Asset Types and their characteristics

assetAn asset is defined as any­thing that puts more mon­ey in your pock­et than it takes out. How­ev­er, some peo­ple mis­take lia­bil­i­ties for assets. It is true that some things put mon­ey in your pock­et .But in order to be a true asset it has to gen­er­ate more income than it takes out. I used to get con­fused with assets, I thought assets were things like cars and hous­es and sure these things can be used as assets but a major­i­ty of times they aren’t.

Assets are impor­tant to any­one inter­est­ed in wealth cre­ation. The wealthy buy assets. Oth­er peo­ple buy lia­bil­i­ties they think are assets such as the house men­tioned before. From my read­ing of finan­cial books like Rich dad poor dad, I under­stand that a house is gen­er­al­ly a lia­bil­i­ty.

Some peo­ple may get out­raged at that state­ment because they have a dif­fer­ent def­i­n­i­tion of what an asset is. but the impor­tant thing is to under­stand­ing how cash flows. A house has bills like water bills, elec­tric bills, main­te­nance costs, heat­ing bills if you are in cold cli­mate and so on.

The rea­son peo­ple don’t like to think about their house as a lia­bil­i­ty is because of their attach­ment to it. A house is where we live and although it is an asset in terms of pro­vid­ing shel­ter for us. It keeps us warm and pro­tects us from the ele­ments how­ev­er it is a finan­cial lia­bil­i­ty.  This is because it needs to be main­tained. It is impor­tant to look objec­tive­ly at what you own and be aware of how cash flow oper­ates for that par­tic­u­lar item. Let’s talk about the Four Asset types and how they gen­er­ate cash flow for you.

 The four asset types


Asset type: #1

 Type #1 assets gen­er­ate high returns on cap­i­tal invest­ment. They can gen­er­ate sub­stan­tial cash on very lit­tle cap­i­tal invest­ment but can be grown by rein­vest­ing prof­its into the core busi­ness for expan­sion.

An exam­ple would be a busi­ness like Microsoft or Coca-Cola where the under­ly­ing com­pa­ny can earn a good per­cent­age of return on a share­hold­ers equi­ty, (the val­ue of shares issued by a com­pa­ny). This means that each dol­lar retained in prof­its is gen­er­at­ing an enor­mous return the fol­low­ing year. Dur­ing their growth phase, these are com­pa­nies such as Wal­mart, Hewlett Packard, Best Buy etc. The best course of action is to pour as much mon­ey as pru­dent­ly pos­si­ble into the main busi­ness so it can expand and earn huge rates of return.

Asset type: #2

  Those assets that gen­er­ate high returns on cap­i­tal. They yield sub­stan­tial cash on very lit­tle invest­ment but they can­not be expand­ed by rein­vest­ing in the under­ly­ing asset. These are con­sid­ered to be the sec­ond best invest­ment because you can earn large returns on very lit­tle mon­ey. The down­fall is that you have to pay out all of the prof­its as div­i­dends or rein­vest in low­er return­ing assets.

The rea­son for this is that the core busi­ness can’t be expand­ed through cap­i­tal infu­sions alone. An  exam­ple of this is a patent to a device that gen­er­ates hun­dreds of thou­sands of dol­lars per year. There are lit­tle or no invest­ment require­ments once the cash starts com­ing in .How­ev­er, the draw­back is that you can­not invest in more patents at the same rate of return. Unlike asset type #1 you can’t put that mon­ey to work at the same lev­el.

A fran­chise which is a type #1 asset can build anoth­er loca­tion gen­er­at­ing rough­ly the same return.
At some point, all type one busi­ness­es become type 2 busi­ness­es this nor­mal­ly hap­pens at sat­u­ra­tion. At that point man­age­ment will like­ly repur­chase huge amount of stock. This is done to increase the remain­ing shareholder’s equi­ty in the busi­ness or they may pay out cash div­i­dends.

Asset type: #3

 Appre­ci­ates far above infla­tion in val­ue but doesn’t gen­er­ate cash flow
Think of a coin col­lec­tion or fine art. If your great grand­par­ents owned a cer­tain antique it’s worth increas­es over time. This antique could poten­tial­ly be worth mil­lions today in con­trast to the small invest­ment they made on it in the past. As it appre­ci­ates in val­ue, how­ev­er, you would not be able to use it to pay for every­day liv­ing expens­es with it because of the lack of cash flow. These types of assets are typ­i­cal­ly owned by the wealthy who have enough liq­uid assets.

Asset type: #4

These store their val­ue and will keep pace with infla­tion. This type of asset includes fur­ni­ture from Bern­hardt and more. They may cost a sub­stan­tial amount upfront but they hold their value.They can keep pace with infla­tion and some­times exceed it. These assets are typ­i­cal­ly owned by mil­lion­aires because of their abil­i­ty to hold their val­ue. These assets also have the pos­si­bil­i­ty of being sold for greater or at least what they bought them for even adjust­ed for infla­tion.

What asset class inter­ests you the most? Leave a com­ment below, sub­scribe to my newslet­ter and as always stay focused

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