Did This Video Touch the Third Rail???
Some of you may be too young to remember but there used to be the idea that Social Security was the third rail in politics; Touch it, you die. It was that simple.
Just watch this video of Dan Rostenkowski facing some of his constituents after he promoted changes to Social Security. Remember, politicians are like electricity, they ALWAYS take the path of least resistance. No politician wants this to happen to him.
So, when I posted a video titled “Your House Is Not an Asset?” I knew it would receive some negativity. After all, Youtube is alive and well with folks promoting real estate as a sure-fire way to riches.
I’ve no problem with any of that. If real estate is your thing, more power to you. But to also say the home in which you own is not an asset is pure silliness and needs to be challenged.
What Is An Asset?
To understand what an asset is you need to first understand a balance sheet. (This is a critical piece of financial planning, especially for married couples. We look at something called “equalization of estates” to determine who owns what. An unequal estate, i.e., husband owns 90% of the net worth and wife owns 10%, can lead to some serious financial planning issues that need to be addressed.)
A balance sheet is simple. Take a blank piece of paper and draw a vertical line down the middle. On the top of the left write “ASSETS” and on the top of the right write “LIABILITIES”.
What you OWN goes on the left. What you OWE goes on the right. The difference is your net worth.
If you OWN a house that’s worth $200k and OWE $150k on that home you put $200k on the left side of the balance sheet. You also put $150k on the right side.
As you can see, from a pure accounting methodology, that home is inherently an asset, it goes on the left side of the balance sheet.
Even if you have negative equity, i.e., owe more than you own, the value of the home goes on the Asset side of the balance sheet.
In that case, if your home is worth $200k but you owe $250k, as happened a lot from 2006-2009, you still put $200k on the left side of the balance sheet. The $250k you owe goes on the right side, indicating in this case you have a NEGATIVE net worth.
An Asset Need Not Be Income-Producing
Now, what I think the people proclaiming “your home is not an asset” mean is that an asset SHOULD be providing you with income. And this is where I take issue with these folks, and more than just semantics too.
Look at your car. It produces no income. It actually is depreciating in value, i.e., LOSING value! Yet it has a utility. It performs work for you, in that it drives you around from place to place. Yes, there is a cost to that vehicle. You have to maintain it, put gas in it, carry insurance for it. But for most people, the utility of the car is MUCH higher than the cost to carry it. If not, they wouldn’t keep the car.
Is the car an asset? Of course it is. Is it income-producing? Not in the strictest sense. But let’s examine this further.
If I had NO car and needed to get to the grocery store, how would I do it? Take a cab, an Uber, a bus, ask a friend, something like that. But it takes COLD, HARD CASH to do this. Even if my friend drives me, that friend still needs cash in which to fill up the car with gas and also maintain the vehicle. Someone’s got to pay for my trip to the grocery, and that someone is going to be me.
So, where does that money come from in which to pay that trip to the grocery? Well, I had to earn it somehow. And when I earned it, most likely I had to pay tax on it too. It’s INCOME after all.
Understanding Imputed Income
And this gets to the crux of the issue, there is this thing called IMPUTED INCOME that needs to be considered. By me not owning a car, I need to generate the income required to pay for my trip to the grocery store. However, by owning the car, the asset, I do not need to have any income in which to pay for my trip to the grocery store.
That imputed income is money I do NOT need to generate. If I do not need to generate it, I also do not need to pay tax on it either!
Think about growing your own food. Every carrot I pluck from my garden is one I don’t need to buy from the store. Every quart of strawberries is one quart of strawberries I don’t need to buy…etc. When I don’t need to buy those products, I inherently don’t need to generate the income in which to buy those products. Yet, and this is the awesome thing, I can still consume those products! I am not without.
Solar PV panels could be the same thing. If your electric bill is $200 a month and you can replace that with Solar PV, that means you do not need to generate $2400 a year in income in which to pay for your electric bill, yet you still have electricity. Amazing right!
Once you think about being self-sufficient you begin to see all the IMPUTED INCOME you can generate in various products and services. Just cooking your own meals at home. That’s IMPUTED INCOME. Again, IMPUTED INCOME is income you don’t need to generate in order to live the same way.
Changing the oil in your vehicle. IMPUTED INCOME.
Putting more insulation in your home…IMPUTED INCOME.
Switching to LED lights…IMPUTED INCOME.
See how this works? And how fun it is?
Living in your home, mortgage and rent free…IMPUTED INCOME. And that’s the BIG one. My entire argument around retirement planning is your income needs DROP as you get older. Why? Because the older people get the more people own their homes outright. And thus what used to be, say a $2000 a month expense, is GONE.
They no longer need to generate $24k a year in which to pay for the roof over their heads. Oh, and by the way, that $24k a year income which is needed to pay for the house, is also TAXED! So, it may cost $26k a year in which to pay $2000 a month for your home.
Yet, once that baby is paid off…You no longer need to generate that $26k a year income. Yet, you’re still living in that home! Nothing has changed, except your income needs.
Living Large on Imputed Income
My goal at retirement is to have a lot of the income I currently need to live to disappear. House paid off. Solar PV and/or thermal, shoot maybe even geothermal. Food forest. Cars paid for. Heavy insulation. Wood stove. LED lights. Sustainable living, not in the modern vernacular of being “green” mind you. But in terms of sustaining my lifestyle with a heck of a lot less income needed.
But the big one is always NO MORTGAGE or NO RENT. It’s literally that simple. The bulk of your income is used on your housing arrangements, either through paying the banker or paying the landlord. Get rid of both of those people and life is good.
Your home is an absolute asset, even if doesn’t produce taxable income. For anyone who says it is not, just utter these two words “Imputed Income” and walk away laughing.