Difference between investment and expense explained with examples

It is often difficult to distinguish an investment from an expense. Didn’t happens to you, that you are facing an important outlay, and you don’t know if you should undertake it or not? In this article I tell you how to know it in a totally clear way.

Contents

What is the expense?

An expense will always take money out of our pocket never to return. That is why the expenses should be avoided at all costs, since it is the main way in which you lose money and you run out of cash. This is what is known as “consumer goods” or, for other authors, such as Robert Kiyosaki, simply “passive” (at the end of the post I leave some interesting links about this).

You will see it better with an example: An expense is something like buying a candy that we eat on the spot, after a while we do not have the money we have spent, nor the candy. But an expense is also a real estate property that does not produce rents, a car that we do not use to work, and spending is all that we could really be saving the money of its acquisition or maintenance.

Beware of “ant” expenses

Many people think that because they do not buy a super sports car, they are no longer making expenses. However, even though they have regular income, they are drowned by credit cards and have problems getting to the end of the month.

The usual suspect is usually the “ant expenses”: Small unnecessary things that we pay day after day without realizing it, and that if we observe them together it ends up being a lot of money. The solution for this is easy: keep a small accounting of the money you earn and how you use it. In this way, you can add up every X time how much you have spent going there, whims … etc.

If you want to take an extra step you can also do it, and that is to limit those ant expenses. There is no problem in that sometimes you spend some money on things that you like, leisure, luxuries … etc. The problem is when you see yourself drowned by debts, or lose investment opportunities (now we talk about what that is) for not having cash. On the other hand, if before spending you make a monthly budget in which X percentage of your income you have destined for ant expenses, and you do not get out of there … you will know how far you can spend that day you go “to drink something” or when you want to “go shopping”. You simply need to have a plan, and commitment to apply it.

What is an investment?

Investments, on the other hand, (also “capital goods” or “assets”) take us money out of pocket first but then make us earn even more money. If, for example, instead of eating the candy we re-sell it for more money than it cost us, we are making an investment in sweets. This is due to the fact that, with the investment, we end up with more money in our pocket than we initially had as a result of it.

But the same payment of money can be considered an investment or an expense at the same time. Everything depends on the approach we give

How to decide if something is an expense or an investment?

Some time ago I read “For the poor everything is spending, for the rich everything is investment”, I can not be more in disagreement with that phrase. Spending is spending rich or poor you are, and an investment too. In the same way that you do not have to be rich to invest, a good way to have money to invest is by using the pre-savings technique.

For example: Is buying your own home an expense or an investment?

Imagine that you decide to buy a house for € 100,000. The cost of it is a fixed parameter, but are those 100000 euros an expense or an investment? And this is important, because many people believe that living in a house of their own is an investment. However the house takes maintenance, costs (water, electricity, repairs …), it involves paying taxes on the patrimony … and it does not report liquidity, since even if you are going to sell it after many years of use it can be worth much less than what you paid for things like deterioration, inflation or the state of the real estate market. This is an expense And there are people who even ask for mortgages and get into debt for life for this!

However, if you “invest” € 100,000 in buying a house, which you then rent, and it gives you an income every month, you have invested in what is known as “real estate”, and in the long run you may earn more money that what you paid for the house, and all its expenses, taxes etc. That is an investment and, even asking for a mortgage, the house itself pays for itself. This is what is known as “amortize the investment”, and allows you to measure the “ROI” (Return Of Investment).

Summary and where to expand the information

The important thing then is to have enough financial intelligence, which is sometimes acquired by making wrong decisions, to distinguish one from the other. But above that is knowing the rules of investment and spending that I have introduced in this article.

Does that business guarantees of recovering the money you are putting in there? Do you recover it in a viable way for you? In how much time? Does it compensate you for the effort involved in getting the return on that investment? How much do you need the money you are going to risk? Is it worth that risk? … and so many other questions you must ask yourself.

If you are interested in these topics I recommend the book “Rich Dad, Poor Dad” by Robert Kiyosaki, where you can expand much more information and there are many examples of the difference between investment and spending.

Rich Dad, Poor Dad