Article

Valuing Liabilities like Assets

It’s natural for you to gravitate towards the idea of financial planning being focused on growing assets such as stocks, bonds and real estate. Many are surprised to learn that developing a comprehensive financial strategy doesn’t only involve focusing on what you own, but also what you owe.

September 10, 2024
Important Disclosure: Content on our website and in our newsletters is for informational purposes only. The information provided may (or may not) directly apply to your situation. We recommend that readers work directly with a professional advisor when making decisions in the context of their specific situation.

When the topic of financial planning comes up, most individuals naturally gravitate towards the idea of growing their assets. Stocks, bonds, real estate, and retirement accounts usually dominate these discussions. However, a comprehensive financial strategy doesn't only involve focusing on what you own, but also on what you owe. Liabilities, or the debts one owes, are just as crucial to understand and manage, especially in an economic environment of rising interest rates.

Why Liabilities Matter

  1. Net Worth Calculation: At its core, a person's net worth is calculated as assets minus liabilities. If we only focus on half the equation, we can get a distorted picture of financial health. A person might own assets worth a million dollars but could be deep in debt, resulting in a low or even negative net worth.
  2. Cash Flow Implications: Monthly debt payments can take up a significant portion of an individual's income.

    This can restrict the ability to invest for the future, save, or even cover daily living expenses. Understanding and managing liabilities helps ensure a smoother cash flow.
  3. Interest Rate Risk: With floating rate debt, the interest rate isn't fixed but varies based on market conditions. In a scenario of rising interest rates, the cost of servicing this debt can shoot up rapidly, making it more expensive for the borrower.

Treating Liabilities Like Assets

Given the importance of liabilities, here's how one can give them the same attention as assets:

  1. Regular Review: Just as one would review an investment portfolio periodically, it's essential to review outstanding debts. This includes checking for interest rates, payment terms, and the remaining balance.
  2. Refinancing Opportunities: As markets evolve, there might be chances to refinance debts at a lower interest rate or better terms. This can result in significant savings over time.
  3. Prioritizing Repayment: Not all debts are created equal. Some might have a higher interest rate, while others might be tax-deductible. By understanding the nature and cost of each liability, one can create a repayment strategy that maximizes financial benefits.
  4. Establishing an Emergency Fund: One of the best ways to prevent unnecessary debt is by having an emergency fund. This cash reserve can cover unexpected expenses, reducing the need to rely on high-interest credit options.
  5. Considering Debt in Investment Strategy: If an investment opportunity offers a return of 6%, but one has outstanding debt with an interest rate of 8%, it might make more financial sense to pay off the debt first rather than invest. It's essential to weigh the prospective returns against the guaranteed cost of the debt.

A holistic financial plan is a two-sided coin: assets on one side and liabilities on the other. By valuing liabilities in the same way we value assets, we not only get a clearer picture of our financial health but also make informed decisions that set the stage for long-term financial stability and growth. As interest rates evolve and economic conditions shift, understanding and actively managing liabilities becomes not just a good practice, but a necessity.

Other content you may like

  • The Rising Price of Crude Oil and Gasoline

    The Rising Price of Crude Oil and Gasoline

    March 22, 2022
    What should consumers and investors expect beyond March 2022? The oil market has been uncertain for several reasons. This article looks into factors that affect the price of oil, resulting in gasoline price changes. Add to that all of the products beyond the pump that contain crude oil and you get a better picture of how the cost of energy affects virtually every aspect of the economy.
    Read this Article
  • Q1 2022: Greatest Hits

    Q1 2022: Greatest Hits

    March 15, 2022
    Looking for stats on market volatility in uncertain times? These stock market numbers going back to 1950 might help you stay the course. In addition, here’s an overview of 2022’s 1st quarter in all the issues that matter: stock and bond returns, money market assets, growth vs value, interest rates, and the effects of inflation. Included is an important visual showing how a diversified portfolio can work even when it may not feel so good.
    Read this Article
  • Ranking the Best and Worst Presidents - Part I

    Ranking the Best and Worst Presidents – Part 1

    September 13, 2020
    What if we ranked the best and worst presidents simply by the performance of the stock market? Surely that would settle the debate as to which president was best for investors, right? Well, while it sounds easy there are a few big caveats to consider.
    Read this Article
  • What to Do When the Bear Market Rallies

    What to Do When the Bear Market Rallies

    August 9, 2022
    The real value of a bear market may be that it gives investors, who are temporarily frozen within its grip, the opportunity to learn or relearn important lessons regarding risk and diversification. For savvy investors, a bear market also creates a period for looking beyond emotional headlines and studying the hard facts – facts that […]
    Read this Article
  • The link you have selected is located on another server. The linked site contains information that has been created, published, maintained, or otherwise posted by institutions or organizations independent of this organization. We do not endorse, approve, certify, or control any linked websites, their sponsors, or any of their policies, activities, products, or services. We do not assume responsibility for the accuracy, completeness, or timeliness of the information contained therein. Visitors to any linked websites should not use or rely on the information contained therein until they have consulted with an independent financial professional. Please click “Continue to Link” to leave this website and proceed to the selected site.
    phone-handset