The Thin Line That Separates the Rich from the Upper Middle Class

You have probably heard it many times — the rich buy assets and the poor spend their money on liabilities. This is the popular view about why the rich get richer. But there is more to it.

This is because many of the assets the rich buys are also bought by regular people. Yet, the gap is still wide. For example, lots of people own stocks and they aren’t rich. The upper-middle-class often gets as much money as the rich but if they lose their jobs, they will move closer to the poor. The thin line that separates the rich from the upper-middle class is the way the rich buy liabilities.

Generally, most people think of an asset as something that appreciates. And so they would think of the house that they live in as an asset. The problem with this thinking is that the house can depreciate just as it can appreciate. In fact, it is said that the real estate market has its cycles of appreciation and depreciation.

For the purpose of growing rich, assets need to be defined differently. This is because you don't really need something that appreciates but take money from you. Instead, you need something that brings money to you (which can also appreciate). That is a true asset.

Practically, anything can be molded into a true asset that brings money into your pocket. As an example, owning a house from which you receive rent monthly makes the house a true asset. However, the amount you make from leasing the house must exceed the amount you spend on the house.

Liabilities, on the other hand, are things you own for your comfort and convenience. They don't bring money to your pocket and they depreciate with time. A common example is a car you drive to get around.

The people who struggle financially are those who spend money on liabilities and think they are buying assets. There are two categories here. The first are those who buy something that appreciates but does not give them any income. They hope to sell it at a good rate someday but they eventually sell during a crisis at a loss.

The second are those who buy something that appreciates and generates income but they lack the financial intelligence to manage it. So, the asset is losing more money than it is making. An example is a house that is leased but brings in $2,500 a month while you spend $3,000 monthly on it.

Those two sets of people are trying to be rich, but they are actually struggling. This is often the upper-middle class and their attempt at breaking out of the rat race. Yes, when just getting started, most people fall into these categories. But the trouble is in staying there.

Most people would rather live in lack than admit that their system is not working. They will argue while they are getting all the wrong results. They don't want to change.

But some people get it right. They buy the right assets. They gain residual income but are still far out. They even get tired of buying assets and want to enjoy life. After all, what is the purpose of getting rich without enjoying life?

And this is where the rich get ahead. The upper-middle-class buys liabilities with their capital. The rich buy liabilities with the residual income from their assets. The rich never use their capital to buy liabilities. It looks like an insignificant thing but it is a big difference.

The rich never eat their capital. If you exchange your time for money, the income you receive is more or less your capital. Poor people spend that on things that depreciate and doesn't produce income. Rich people always invest their capital. They spend the residual income.

This is why many rich people cannot go broke, regardless of how much they spend. If they want something for their comfort or convenience, they think about the asset they can buy that will produce the residual income for the comfort.

This is the mindset change for a better financial life. Any amount gained as a result of spending your time to work on anything is capital, not income. Think of how to make the capital work for you to produce residual income. Then, you can spend the residual income however you want.

The moment you start spending your capital on liabilities, the effort you put into making your assets work out becomes weak. And that would perpetually reduce the efficiency of whatever investment you have. This is the mistake the upper-middle-class often fall into.

However, when you buy liabilities from residual income, it gives energy and encouragement to do the same again. You are rewarding yourself for being good with money. Meanwhile, when you spend your capital lavishly, you are rewarding yourself for being average with money. And whatever you reward will grow stronger.

The rich don't spend their capital on liabilities. They build the residual income from their assets and investments to be able to afford the liabilities they want. The upper-middle-class spend their capital on liabilities.

Think about that.