Today I'm going to introduce you to a concept that will forever change your financial future. And should you choose to share this knowledge with your friends, your kids or grandkids... it will change their financial lives too.
I know that's a bold claim and promise, but I assure you its 100% true.
In all my years in business, as an entrepreneur and as an investor, reflecting back on every win, every loss, every lesson and every mistake... if I would have known and understood this one concept, it would have made the biggest difference to monetary wealth building and peace of mind.
If I could go back in time, its the number one thing I would change today.
You're about to get a real world PhD in functional finance within a few short minutes. You'll save the million dollar education expense that I and others have paid.
And you'll learn the only type of debt that is ever considered "good debt".
This concept came to me, honestly, through some deep self reflection and prayer.
As goofy as it sounds, I was asking the Creator for wisdom on how to simplify things, meaning the financial concepts of wealth building and it led to an updated new audio training of the True Wealth Formula.
I wasn't only asking for myself, but because I was preparing to share some ideas with our kids at an upcoming annual family meeting we were having. In short, I wanted something they could learn at any age that they would never forget.
I want to share with you what I got in that prayer, the vision and the diagram that was given to me.
Don't let its simplicity fool you.
If you memorize this diagram, you’ll know and understand more than 90% of all “professional” advisors out there because it will give you a foundation of context AND understanding of how wealth is created (or destroyed).
It's so simple, once you learn it, you can never unlearn it.
And as I said, its something you can easily teach your kids and grandkids.
When it comes to finances, its all about the Balance Sheet. I won’t go into the nuances at this time, and for those who would argue that the Income Statement (i.e.; P&L, income, expenses, etc) is more important, we’ll cover that in another article. But for now, just understand that it all starts with the Balance Sheet (what you own and what you owe).
Here’s what you need to know... there are essentially only 4 types of debts or assets possible.
Take a look at this diagram. Memorize it for the rest of your life and never forget it so long as you live.
Now lets explain what this diagram means.
Whenever you "buy" something, whether via cash or debt, think long and hard about what you are buying and what type of asset or liability the transaction is creating on your Balance Sheet.
Type #1 is C for Consumption (lower left corner):
- This is debt that is essentially backed by nothing. It was capital or debt that was used to accumulate something that was ultimately “consumed”.
- It could have been food, clothing, housing (i.e.; rent), utilities, insurance, travel or even a medical bill.
- When its all done, you have nothing to show for your debt but a credit card balance and monthly payment.
- It's essentially 100% consumed and there is no “asset" on the balance sheet to offset the debt (essentially this is only a debt quadrant, not an asset quadrant).
Type #2 is DA for Depreciating Asset (lower right corner) or what I call “dumb ass” debt:
- This is what most people in the middle class do, when they start to make a little money and get beyond the survival basics of life, they start buying things like cars, houses and boats or even a big screen TV.
- Granted, a lot of these things are necessary, obviously we need transportation and its usually better to own a house than to rent (in some but not all cases).
- Most of the time, people use debt to finance and acquire these types of “assets”.
- They’re recognized as assets on a Balance Sheet, but in all actually they are extreme negative cash flow, and they depreciate every single year.
- In the case of a vehicle, it depreciates the moment you drive it off the lot. If you’re going to buy a “new” car or truck, the largest rate of value loss happens in the first 3 years so as a rule of thumb, only buy vehicles 3 years or older and you’ll minimize the rate of depreciation.
- Some would argue that a house shouldn’t be a depreciating asset because over time they usually appreciate in value and that’s certainly possible (only if and when bought and sold at the right time).
- But as an investor, when you hold a rental property, you take depreciation for a reason. The materials are depreciating over time and will need to be maintained or replaced, they are in fact not appreciating in value but depreciating.
Type #3 is AA for Appreciating Asset (upper left corner):
- This is where 90% of all “investors” make their mistakes. Its what most people put their money into thinking they are investing in something that will go up in value.
- It could include things like houses, land, stocks, precious metals, art, antique cars and other collectibles.
- If you use debt or leverage to acquire these types of assets, you’re gambling because you have no control over whether or not they’ll go up in value.
- And even harder, you not only have to buy right (at the right time) but you have to sell right (at the right time) as well which can be even trickier to do.
- Most people, because of emotion, even though we know cognitively that we’re supposed to buy low sell high, do the exact opposite and buy at the top of markets (when greed is at an extreme), then sell at the bottoms (when fear is at an extreme).
- Worse, these types of assets are negative cash flow, they cost money every year in taxes, insurance, storage, maintenance and other transaction fees.
- They make you poorer every single year while you hold your breath and wait and hope they go up in value, and that you’re smart enough to sell at the right time.
- They make you lose sleep at night because they are volatile.
- Why do people buy these kinds of assets? Because they’re exciting.
- Amateurs notoriously and consistently over allocate into these types of negative cash flow, speculative “appreciating” assets.
Type #4 is CFA for Cash Flow Assets (upper right corner):
- This is where the professionals put their focus. Those who create wealth own the means of production in society and production generates cash flow.
- I’ve said there is only one type of "good debt" and if you’re going to use debt in any way ever, this is the only type of asset where it can be smart - if you know what you’re doing.
- These types of assets include anything that pays you money to own the asset.
- Things like rental property, intellectual property (royalty & licensing fees), dividend paying stocks, bonds, private debt (mortgages or loans) and other forms of interest payments, even cash crop farmland or a successful business.
- These types of assets make you richer every single year by putting money in your pocket, regardless of whether the asset increases or decreases in value.
- They are usually less volatile and therefore less exciting than Appreciating Assets, but they are what the wealthy focus on.
- When you’re investing in these types of assets, you’re much less likely to buy and sell at the wrong time.
- You’re much more focused on the underlying value, crunching numbers up front to determine your best entry and exit point and you’re also more likely to focus on compounding your returns which both compound the underlying asset value as well as the income stream being generated by the asset.
- They typically have more favorable tax treatment.
If you’re going to use debt or leverage to create wealth, the only time you want to consider doing it is type 4, CFA. And only if you’ve mastered some of the other wealth building fundamentals.
This is what so many of the so called wealth gurus get wrong, in every single asset bubble. They teach people to use leverage (debt) while the asset class is rising, with each successful transaction people lever up along the way, then the bubble pops and the underlying asset values collapse but the debt remains resulting in write downs, fire sale liquidations, bankruptcies and destruction of wealth (capital).
The guru's walk away with their best selling books and success testimonials. But the clients get screwed because they never had any understanding of what I'm sharing with you in this article today.
All the fancy wealth building strategies and techniques mean nothing if you don't have a basic knowledge of finance. You can have a few wins along the way, but eventually you'll get caught with your pants down and when it happens, its not going to be fun trust me.
If you're a long term wealth and legacy builder, you want to own the means of production, the Cash Flow Assets (CFA).
Focus most of your efforts in the top right CFA corner.
Its okay to have some AA assets, but if have too many of them, you'll want to consider doing some Balance Sheet reorganization and get things re allocated into the CFA quadrant.
It will improve your results, build your wealth, and you'll sleep better at night.
Want to be rich someday? Its simple.
- Get a bonus or refund check? Buy a CFA.
- Get a promotion or a raise? Cap your overhead and put the difference every month into a CFA.
- Save some money via sale or coupon? Buy a CFA.
- Get a tax refund? Buy a CFA.
- Receive a gift, inherit some money or win the lottery? Put it into a CFA.
- Downsize your current living expenses and overhead? Use the difference monthly to buy a CFA.
- Have capital gains or cash flow from an existing investment? Reinvest it into a CFA.
This is how you compound your money and become filthy stinking rich.
To be clear, I'm not talking about whether or not you're a good person. I'm just talking about money.
You could still end being a Rich Miserable Bastard. But that's a heart issue and a completely different situation to deal with.
If you want help, I'd encourage you to pickup this training. It will go into these concepts deeper and reprogram your brain to be a Wealth Builder.
If you have "bad debt" (Type 1, 2 and 3 above), you can use our Debt Payoff Accelerator calculator to totally elliminate is super fast.
If you want to go to the next level and mastery, consider signing up for our TWF Implementation Program or Monthly Group Coaching.
For now though, I thought it would be helpful for you to have this 4 Types of Debt & Assets diagram.
As I said, if you memorize it and the core concepts you will avoid 90% of mistakes most people make and you’ll be in a much better position the next time you sit down and talk to an advisor.