Wealth is the total assets minus the total liabilities of an individual, organization or government. Wealth is effectively the sum of resources available for disposal at any given time. Wealth is calculated according to current market rates, or appraised estimates when an effective market pricing mechanism does not exist.
The Significance of Wealth
Wealth is an important concept as it differentiates between total assets and total assets less total liabilities.
Individuals, organizations and governments all face the same vulnerabilities that are associated with high levels of assets and low levels of wealth. A large amount of assets may seem beneficial at a superficial level, but if the actions of the owner are heavily constrained by the need to service the associated liabilities, then they may face worse outcomes than if they had a lower overall level of both assets and liabilities.
Wealth for Organizations
Many companies and governments are faced with dangerous levels of debt that threaten their financial stability and long-term viability. Sudden increases in interests rates or emergency expenses can make debt servicing difficult or impossible, which can lead to a contagion of problems that further strains their capacity to service their debts in a vicious circle.
Companies with excessive debt levels are often valued at a deep discount on the market, even if they make effective use of their total assets.
Both governments and companies face lower credit ratings and higher corresponding debt servicing costs when they have a high ratio of debts to assets.
Wealth for Individuals
Individuals in particular should make an effort to focus on wealth over total assets due to the impact of consumption on their behavior. Many individuals will incur heavy debts to purchase properties and assets that do not generate income, and may even depreciate in value over time. This can lead to drastic reductions in wealth from attempting to maintain unsustainable levels of consumption.
Most personal financial advisors recommend that individuals look to minimize their overall debt load by purchasing assets for consumption, such as houses, that are affordable, and look to acquiring revenue generating and value preserving assets that will increase their overall level of wealth.
Wealth building assets can come in a variety of forms, but all of them offer a form of cash flow, an appreciation in value or both.
For example, many wealthy people can afford to buy pieces of art, decorations and a variety of luxury goods that tend to appreciate in value over time. They may enjoy using these assets with little or no risk to their value, and then resell these assets at a profit in the future. They can also borrow against the value of these assets when necessary or when profitable opportunities arise. Unlike most expensive cars, which tend to depreciate in value, or bottles of wine, which are worthless once they have been drunk, there are many assets that can be enjoyed while they also appreciate in value at the same time.
Examples of income generating assets include businesses, securities and licenses. These assets can be bought and sold, and tend to have a clear market value, while also offering a steady cash flow to the owner. Income generating assets can also appreciate in value as well, further increasing the overall wealth of their owner.
Ideally individuals should be looking for assets that they can enjoy while they appreciate in value and generate an income, but this will not always be possible. Instead wealth building should be looked at as a balance of costs and benefits, where individuals trade off the enjoyment of assets for their wealth building potential.
Individuals should be looking foremost to build wealth, and then to enjoy the use of assets that do not threaten their level of wealth. By building wealth first before enjoying its benefits, individuals ensure that they will remain wealthy far into the future.
Wealth is an important concept for all modern individuals to understand. It is ultimately wealth, the difference between assets and liabilities, and not just assets that determines the outcomes and enjoyment of life for an individual. Therefore, they should always be looking to build wealth first, and then to enjoy their wealth in a way that does not threaten the maintenance and expansion of that wealth in the future.