your cash holdings will decrease. However, if you own income-producing assets, the income they generate may rise along with inflation.
What are income-consuming assets?
Income-consuming assets are investments that require cash flow from you. Examples of income-consuming assets include your home, car, and other personal possessions. When you invest in an income-consuming asset, you can expect to have to spend money on maintenance, repairs, and other expenses associated with that investment.
One of the biggest disadvantages of income-consuming assets is that they can be a drain on your finances. If you own a car, for example, you’ll have to pay for things like gasoline, maintenance, repairs, and insurance. All of these expenses can add up over time and take a significant chunk out of your budget.
Another disadvantage of income-consuming assets is that they don’t generate any income for you. Instead, they require you to spend money on them. This means that if you’re trying to build wealth over the long term, income-consuming assets won’t help you achieve that goal. Just like income producing assets can be a hedge against inflation, income consuming assets can exacerbate the negative impacts of inflation.
So what is the argument for buying income consuming assets? Well, I don’t know about you, but I am not a machine – I am a person…a person who enjoys taking trips, going to concerts, buying gifts for friends and family, and having a really comfortable couch to read the latest Common Cents article. Like so many things in finance and investing, balance is key and the below considerations can help you find the right balance of income consuming assets for your life.
- Necessity: Some income-consuming assets, such as a home or a car, are necessary for daily living. In these cases, it may be necessary to buy income-consuming assets, even if they don’t generate income for you.
- Personal enjoyment: Some income-consuming assets, such as a vacation home or a boat, and concert tickets may be purchased primarily for personal enjoyment. While these assets may not generate income, they can provide significant enjoyment and relaxation, which is an important part of life! Be mindful, the warp of social media on the definition of personal enjoyment. Constant comparison to false and unrealistic expectations of reality can trap us into spending more on things to impress others than for personal enjoyment.
- Tax benefits: Some income-consuming assets, such as a primary residence or a charitable donation, may provide tax benefits that can offset the cost of ownership. For example, the interest you pay on your mortgage may be tax-deductible, which can reduce your overall tax liability.
Conclusion
I often struggle with finding the right balance of allocating money toward income producing assets and income consuming assets. In order to help me stay committed to prioritizing income producing assets is to allow myself the benefit of realizing their reward shortly after buying them in short spurts. For example, if I decide to forgo splurging on that $3,000 exercise bike and instead dropped $3,000 into my brokerage account that will pay me a 4% dividend yield – I will take $120 from that account and buy myself a new pair of running shoes or take my family out for dinner – I will do something small but use my passive income to pay for it. It feels good when you can pay for the fun things in life with money that you didn’t have to work for – that feeling can only come when you plan your life accepting that income producing assets > income consuming assets.
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The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
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