What is a Personal Balance Sheet?

Are you fully aware of your financial health? 

Understanding your financial position is crucial for helping you make informed decisions and track progress toward your goals.  

A personal balance sheet is one of the most effective tools for gaining this understanding – offering a complete overview of your wealth at a specific point in time.  

You can think of it as a snapshot of your financial health. This is a strategic tool for visualising what you own versus what you owe, and understanding your net worth at any given moment. 

A personal balance sheet can be broken down into: 

• assets (what you own), both lifestyle and investment; 

• liabilities (what you owe), tax deductible and non-tax-deductible debt; and    

• net worth (assets minus liabilities). 

Before considering what makes a personal balance sheet strong, let’s first break a personal balance sheet into its four main components; lifestyle assets, investment assets, tax deductible debt, and non-tax deductible debt.

Lifestyle Assets

Lifestyle assets include your home, contents, cars, bikes, boats, caravans, etc. Apart from the home (or homes), most lifestyle assets actually fall in value (depreciate) rapidly from the time of purchase. 

Homes may depreciate if cash flow is not used to maintain them, with capital appreciation mostly arising from land size or property location. In most cases where lifestyle assets produce no income, then any interest on the associated debt is not tax deductible. 

Investment Assets

Investment assets include income producing cash, bonds, property, and shares as well as listed and unlisted funds. If you have borrowed to buy income producing assets then, as a rule, the interest on the debt is tax deductible. 

Other investment assets which may or may not produce income include options or shares as part of remuneration, private business investments, and partnership interests. To be regarded as an asset, you should be able to value it and at some time be able to sell it. 

There are also investments which don’t produce income, such as collectibles (including cars, art, stamps, and currency), precious metals (such as gold and silver), as well as education, insurance, and age care bonds. 

Of course, there is also superannuation (a very regulated Australian investment holding structure) which doesn’t provide income until you are over the age of 60 and retired (with some significant exceptions to this basic rule). A superannuation pension can form the backbone of retirement income because of its tax effectiveness. 

Tax Deductible Debt

Generally, interest on a loan is only tax deductible if the purpose of the loan was to acquire an income producing asset. Collateral or security is required to take out a loan for an investment property, shares, or other investments that produce income. Usually loans are in the form of traditional principal and interest loans, lines of credit, or margin loans, and investors should select the right loan or combination of loans for the purpose. 

We often hear tax deductible debt referred to as ‘good debt’ because it can help build a personal balance sheet faster when asset prices rise and income losses can reduce tax on other income such as salary. But the downside is that good debt can turn to bad debt very quickly if holding costs are no longer affordable because you lose your job, suffer ill-health and are not adequately insured, interest rates rise, or asset prices fall and your lender asks for more security. 

Non Tax Deductible Debt

Where a loan is drawn to purchase something that does not produce income, then the interest on the loan is not tax deductible. Most often we use non tax deductible debt when we start working to buy a house to live in or a car. Because it is non tax deductible, the debt is often referred to as ‘bad debt’. However, it is necessary and desirable to own a car if you need it to get to work and to enjoy living, and owning your own home (and trading up through your life) is a great way to save and create a foundation for your lifestyle and development of your investment portfolio. 

For more information, we invite you to contact us on (07) 3391 5055 or via connect@mgdwealth.com.au. 

Any advice included in this communication is general and has been prepared without taking into account your objectives, financial situation or needs. As such, you should consider its appropriateness having regard to these factors before acting on it. Any tax information refers to current laws, is not based on your unique circumstances and should not be relied on as tax advice. Before you make any decision about whether to acquire a certain financial product, you should obtain and read the relevant product disclosure statement.