Blog | Personal Finance

The Key to a Secure Financial Future is Understanding These Two Concepts

Social Security, Unfunded Liabilities, Assets, and Cash Flow

Words have the power to make you rich-or keep you poor. For example, you have to know the difference between an "asset" and a "liability." Many "experts" do mental gymnastics to make things seem like assets when they're really not. The result for the average person is confusion at best and financial ruin at worst.

Take for example this article "Social Security is a bigger deal than you think," by Scott Burns in "Dallas News". He writes:

Burns rightly says that Social Security isn't an asset and then promptly calls it the biggest asset Americans have. Confusing enough. But perhaps more confusing is the "assets" that he uses to compare Social Security to.

Using the Federal Reserve flow of funds figures, Burns lists the following select figures:

• Houses at a net equity of $12.8 trillion
• Mutual fund shares at $6.7 trillion
• Pension entitlements at $21.7 trillion
• Small business at $11 trillion

He then lists the "assets" of Social Security in comparison:

• Current trust fun: $2.8 trillion
• Unfunded liabilities: $32.1 trillion
• Future payroll tax collections: $99.4 trillion
• Total: $134.3 trillion

Back to basics

Let's take a moment to get back to basics before we discuss what Scott Burns is writing. Here's the simple and accurate definition of assets and liabilities: An asset is something that puts money in your pocket, and a liability takes money from it.

Take housing, for example.

"Our house is an asset," my poor dad would say.

But, my rich dad saw things differently. "Your house is not an asset, but a liability," he said.

You see, even though my poor dad thought of his house as an asset, the fact is that every month it took money from his pocket via mortgage payments, utilities, and upkeep.

Now my rich dad owned several houses. But instead of depleting his wallet, those homes were rented out. They generated enough income to cover his expenses-with money left over. That's a true asset.

Cash flow vs. capital gains

In addition to "asset" and "liability," there are two other very important concepts you need to understand: "Cash flow" and "capital gains."

One of the reasons I was able to retire at age 47, and my wife, Kim, at 37, was simply because we had enough cash flow coming in (primarily from our real estate investments). It wasn't much-about $10,000 a month-but we only had about $3,000 in monthly expenses. That left us with $7,000 a month to do with as we pleased.

On the other hand, capital gains are when you buy a stock for a dollar, and it goes up to $10 so you make $9 a share. Or, you buy a house for $100,000, and it appreciates to $150,000. You sell it and make $50,000.

One of the reasons people do not become financially free is because most of them are focusing on capital gains rather than cash flow. Chasing capital gains alone is gambling-not investing. Want proof? You don't have to go back very far to find it: During the great recession starting around 2008, millions of investors lost trillions of dollars in the stock and housing markets.

"When you invest for cash flow," my rich dad said, "you're investing in a money-back guarantee. If you invest for capital gains, you invest in hope. The biggest thief of all is hope."

The "hope" of social security

Perhaps the scariest thing about thinking of Social Security as an asset is that it is the ultimate gamble on hope. The numbers that Scott Burns uses to talk about it as an asset assume the government will be able to fund the $32.1 trillion in unfunded liabilities-that is promises they don't have the money to keep-with "future" payroll collections of $99.4 trillion.

Of course Social Security has been around for a long time now and they only have $2.8 trillion on hand. How they would ever catch up, especially given that, including other obligations, the US has $100 trillion in unfunded liabilities, is not explained. Why? Because it is the big elephant in the financial room.

To put it simply, US unfunded liabilities are larger than the "future" payroll collection income for Social Security-money that has not been collected yet can't even cover the money we owe today.

Add to that the fact that Burns (and the Federal Reserve) list housing and mutual funds as assets Americans rely on-things that do not put money in your pocket and rely on only capital gains-and you can see how much trouble we're in.

Finally, couple that with the fact that public pension funds have $1.75 trillion in unfunded liabilities, and the only true asset left on the list Burns gives is small business. So, score one for entrepreneurs.

Take control of your financial future

In the end, relying on things that are called "assets" but that don't put money in your pocket is the biggest gamble you can take with your financial future-and relying on a government program like Social Security as your "biggest asset" is the ultimate gamble…one that you will lose big on.

Rather than passively rely on capital gains and the government to make you financial secure, you need to take control of your own financial future. That starts with increasing your greatest asset: financial intelligence.

And the key to financial intelligence is how to use both cash flow and capital gains to grow wealthy. So many people are not successful, because they're generally focusing on only one of the two. The majority is focusing on capital gains.

In my opinion, one of the primary reasons people invest in tomorrow, rather than today, is simply because they think they cannot find or afford an investment that pays them today. As a result, they often become believers in tomorrow. These are the people who often fall prey to financial predators selling dreams of the future.

As my rich dad said, "An investment needs to make money today and tomorrow."

Today, start putting the power of true assets and cash flow to work for you.

This post is an update of a previous article I wrote back in 2005, Investments That Pay Today -- and Tomorrow.