This is Part 3 of my nine-part series connecting financial frameworks with personal growth.

1.      Finance as a Framework

2.      Assets = Liabilities + Equity: What You Own Comes with Strings Attached

3.      Assets = Liabilities + Equity 2: What You Have vs. What You Can Use

4.      Time Value of Money 1: The Power of Compound Interest

5.      Time Value of Money 2: Why Humans Use Bad Discount Rates

6.      Risk and Return 1: No Risk, No Return

7.      Risk and Return 2: Why Humans Are Bad at Calculated Risks

8.      Risk and Return 3: Diversification and Building Multiple Pillars of Resilience

9.      Conclusion: The Emotional Balance Sheet

This week, we are discussing the quality of our assets—as viewed through the lens of liquidity, time horizon, and market value. First, we’ll review the financial concepts themselves, and then we’ll go over how they map to our personal development.

The Quality of Assets

In finance, assets are not all created equal. Two assets with the same price can have very different properties—a house worth $500,000 is very different from a stock portfolio worth $500,000. The main dimensions along which assets differ are liquidity, time horizon, and price volatility. (And credit, but that’s a discussion for a different day.)

Liquidity—the Financial Dimension

Liquidity refers to how quickly an asset can be converted to cash without a significant loss of value. More liquidity = easier conversion and lower loss of value.

Most financial securities like stocks and bonds are relatively liquid assets—as long as the market is functioning normally (not a given), they can be sold with a few clicks and a cash amount very close to the listed market price will hit your bank account within two or three days. By contrast, a house is an illiquid asset—the process is likely to take two months at a minimum, and there may be a significant divergence between what you think the house is worth and what a buyer is willing to pay.

Normally, we want some portion of our assets to be liquid because liquidity is what ensures that we have assets to respond to a crisis or unexpected event. If I lose my job or get in a car wreck, I need cash now because I have costs now. If I have nothing I can convert to cash, I am screwed.

Liquidity—the Personal Dimension

We can apply the same thinking to our non-monetary assets. Liquid non-monetary assets are those that we can use right now.

For example, if you are pursuing a lengthy educational certification (like a 7-year PhD), you are likely to learn a lot in the first two or three years of your program. But that “incomplete” two or three years of knowledge is not liquid in the sense that the market is not going to pay you for an unfinished degree.

I also see networks and relationships mostly as illiquid assets. They can be extremely valuable, but they usually can’t be converted into cash immediately. If you have a good reputation in your network, deals, business opportunities, introductions, and the like will flow to you over time. But most of the nodes in our network won’t be able to produce an outcome we want overnight.

By contrast, time is a liquid asset. If we have time, it’s something we can use immediately, and it’s something we can convert to other assets that we want (health, relationships, career improvement, etc.) The adage that time is money is apt because time as a non-monetary asset is the closest analogy I can think of to cash as a financial asset. If we are faced with a sudden non-monetary crisis, if we have time, we can find a way to deal with it, just like cash can solve a financial crisis.

The corollary is that just like cash, we want to have some spare, unstructured time in our schedule. If your time is 100% booked with outstanding commitments (pursuit of other illiquid assets), to me, that isn’t a safe place to be. That means you won’t have the capacity to deal with the randomness of life—both putting out fires and taking advantage of unexpected opportunities as they arise.

Time Horizon—the Financial Dimension

Assets also differ in their “time horizon,” or lifespan.

The time horizon can refer to how long the asset lasts (e.g., a two-year bond will expire in two years), or how quickly it will produce its cash flows (investing in a startup at creation is not likely to produce any cash flows for the investor for 5-7 years).

As with liquidity, we are looking for a balance between long- and short-term assets. We want some assets that will produce cash flows far into the future, when we retire and are no longer working, and we may also want some cash flows in the near term (let’s say we have an expected payment coming up—we want an asset that will satisfy that payment). Part of the reason is that short- and long-term assets tend to have different risk profiles, and we want a balanced set of risks in our portfolio (diversification, a concept we will return to).

Time Horizon—the Personal Dimension

I think having assets with different payoff schedules is more important in our personal life than it is in financial management.

Investing only in assets that have long-term, delayed payoffs feels like a recipe for burnout to me. The human mind inherently has problems with delaying gratification, so pushing all rewards off into the future is like running uphill constantly. In my view, in order to reinforce good behavior, we have to be able to taste some rewards for it.

The opposite is also harmful. Most of humanity largely pursues short-term payoffs (e.g., eating satisfying but unhealthy food all the time, chasing get-rich-quick schemes). The downside of not investing anything in long-term payoffs is obvious.

Ultimately, having a balance of short- and long-term rewards is what I see as the right approach, largely for the same reasons that diversification is beneficial in finance. If you delay the fishing trip with your son so that you can put in an extra afternoon reconciling the Q2 numbers, and then you get hit by a bus tomorrow, did you maximize your total happiness over the course of your life? Less nobly, cheat meals follow a similar principle. If you love pizza and ice cream, and you’re a workout warrior, occasionally you should still indulge even if it screws up your calorie counting for the day.

Price Volatility—the Financial Dimension

Assets fluctuate in price over time.

You may buy a house for $500,000, but its value is unlikely to be exactly $500,000 in 10 years. In accounting terms, the price you paid for the house is called its “book value,” while the price you can actually sell it for is its “market value.”

Companies (and people) who are unaware or unwilling to recognize that the market value of their assets is significantly different from the book value can get into trouble. This goes both for undervalued and overvalued assets. If you have been sitting on a piece of real estate that you bought for $100,000 40 years ago that is now worth $2 million, you might want to recognize the value and redeploy the value in assets that are appropriate for your current life position. Likewise, if you invested $100,000 in your friend’s startup that has gone nowhere for 10 years, and you’re counting on that $100,000 as part of your retirement, you are fooling yourself.

A related accounting concept is “depreciation.” Depreciation refers to the accumulation of wear and tear on an asset as it is used, reducing its value. A piece of factory equipment purchased for $1 million that wears out over 10 years won’t be worth $1 million in the ninth year of its life.

Price Volatility—the Personal Dimension

Personal, non-monetary assets also fluctuate in value and almost all of them deteriorate over time.

Your health will “depreciate” over time due to aging. Old friends grow distant. Unused skills atrophy. Failing to account for the decline in the value of personal assets leads to a distorted sense of self-worth.

Like in finance, countering depreciation of personal assets requires continued reinvestment. In the same way that companies are continually spending money on maintenance and upgrading equipment, we have to continually reinvest in our personal non-monetary assets. Old friends need a call once in a while, skills have to be practiced, and maintaining our health is a lifelong endeavor.

Independent of depreciation, our personal assets also fluctuate in value. Knowledge and skills are a key area where our value is likely to decline, not just from forgetting things because we don’t practice them, but also because the frontier of knowledge is ever-expanding and we have to keep abreast of new developments in our field in addition to practicing the things we already know. Furthermore, as the economy and the world evolve, the skills and knowledge that are in demand will also change.

Like with financial assets, the danger lies in not acknowledging when the “book” or self-perception of our personal assets diverges widely from the “market” value. Just because someone paid you $200,000 to be a software product manager last year doesn’t mean that knowledge is guaranteed to be worth $200,000 this year. Similarly, if you were able to run a marathon 5 years ago, meaning you were in great cardiovascular shape, doesn’t mean you are still in great cardiovascular shape today. Don’t neglect seeing your doctor.

Conclusion

Managing liquidity, time horizon and market value are as important in our lives as they are in managing our portfolios. Imbalance in any of the above are likely to lead to problems of us just as surely as they will lead to problems for a company.

Next week, we’ll discuss the time value of money and compounding, the most important concept in finance. While compounding has incredible power when it comes to investing, it is just as powerful in other dimensions.

Exercise

Journal on the following or discuss with a friend.

1)      Assets

Return to your list of personal, non-monetary assets from last week.

Where does each asset fall on the dimensions of liquidity, time horizon, and divergence between book (perception) and market (reality) value?

2)      Audit

Where do I see imbalances in how your personal assets are allocated?

Am I emphasizing the short-term too much? Or do I never let myself have any wins or rewards in the present?

Do I have capacity to deal with emergencies as they arise?

Have my personal assets depreciated in value, or have they increased?

3)      Reinvestment

Where do I need to shift my energy?

Do I need to reinvest in my friendships, family, network, or romantic relationship? Which ones are slowly depreciating without me noticing?

How much am I reinvesting in my health—physical, mental, emotional and spiritual?

Where have my skills atrophied? In what areas of my field am I falling behind the curve?

Where am I undervaluing my skills? What am I good at, which I am not using, and people want from me?