Tuesday, April 04, 2006

Wealth Creation Lesson

This is a true story from my own experience that illustrates how buying assets for wealth creation works.

Just over 3 years ago I found myself with $75,000 to spend or invest. My wife and I needed a new car as the old one was 8 years old and not as reliable as it used to be, so we spent $40,000 on buying the latest model.

Our $75,000 was now reduced to $35,000.

We now made the wisest financial decision we have ever made (apart from buying our own home) and used the remaining $35,000 as a deposit on an investment property to help provide for our eventual retirement. The investment property cost a total of $178,000 including mortgage, conveyancing, and stamp duty costs.

Three years have gone by and this is what has happened.

The car has dropped in value by at least $10,000 and possibly more, but is providing good reliable transport.

The owner of the neighbouring property to our investment has put his identical property on the market for $319,000 which compares favorably with other properties in the area. As a conservative guess I would expect it to achieve a sale price of $300,000 or thereabouts.

This means that we have made around $122,000 on our original investment in the house and lost $10,000 on the car. It's actually worse than that. By buying the car instead of the neighbouring house we have forgone a possible $122,000 profit, so the car has has actually cost us $162,000! The old car is still running and in daily use.

The end result is that we have a paper profit of $122,000 on the house and a technical loss of $132,000 on the new car ($162k - $30k residual value).

The moral of this story is to put your money into things that increase in value (assets), and NOT into things that decrease in value (liabilities). You may not have a large sum of money to invest in real estate but there are other asset classes like art, antiques, coins or stamps where there are plenty of smaller investing opportunities.

If you can remember this story of buying a house versus buying a vehicle next time you make a major purchase, you can evaluate how the purchase is going to affect your future wealth. Do you really need a new vehicle or a wide-screen TV? Would a low-mileage second-hand car, and keeping the existing TV be sufficient? Making the right decision now will have a huge bearing on your retirement.

Learning to distinguish between wants and needs, and investing in assets is the key to wealth creation and a comfortable retirement.

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