With your foundation of savings in place and a budget that allows you to continually add to your savings you will reach a point in which you will need to put some of your saved money to work. The best place to start with this is buying assets that make you money.
Money has a time value and extra money sitting under a mattress is not just sitting there, it is actually losing value. Inflation is the quiet tax that plagues us all but more than that you have an opportunity cost to think about.
In other words what is your money not earning by not being used?
You will want to be prudent in your use of this money as it was the fruit of your hard work and discipline.
Acquire Your Debtor’s Assets by Buying Back Your Debt Notes
The fastest return on cash is the elimination of debt.
Debt like credit cards, car loans, and student loans are all great places to start. These debts eat away at your excess cash and don’t just cost the additional interest, they also cost you what having the money in you pocket would afford you.
Think about why people want to lend you money. They have extra money that they want to make money off of so they let you borrow it at a high percentage rate.
What is an Asset?
One of the best definitions of an asset can be found in Robert Kiyosaki’s Rich Dad Poor Dad. He has his own way of describing it but in short, an asset is something you own that makes you money. This could many things some examples would be stocks, mutual funds, rental property, bonds, or a business. Robert maintains that your home is not an asset. You will have to read his book to see why.
A dividend paying equity (stocks/mutual funds) can be a very easy thing to purchase at low prices to begin your asset acquisitions. I won’t go into the investment strategy at this point but what I want you to realize is that you can buy things that are able to make you passive money.
How Do Assets Make You Money?
As the owner of an asset, you have a right to the earnings it generates. You also have a right/obligation to the expenses. So, in short you get a piece of the action. For a stock you would own equity in the underlining business. As the value of that business grows or as the company pays dividends you receive a commensurate amount for the amount of the company that you own.
For a rental home you would receive the rent from the tenant, pay for all the expenses, and what is left over is your profit. Homes often also appreciate so you would likely see appreciation in the home value over time as well.
A business works the same way. You take the money that came in, subtract the money that goes out to pay for everything, and what is left over would be your profit in the form of retained earnings. You could take the earnings out of the company or leave them in the company to cover future operations.
What Assets Should I Buy?
Buy a Money Machine of course…
Kidding, starting out you will want to find low risk opportunities with high liquidity.
What you don’t want to do is lose the principle you worked so hard to get or tie up your money for a long time.
Mutual funds are a great way to go. They have a relatively low cost and an assessable history, so you know about what to expect. A common minimum for a fund is between $1,000.00 and $3,000.00 USD. The other nice thing about a mutual fund is that they are a collection of many equities. This means that you don’t have all of you eggs in one basket. If a company in the mutual fund portfolio goes belly-up you won’t lose all of your money.
I love love love rental property. I grew up with rentals. My dad was an appraiser, so real-estate has been in my blood for a long time. I have helped fix, paint, clean, and redo just about everything that needs to happen for a rental home. I hated it at the time, what kid wouldn’t, but now am equipped to see an opportunity when one arises.
Rentals have a higher barrier of entry in that you will likely need 20% of the sales price in cash in order to finance the home. So, on a $200k home you will need to put $40,000.00 down.
Rental homes are not for everyone, but they can also be a great source of cash flow.
What Assets Shouldn’t I Buy?
There is a saying “Profits are made in the purchase” and it means that you make money when you make a good buy. This means it’s possible to acquire a good asset at a bad price. Until you know what a good buy is don’t pull the trigger. This will require homework on your end.
We would advise against anything that sounds too good to be true, digital currency, and anything your broke friends say is a good idea. These “assets” are likely not good assets at this point of your journey. I would also steer clear of land, partial ownership of anything, and lottery tickets. Do not buy a new car. Something like your car can be a necessity but it is not an asset.
The whole point of an asset is to make you money.
Ask yourself, will this make me money this month? This year? If so how and how much? If you have trouble answering these questions your potential purchase is likely one to avoid.
How Much Will an Asset Make?
This will vary but you could expect between 4% and 10% per year on average. Some years your portfolio will do better and some it will do worse. You will see negative returns over short periods but over all a 4-10% annual spread is what most people plan around. The 4% rule in retirement as an example is in place because it assumes that if you only take 4% of your account out in a year the principal balance will not depreciate over your time horizon.
How Much of My Savings Should I Use?
In short you don’t want to use any of your savings. We want to use money beyond your savings. The money you use to invest with should be the money beyond what you need for short term fringe events. For some this could mean any money over one years living expenses. For others it could be any money beyond three months living expenses.
Wherever you are on your income journey be sure to check out The Four Stages Of Wealth Creation; From Clueless To Capitalist. We put this together as a guide for those looking to grow their financial acumen and take their next step towards financial independence.