So you’ve finally gotten to the point where you decide to take charge of your life. You’re going to act more responsibly now and try to save money. You’re willing to cut your expenses and even lower your standard of living just so you can sort out your personal finances. No more excess partying. Mo more splurging. You are now willing to sacrifice in order to have a better and brighter financial future. You’re going to save and stash every single penny you can and you’re going to invest it in things that count.
But hold on for a moment.
You have to make sure you know what a real “investment” is before you start locking in all your hard-earned savings into anything. You see, a lot of well-meaning people actually mistake cash-sucking, life-shackling expenses for investments. Determining whether or not something is an “investment” is not always black and white. Not all assets in an individual’s balance sheet can be considered investments. Purchases like a family’s house or car – which, conventional wisdom commonly identifies as investments – may not actually be investments.
An investment has one fundamental characteristic. It produces profit.
Now consider the young professional who dreams of having his first brand new car. He’s got it made. He landed the perfect job and now has a monthly salary enough to pay for the monthly amortization. He just eats hotdogs for lunch and eats dinner at home. He stopped drinking luxury coffees and finally he’s been able to come up with enough cash for the down payment on the car. He’s ready to make this “investment.” Unfortunately, it’s actually not an investment. Although a lot of sacrifice, self-control and financial prudence was necessary for him to be able to save up for the down payment, the whole exercise in self-denial doesn’t turn the brand new car into an “investment”. He threw away all his savings into a cash-guzzling mechanism. The car immediately declines in value the moment the yuppie drives it off the lot. (Yuppie already lost money there). After that, more money will have to be paid for interest expense on the car loan, car insurance, gasoline, toll fees, parking fees, taxes and regular maintenance costs. When does the “profit” aspect of the “investment” show itself? Never. So, nope. It’s not an investment.
On the other hand, another guy might want to buy the very same car model as the yuppie but intends to use it for his Uber business. Let’s put aside the issue of whether an Uber business is actually profitable for now. This guy’s intention to generate profit from using the car makes his purchase a valid and true “investment.” Of course, he only profits if interest, fuel, maintenance and all the costs mentioned previously are more than covered by what he earns from driving people around. But for all intents and purposes, the car he buys is an investment.
And then there’s every family’s dream of owning their own home. The bigger the better. Again, interest expense, real property taxes, association dues, maintenance and other costs will all have to be paid in owning the house. Will there be any profit generated? None. You might say the property’s value is going to appreciate because the “investor” chose his location well. Fair enough. But remember, this is the “investor’s” dream home. He’s going to retire and grow old in it. He’s going to watch his grandchildren and great grandchildren run around its beautiful backyard. They’re going to have decades upon decades of family reunions in that house. In other words, the “investor” is never going to sell that house. Hence, regardless of any appreciation in its price, there won’t be any realized profit. Conclusion, it’s not an investment.
In contrast, a senior couple want to use their retirement pay to build a small row of apartment units. It is their hope that the rental income from the property they build will provide them with some passive income to augment their pension and sustain them for the rest of their life. All the expenses related to home ownership will still be incurred by the senior couple. However, they will also be earning an income and hopefully making a profit from their real property. This makes a house an investment.
From these examples, we see how an asset – like a car or a house – can be an investment for one person and an expense for another depending on how the owner intends to use it and we explain it more at LOM. If intended for personal use, then it is not an investment. If used to generate profit, we can say that it is a valid investment.