According to wealth guru Robert Kyosaki, there are three important financial concepts which, if you understand them, will greatly increase your prospects for building wealth. These three concepts are assets, liabilities and cashflow. They are inter-related and the trick is to get them working together to maximise your wealth.
Assets are things that have a value, can be readily sold, and either increase in value over time or produce an income. Examples of assets are property, a business or ‘paper’ assets such as shares and bonds. The investment return you receive from an asset comprises the change in value plus the income. For example, if a property worth $500,000 increases in value by 5% in a year as well as producing a net rental income of $20,000 (4% of the value), the total return from the asset is 9%. Compare this to a car which drops in value every year and costs money to run.
Liabilities are things which drain your financial resources rather than adding to your wealth. Mortgages and credit card debts are two examples. Keeping your liabilities to a minimum helps stop the drain on your finances. The exception, of course, is debt which is incurred in order to buy assets that produce a good return. Borrowing will add to your wealth if the net cost of debt (that is, the interest) is less than the net return on the asset.
Cashflow is the amount of money coming in and going out. The net cashflow is the difference between money coming in and money going out. For your wealth to increase, your net cashflow has to be a positive number. If it is negative, your wealth is decreasing.
Smart investors are those who know how to use cashflow to buy assets and to keep liabilities low.