First of all, I haven't added any new posts in a while as I've been busily jumping through hoops to stay employed (such is the new 'gig economy' we have now). Although my 'jumping' has contributed in many ways to the advancement of my financial knowledge, so I now feel as though I have some useful tidbits to add here. Especially to the younger generation, who I feel have been treated incredibly unfairly by pretty much everyone. If any of them accidentally stumble into this blog whilst exploring the deep dark depths of the internet and happen to pick up just a tiny speck of helpful information, then I will feel as if my ramblings have done a bit of good. The education system fails miserably at teaching its charges the basics of money, and today's young people are the ones who will need these skills more than anyone!
So... without going into the boring details, since we last met I've had a big career change, graduated, completed a vocational course at break-neck speed, and I'm now employed to do very geeky things by a nice team of fellow geeks (who I'll avoid naming here in case they throw Lego at me). During my detour I spent some more time within the banking industry (the 'eye of the storm' is always an interesting place) and expanded my understanding of assets vs liabilities, which I will now attempt to explain using the medium of colourful pictures and witty yet informative prose. I apologise in advance for the lack of artistic skill.
Say hello to Ben and Eric...
Ben and Eric are exactly the same age (25), have exactly the same education and student debt (£30,000), began life with exactly the same amount of money (£0) and earn exactly the same wage (£20,000 per year) in the exact same job. Because sometimes life is just crazy like that!
Both Ben and Eric are dating a girl named Jennifer, but we'll avoid that awkward conversation for now.
Both Ben and Eric work hard and are pretty sensible with money. They both decide they want to have as much money in the bank as possible by the time they are 35, so they can afford to buy a house. A small starter home in the local area costs £150,000 and the bank wants a minimum deposit of £25,000. Both Ben and Eric plan to save up the £25,000 over ten years so they can buy the house (they are both equally deluded, but we can admire their optimism for the sake of this story).
Here's a picture of the house: average sized two-bed semi, small garden with patio area, lovely south-facing views from the main bedroom. If you follow me upstairs you'll notice the additional storage space to your left and over there is the entrance to the 2 by 2 square foot attic conversion the owners had installed. Because everyone loves an attic conversion, right? Every self respecting home owner needs somewhere to keep their important-junk-that-will-be-boxed-up-and-undisturbed-until-the-year-2875!
(I'm aware that it looks like a dolls house - don't judge me!)
Ben and Eric both have £2,000 disposable income left each year after paying tax, rent, commuting costs, bills, food and presents for their always slightly distant girlfriend. Both Ben and Eric are careful to avoid wasting money on any expensive purchases like flashy new cars, holidays abroad, high end gadgets or weekends clubbing. They live like hermits, remaining totally focused and dedicated to the cause. Constantly having landlords sell up and having to move flat gets pricey, so they both decide to live in an abandoned warehouse during the summer months to save a bit extra. Both Ben and Eric know that anything worthwhile in life takes hard work, patience and the odd stint living on the streets.
For the first three years, both Ben and Eric save £6,000 in a savings account. The interests rates are very low and their savings don't grow all that much. But they keep going, determind to get that house!
However, one cold and frosty winter evening Ben accidentally flicks past a business channel on TV whilst searching for the latest episode of X Factor. The reporter mentions 'assets' and Ben wonders what they mean. He decides to look up that word on a completely nondescript search engine.
'That's interesting', he thinks. After a bit more reading he discovers another useful term: 'liabilities'.
'Maybe I should start buying assets instead of presents for Jennifer?' Ben thinks to himself. 'That way I will still be earning money from my salary, but my money will also be earning money at the same time.'
Ben does a bit more research into the different types of assets he can buy. Many of them are too expensive, but there are some that Ben decides he can afford with money he has saved. Ben leaves £2,000 in his savings account and splits the remaining £4,000 into a £2,000 index fund and £2,000 into a peer-to-peer property investment platform he finds (because he reads that keeping his money diversified is always a good idea). Both assets earn him an average of 7% a month. Instead of adding £100 to his savings account each month, he adds £50 to each of his assets and only £50 to his original savings account.
At the end of year four, Eric has the original £6,000 plus another £2,000 he has saved. So £8,000 in total.
Ben has £2,000 still in his savings account plus another £600 he has added that year. So £2,600 in savings. However, the intitial £4,000 in assets, plus compound interest, plus the £100 a month he has regularly added now total £5,535.65. So altogether Ben has £8,135.65.
Jennifer is no longer talking to Ben. Eric is very smug, but Ben doesn't care. Ben now has a small but growing passive income stream and has entered the matrix of asset growth.
For the next four years Eric continues to add to his savings account. At the end of eight years, he has a total of £16,000.
For the next four years, Ben continues to add to both his savings account and both assets. At the end of eight years he has £5,000 in his savings account plus his assets are now worth £12,871.55. He has a total of £17,871.55.
After a bit more research, Ben finds two different assets that will earn him a higher interest rate at 8.5% He sells both of his original assets and puts £6,435.78 into each new asset.
Two years later Ben and Eric meet up in the pub one afternoon to celebrate their 35th birthday. Eric is sad because Jennifer has run off with a man she met on holiday named Pedro. Over the last ten years he has saved a total of £20,000. Not enough for a house.
Ben is happy because he has saved £6,200 in his savings account and has two assets worth a total of £17,872.07. Altogether he has £24,072.07. Not exactly £25,000, but pretty darn close!
But at least Ben has an extra £4,072.07 to spend on whatever he wants! Or he can leave all of his money in assets to keep growing by themselves while he pays off his student loan. The sensible option.
Ben decides to move to the Greek island of Symi, open up a bar and spend the rest of his days surfing instead.
The morals of this story are all over the place, but the assets part is very useful to know. Whatever you decide to do with your life, if you can make your money make more money while you go off and do other things then you will always be in a better situation financially. At the same time, keep your liabilities to an absolute minimum. Consider if a purchase is going to either depreciate in value or keep costing you more money in the long run. Like many people my age, I was made redundant several times during the recession and learned very quickly that I could never rely on a constant salary. These days I only care about how much I earn while I sleep. Anything else is a nice bonus.