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Asset Vs. Liability

Fundamentals of Finance: Must-know Facts on Assets Vs. Liability

Understanding the difference between an asset and a liability is very important for anybody interested in mastering the fundamentals of finance. The explanation presented in this article will clarify the difference.
WealthHow Staff
Last Updated: Jun 3, 2018
Being aware of our assets and liabilities is essential for all of us. This can help us in judging our financial position. When applying for credit from banks and financial institutions, lenders will consider whether your liabilities are in complete control and you have substantial assets which can be used as collateral. The information given below will help you know the exact difference between the two.

Comparing Assets and Liabilities

The day people start earning, they are advised to start accumulating assets and have a strict check on their existing and potential liabilities. Assets are those things which help you earn cash, whereas liabilities are those purchases for which you have to make regular payments. Some objects included as liabilities can turn into assets in certain situations.

The best example for this is a home bought with a bank loan. For your home loan, you pay monthly installments and hence there is outflow of money. In this particular case, the home would be considered as a liability for the person.

In another case, let us assume that a person is an owner of a home and he has decided to rent his home to someone for a fixed rent every month. This means that the owner would be making a certain amount in cash every month and this will add to his total monthly income. This added liquidity makes the home an asset for the person. So, the situation and circumstances can convert an asset into liability or vice versa. Studying these circumstances carefully is essential.

The comparison of assets and liabilities suggests that the total amount of assets should always be higher than that of the liabilities. By following this rule, people would be able to stay in a good financial health. You should also be aware of which assets can give you the maximum returns and help you increase your net worth.

Over the years, it has been observed that stocks of blue chip companies have appreciated over hundred percent and investors with long-term investment horizons have benefited from them. So, stocks would definitely top the list of high return assets. At the same time, they would also be called high risk assets since stock prices are fluctuating and can make you incur huge losses in times of market crashes. Stocks would be a good asset class for investors who can take more risks and have the ability to bear losses at times.

Mutual funds are known to be the finest assets a person can possess over the years. They are available in different formats and can be safe investment bets due to their diversified nature and handling by expert fund managers.

Again, there are types like high-risk-high-return or low-risk-low-return funds which investors may choose. Bonds, which are loans forwarded to corporations, for their expansion plans, are also an excellent example of long-term assets, since the returns for bonds are enjoyed by the investors for many years. While cash can be the biggest liquid asset a person can have, rental properties, gold, silver, bank savings and deposits are also assets which one cannot ignore.

Credit cards, loans from banks, and cars are some common liabilities for people. Taking right decisions regarding asset acquisition and maintenance can benefit an individual to a great extent.