Using the Earning Assets to Total Assets Ratio to Measure Your Wealth explained by professional Forex trading experts the “ForexSQ” FX trading team.
Using the Earning Assets to Total Assets Ratio to Measure Your Wealth
If you want to live comfortably, sleep soundly, and retire in style, there is a trick you can use to determine how much progress you are making on your journey to financial independence. I adopted it from bank holding companies, which differentiate between earning assets and non-earning assets on their balance sheet when giving an account of the business results to shareholders and regulators, but it can just as easily be applied to an individual family.
Banks use the Earning Assets to Total Assets Ratio to shorthand the percentage of the balance sheet that is working to generate income. All else equal, the difference between rich and poor families is the percentage, and amount, of earning assets relative to non-earning assets.
Defining Earning Assets and Non-Earning Assets
First, we need to define the terms in case you haven’t encountered them in the past.
- Earning Assets are anything that directly generates income, such as stocks that pay dividends, bonds that pay interest, real estate properties that generate rents, copyright and patents that bring in licensing fees, and machinery that allows you to produce goods for sale at a profit.
- Non-Earning Assets are anything that do not generate income for the owner. A car is an example of a non-earning asset because it drains money from your life, rather than produces it, unless you own a delivery service, trucking company, or taxi business.
How to Calculate the Earning Assets to Total Assets Ratio
To calculate the earning assets to total assets ratio, you need to use the following formula:
(Beginning Earning Assets for the Year + Ending Earning Assets for the Year) ÷ 2
————– divided by ————–
(Beginning Total Assets for the Year + Ending Total Assets for the Year) ÷ 2
An illustration might help make sense of the numbers if it’s been awhile since you broke out your calculator. Imagine a guy named Lance. He’s likes investing his money to generate passive income. While he enjoys working, the idea of collecting dividends, interest, and rents is one of the great joys in his life; money he doesn’t have to sell his time to collect, as he does when earning a paycheck. He starts the year with $100,000 in bonds, $250,000 in stocks, $250,000 in rental property, $50,000 in cars, $300,000 in a personal residence, and $75,000 in other, personal assets such as furniture and clothing. During the year, he saves $80,000 and invests it all in additional stocks, bringing the new total to $330,000.
We need to begin by separating the earning assets from the non-earning assets at the beginning of the year:
- Beginning Year Earning Assets = $600,000 ($100,000 bonds + $250,000 stocks + $250,000 rental property)
- Beginning Year Total Assets = $1,025,000 ($100,000 bonds + $250,000 stocks + $250,000 rental property + $50,000 cars, $300,000 personal residence, $75,000 other)
Now, we need to calculate the same numbers at the end of the year:
- Ending Year Earning Assets = $680,000 ($100,000 bonds + $330,000 stocks + $250,000 rental property)
- Ending Year Total Assets = $1,105,000 ($100,000 bonds + $330,000 stocks + $250,000 rental property + $50,000 cars, $300,000 personal residence, $75,000 other)
Now we can put them into the formula to find the earning assets to total assets ratio:
($600,000 + $680,000) ÷ 2
——— divided by ———
($1,025,000 + $1,105,000) ÷ 2
($1,280,000) ÷ 2
——— divided by ———
($2,130,000) ÷ 2
——— divided by ———
=0.60, or 60%
This tells us that 60% of the assets on Lance’s personal balance sheet, or $0.60 out of every $1.00 he holds, is earning money for him. In a very real sense, that capital is out there working 24 hours a day, 7 days a week, 365 days a year on his behalf.
Many of Those Who End Up Wealthy Are Constantly Creating or Acquiring Earning Assets
One of the interesting economic phenomenons that repeats itself time and time again is the behavioral patterns that cause certain families to end up rich.
Engineers, for example, consistently end up with more net worth for every $1 in salary than most other professions. That is, all else equal, if an engineer makes $150,000 per year and a college professor makes $150,000 per year, the engineer is going to end up with millions of dollars in additional wealth by the end of his or her lifespan.
Certain immigrant groups display the same tendency to keep costs low and acquire earning assets. Korean Americans come to mind as one academic expert in the field, Dr. Thomas J. Stanley, found in his research they were 3x as likely to earn a six-figure income and many times more likely to become a millionaire. Why? To paraphrase, while others were borrowing to the hilt to get the best house in that new sub-development, they were buying a less expensive home in and older neighborhood and putting the difference into index funds. While others were borrowing money to go buy a flashy new car right off the lot, they were negotiating for a one-year-old model from a leasing company, paying fifty percent off the sticker price, investing the money they saved in rental properties or small businesses. The cultural emphasis on the acquisition of investments means, dollar for dollar, over the years, a Korean American investor is far more likely than his or her counterparts to build a significant nest egg, enjoying financial independence without worry. As the years pass, just like engineers, a bigger and bigger percentage of the family balance sheet is made up of earning assets.
When you wisely adopt this approach in your own life, it helps you make better decisions with your money; decisions that might seem small at the time, but thanks to the power of compounding, end up being huge over decades. A used car early in life might mean the difference between a Ford and a Bentley later in life, when your net worth is productive enough to throw off significant surplus wealth each year.
Using the Earning Assets to Total Assets Ratio to Measure Your Wealth Conclusion
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