Limit depreciating assets to build wealth

One effective way to improve your long-term financial stability and personal net worth is to limit the purchase of depreciating assets, including cars, high priced material goods and more. As one of the basic concepts to financial literacy is understanding, and controlling, how you spend, invest, and consume goods over the course of your lifetime in order to help build wealth. Spending money, and ever worse taking out loans, to pay depreciating assets is one of the most harmful wealth building tactics you can take.

Depreciating assets are items that often lose value immediately after purchase. The most common items are cars, electronics or furniture (especially high priced ones), and many other consumer goods. Ideally, in order to help grow your wealth and make your money work for you, money should be invested primarily into appreciating assets, items that have a substantial chance of increasing in value, and those include real estate (like your house), education or certifications, or investments such as stocks. At the very least, avoiding the use of loans and credit to purchase depreciating assets will result in a more solid financial foundation.

Appreciating Assets

Appreciating assets are items that retain value or have a significant potential to increase in value with time. Examples of these include real estate such as homes and apartment complexes, stocks, a college educations precious metals like gold and investments in a startup or existing business. As part of a diversified financial literacy portfolio, an investor who wants to be successful at building wealth will have a portfolio of various types of appreciating assets, including real estate, stocks, your own persona education/career, and more.

Numerous financial literacy factors affect whether assets gain or lose value. These include supply and demand, brand name, the useful life of a product and the general economy. Although property typically considered as an appreciating asset can lose value, wise investors understand that, based on past performance, these assets can generally be expected to at least retain their value and that there is a substantial chance the asset value will increase with time.

Purchasing a home is usually considered a good investment in an appreciating asset and it helps families build financial stability and wealth. Let says you purchase a home for $400,000 using $100,000 in a down payment and $300,0000 mortgage. If you live in it for 10 years and then sell it for $550,000, you increased your investment by 150% just by simply living in the home.

How? As you will have made over $150,000 in the home ($550,000 sale price – $400,000 purchase), but you only risked your initial $100,000 investment as equity (which was your down-payment). So you risked $100,000 as a down payment, sold the home for and made $150,000 on your initial 100K investment. That leverage is a key financial literacy concept, and buying a home is a great example of an appreciating asset.

Similarly, if you purchased 100 shares of Amazon stock near the end of 2010 at about $180 per share you would have paid $18,000. Near the second half of 2019, shares were selling for about $2000. In nine years, your stock gained $180,000 in value, and all that was required of you was to let the stock sit in your investment account.

Depreciating Assets

Depreciating assets are items that often lose value almost immediately after purchase. They also tend to be things that increase the convenience or enjoyment of life. Examples of these include cars, planes, boats, RVs, computers, TVs, cellphones, furniture and clothing. Purchasing such items is usually not based on sound financial decision-making but more on convenience, the “Keep up with the Jones” mindset or necessity.

As an example, as soon as you drive a new car off the lot the price of the car (asset) goes down about 20%. Boats lose about 25 to 30% of their value (price of the asset) as soon as you drive it off the boat lot. Other items, like (furniture or electronics) also immediately go down in value.

Generate wealth by investing in (purchasing) assets that gain in value

Generating wealth results from a sound strategy that involves purchasing assets that will gain value and reducing the number of assets that lose money. Unfortunately, many people sink their hard-earned dollars into assets that may ultimately cost them even more than the original purchase price in the long run.

Everyone, out of need or desire, is bound to acquire depreciating assets. First of all, before spending money, know the difference between needs and wants. In addition to that, by following a few guidelines, you can help reduce the negative impact of these assets on your long-term financial stability and you can help yourself build wealth over time.

1. Purchase higher quality brands. Do some homework, and try to determine how much value an asset will lose annually. Buying well known or higher quality brands can reduce the projected depreciation rate. As a general rule, particularly for high-cost items, strive to use your resources to purchase appreciating assets and lease depreciating assets.
2. Do not borrow money to buy a depreciating asset. This is a major mistake when it comes to decisions around financial literacy. If you already know the item you want to purchase is going to decline in value, don’t make matters worse by increasing the cost via monthly interest charges by using a credit card or taking out a loan.
   Many credit cards carry interest rates of 15-24%, which can be a financial burden to anyone. Consider the example of purchasing a big-screen TV for $1000 using a credit card with 18% annual interest and paying the debt off at $49 per month over 24 months. With added interest, your TV will ultimately cost about $1200 but, based on typical depreciation standards, the actual value of the TV after two years will be about $400. It was bad enough to lose 60% of the asset’s value after two years, but by using a credit card you threw away an extra $200.
3. Patience can be a virtue when it comes to personal finances and health you build wealth. Having the important financial literacy trait of discipline and patient to wait for your desired item to go on sale or to save money until you can pay cash for an item will often save hundreds if not thousands of dollars. Take your emotion of out investing or spending.
   Purchasing a practical vehicle that will meet your transportation needs while setting money aside until you can buy your dream car can prove financially beneficial in the long run. A vehicle purchase provides a good example of both how money can be wasted and how other options can minimize financial losses when buying a depreciating asset.
   Using typical depreciation expectations, a new car valued at $30,000 will be worth about $11,100 after five years. If you pay cash, you will lose $18,900 on your investment. To make financial matters worse, if you borrow $30,000 at 6% interest to purchase the car, you will pay an extra $4800 in interest over five years. You may enjoy the use of the vehicle, but the combination of value loss and interest payments after five years makes a $30,000 investment worth about $6300.
4. Consider other options when buying a costly asset. Big-screen TVs typically lose 50% of the value after one year while vehicles lose 25%. Purchase last year’s TV model or buy a vehicle that has been used for two or three years. Let someone else take the big hit in value loss that these assets typically experience in the first couple of years. You’ll pay less upfront and minimize your share of the asset’s value loss while still getting a quality item.
5. Lease rather than purchase depreciating assets. If you finance a $30,000 vehicle for five years with a 6% interest loan, you will pay about $20,880 during the first three years. Leasing a comparable vehicle for a $3,000 down payment and monthly lease payments of $250 would have totaled $12,000.
   By leasing and essentially paying for the functional value of having a car and not the added depreciation, you will have saved $8,880 and eliminated the chore of selling the car. The $8,880 you saved over three years could be used to further help improve your financial health by paying down other debt or purchasing appreciating assets.

If you must, borrow money for appreciating assets

If you must borrow money to purchase an asset, only do so for appreciating assets that will provide a greater return than the cost of the loan. Taking out a loan at 6% interest to help purchase rental property such as a duplex that will produce a 10-12% return makes sense and is an example of what is commonly called “good debt.” Taking out a competitive mortgage to purchase is also another good financial literacy example of borrowing to purchase an asset that increases in value.

Or consider your career, education and yourself an asset (which you are!) and borrowing money to invest in yourself and your career is another great example of a helpful appreciating asset. As if you can take out a reasonable loan to pay for IT certifications, a health care degree, financial literacy classes, or some other in-demand career with future opportunities and income growth, that may be the best investment anyone can make as it pay dividends in the future through higher income and more career opportunities.

Help build long term financial wealth by understanding asset types

Investing in appreciating assets helps to build wealth while purchasing depreciating assets inhibits wealth generation. Acquiring depreciating assets may be unavoidable, but by being selective about what you buy, when you make the purchase and how you pay for the asset, you can minimize the negative impact on your personal finances.

By Jon McNamara