Wisdom of Rich Dad

I found this article “As We See It: Fighting debt with education” on Santa Cruz Sentinel (santacruzsentinel.com).  It brought up pretty good points on the root cause of some of the financial probelms, like credit card debt, which we faced today – lack of financial knowledge. 

There’s a tendency to blame aggressive credit card companies for the rising personal debt in the United States.

Americans are billions of dollars in debt, and yet each of us receives multiple offers for new credit cards every week. The worst part is that the interest charged on credit cards is at a level that was illegal not many years ago — 15, 20 and even 25 percent.

We have little tolerance with the various aggressive tactics practiced by these companies, but the solution, ultimately, will probably have to be a personal one. The key is education, and how getting into debt to purchase items is a fool’s game. 

I find it quite surprise that there are people who used the credit card to fund purchases without giving thoughts to their ability to repay the money and interest if they failed to pay after the 1st cycle grace period (which can be up to 45-60 days from their date of purchase).  I am not sure if it is due to their ignorance of the high interest rate or just plain laziness to realize the size of the payment if you start incurring interests payment.  Maybe they are just too blinded by the “shiny objects” or “ego tools” which they are dying to get their hands on.  Robert Kiyosaki called these “shiny objects” or “ego tools” as doodads.

The article also expressed concern about Robert Kiyosaki’s idea of using good debt as part of the finanical strategy.  Robert Kiyosaki defined good debt as money borrowed to invest into asset or investments that will generate income or money.

But Kiyosaki went further than we think is reasonable when he suggested that people go ahead and use debt as a part of their financial strategy.

Certainly there are people around Santa Cruz County who have made a tremendous profit by borrowing a great deal of money, then investing in real estate that has skyrocketed in value.

That said, there have also been people who have lost significant dollars and suffered greatly because they went into hock and had an investment go down.

Personally, I think using good debt is a refreshing strategy if you need to agreesively grow your wealth.  It is however not without a certain level of high risk.  Therefore, you need good judgement to know to use this strategy.  It is not for everyone. 

The author of the article believes that financial education is the key. 

Kiyosaki actually suggests fighting debt with so-called “good” debt. “Obviously, to do this you need to know how to use debt wisely and responsibly, and must be able to find great investments that create cash flow”

Unfortunately, this sounds dangerous to the vast majority of people who find themselves in trouble. But it’s an interesting point — that education in financial matters has become important during these debt-ridden times.

I do agree that with the adequate financial knowledge, you will be much awared of the risk in getting into credit card debt or trying to use good debt strategy.  However, I would seriously cautioned against using good debt to fight your debt.  If you messed up your investment bought using good debt, it will spell double trouble for you. 

We still feel that staying out of debt is a better strategy than trying to finance one’s way out.

But ultimately, each of us is competing on our own in the financial world, and credit-card companies, banks and other large organizations have a big advantage. That’s why getting out of debt is, largely, a matter of education.

In short, having the adequate financial literacy will not only help you to avoid going into debts, but also equip you with the knowledge of getting out of debt.

My co-worker and I were driving past the construction site of a high end condominium near to our work place.  Naturally, the conversation shifted to the condominium and my co-worker muttered that if he has the money, he would seriously consider buy a unit although his current place is less than 3 years old.  He was speculating that the property price will go and in a few years time, he would be able to sell it off for a tidy sum of profit.

Thinking back, this has been the traditional investment model which most people are practicing. It is what Robert Kiyosaki called the Capital Gain or Captial Appreciation investing model.

Generally, with this investing model, people invest into things which they think the value will go up with time.  Commonly, people would buy up and invest into real estate with the hope that it will appreciate and they can sell it off for the profit later on.  However, there is no guarantee that real estate you own will appreciate.  The price can go down!  I have seen it with the houses of my relatives and my friends.  They are stuck with it, for selling it would incur a loss.

In fact, Robert Kiyosaki cautioned that capital gain investing model alone is risky.  Instead, he advocated Cash flow investment model.   Robert Kiyosaki, in his Yahoo Finance column, explained cash flow and capital gain this way:

One of the reasons I was able to retire at age 47, and my wife, Kim, at 37, was simply because we had enough cash flow coming in (primarily from our real estate investments). It wasn’t much — about $10,000 a month — but we only had about $3,000 in monthly expenses. That left us with $7,000 a month to do with as we pleased.  

On the other hand, capital gains are when you buy a stock for a dollar, and it goes up to $10 so you make $9 a share. Or, you buy a house for $100,000, and it appreciates to $150,000. You sell it and make $50,000.

One of the reasons people do not become financially free is because most of them are focusing on capital gains rather than cash flow. Chasing capital gains alone is gambling — not investing. Want proof? You don’t have to go back very far to find it: Between 2000 and 2003, millions of investors lost trillions of dollars in the stock market.

From what Robert Kiyosaki said, it seems the wiser choice is actually to go for cash flow model.  If you are going to buy real estate, then make sure it can generate cash flow or income for you.  You only buy real estate primarily for the purpose of collect rents from it.  If you are invest into stocks, then go for dividend paying stock or income generating securities like bonds and REITs.

However, it does not means that we should not go for capital gain at all.  The main point here is that capital gain alone is risky.  If you retirement plan is solely based on capital gain investing model, the stake is going to be very high for you, for there is no guarantee that at your retirement age, the value of your investment has appreciated.

Robert Kiyosaki agreed that:

The key to financial intelligence is how to use both cash flow and capital gains to grow wealthy. So many people are not successful, because they’re generally focusing on only one of the two. The  majority is focusing on capital gains.

A simple example of how to use both cash flow and capital gains is buying a piece of real estate that has potential for appreciation in value and renting it out.  You have cash flow from the monthly rent you collected and in event that the property has appreciated to a certain value, you can realized the gain by selling it.  You get the best of both world!

To reach our financial goal, one of the first things that we should do is to figure out what is our financial situation, so as to better chart our path.  And to do that, we need to determine what are the monthly flow of cash into our pocket and the monthly flow of cash out of our pocket.  That is our income and expenses, which will define our cash flow.

Income 

Income is money that goes into our pocket.  Some sources of income are:

• Salary
• Interest on investment
• Dividends
• Rent from real estate
• Distribution from business/limited partnerships
• Royalties
• Capital gain

There are primarily 2 basic types of income: earned income and passive income

Earned income is what you earn when you work for money.  It is money which you are paid for doing a job as employee (whether you are a manager or a delivery boy) or wages you receive as a self-employed person.  Earned income is taxed at a higher rate than other forms of income.  This is the form of income that keeps many people on the left side of the Cashflow Quadrant, including myself.  Robert Kiyosaki mentioned that these people are typically those who listen to parent’s advice to “get a good job” and ended up in the E Quadrant.

Passive income is money that you generated from the asset you own, such as real estate investment or a business.  It is called passive because owners of these assets are not actively involved in generating the income.  It is the money you invested in assets that is working for you, instead of you working for money.  Passive income is the least taxed form of income.

Besides, earned and passive income, Robert Kiyosaki also defined another income called Portfolio income.  It is a type of passive income.  It is income derived from your collection of paper assets such as dividends, stocks, bonds, mutual funds, or royalties from patent and license agreements.  Portfolio income also includes interest earned from a saving account, an outstanding loan, or some other source.

The difference between earned income and passive or portfolio income is this: if you have to show up for a job you have earned income.  If you can sit back and let your asset work for you, you have passive or portfolio income.

Expense 

An expense is the opposite of income. It is money leaving your pocket. 
Robert Kiyoskai in the book “Rich Dad, Poor Dad” defined expenses as all the payments you need to make each month, that is, your total cash outflow, each month. 

Expenses include:

• Home mortgage payment
• Credit card payment
• Car loan payments
• Utility bills payments
• Grocery bills
• Taxes
• Travel and entertainment
• All other personal expenses.

Your income pays your expenses.  And if you don’t have enough income you may have to incur additional debt to pay your expenses.

Robert Kiyosaki defined the term doodad as an unnecessary and sometimes unexpected expenses or item you purchase that does not put money in your pocket.  It may be a pleasure boat, a dream vacation, a new pair of sunglasses, or a meal you ate in a fine dining restaurant.  Doodads can slowly and inexorably deplete your income.

However, do you know that doodad is not all bad?  Robert Kiyosaki pointed out that doodads can also serve as the motivation to make more money.  Let me give you an example.  If you are determined to take a dream vacation but equally determined not to pay it on your credit card, you may figure out a way to purchase a new asset that will generate the cash flow to pay for your holiday.  After you pay for your vacation, you will still have the additional cash flow generated by the asset.   People in the B quadrant of Cashflow Quadrant quickly learn the value of buying assets because it earns them ability to pay for doodads.

Understanding the dynamics of income and expenses is critical to cash flow management.  People who cannot control their cash flow work for others.  People who can control their cash flow work for themselves or have others work for them.

Ariffmahmood in his/her blog (www.bizliner.net/finance/?p=10) discussed about active and passive income with relative to Robert Kiyosaki famous Casflow Quadrant.

The author mentioned that to become rich, it is necessary to switch from an active income earner to a passive income earner.  And one way is to become an investor as in the I quadrant of the Cashflow Quadrant.

The author then questioned the difference between an investor and a gambler.

In my opinion, I see that the primary difference between an investor and a gambler is the way they handle the investment risk.  I am assuming the definition of a gambler in the author mind is a person who is trying to earn money by investing money.   

Both are trying to make money work for them.  They invest to earn more money.  An investor becomes a gambler when he invests money into opportunities, without considering and often ignorant of the risk involved.  They are often blinded by their greed and do not make any sound judgement, either because they do not have the adequate knowledge or they are just too laziness to do so.  Sometimes, they are just too arrogance and think they know everything, as was mentioned by Robert Kiyosaki in the “Rich Dad, Poor Dad” book. 

For a gambler, the success or failure of his investments is based on luck and blind faith.  And as in line with the Chinese sayings: “Gamble 10 times and you will lose 9 times”, a gambler will most of the time fail in his investments.

For an investor, the decision to go or not to go with an investment is based on sound analysis of the opportunity based on adequate and timely information and knowledge, and the management of the risk that comes with the opportunity.  It is mostly made based on facts, information and figures rather than “personal feel”.  Therefore, the chance of the investment successing is comparatively higher.

The difference between an investor and a gambler is therefore, the way they approach the investment.

In the book “Rich Dad, Poor Dad”, Robert Kiyosaki was taught financial knowledge from a young age of about 9 years old by his Rich Dad.  This laid a strong foundation for him which benefited him later in life.

You do not have to simulate Robert Kiyosaki and his rich dad and waited until your children is 9 years old before you can teach you children financial related knowledge.  As long as your children start to understand what is money, you can start off by teaching them simple money handling and saving habits. 

Below are some brief points which I picked up at Yahoo Finance site, which suggest how you can teach your children the value of money.

Earlier Is Better
The benefits of teaching your children about money early on are both immediate and long term. In the short term, they may develop strong saving habits, learn how to make smart purchases, begin to understand the true meaning of “investment”. In the long term, you can help them avoid accumulating debt. And by teaching the value of saving for the future, you can help them plan for financial security.

Where Does Money Come From?
In a child’s world, money comes from Mom and Dad’s pockets. And they naturally assume that money is readily available whenever it’s needed.
Explain to your children that money is earned by working, and that you can only spend what you earn. To help them understand what it’s like to get paid on a schedule, begin paying an allowance and stick closely to the schedule. Then help them set goals for how they spend and save their allowance.

Children and Allowances
Experts differ on whether or not allowances should be tied to household chores. Although many people say children will learn more about personal responsibility if they are NOT paid for pitching in around the home, others feel it teaches them valuable lessons about working and earning. You might consider paying your children for chores outside of daily duties, such as helping to garden or wash the family car.

Make Saving Interesting
A simple savings lesson involves using a piggy bank and explaining to them how you also use a real bank to save your money. Encourage your children to save a portion of their allowance for a special goal. As they save money, you might reward them with a small additional amount, just like a bank pays interest. At the end of each month, calculate how much they have saved and then chip in a certain percentage as interest.

Banking and Investing
Once your children have been saving enough to accumulate $10 or $20, take them to the bank to open their first savings account. Most community banks will allow children to open first accounts with low minimum deposits.

When your children want something that they can’t quite afford, discuss the value of saving versus borrowing. If you do extend credit, use a written IOU, establish a repayment schedule, and charge interest. By doing this, you establish the framework for teaching your children that bonds and certificates of deposit are IOUs representing loans from investors to institutions.

Compounding
In Robert Kiyosaki “Rich Dad, Poor Dad”, the rich make money work for them, while the poor work for money.  Compounding is a simple illustration of the idea of how to make money working for you.

As your children get older and perhaps take on part-time jobs to earn more money, their savings will likely amass at a quicker rate. Now is the time to review the lesson of compounding, or the ability of earnings to build upon themselves.  Explain how compounding can be more dramatic over time; the longer money is left alone, the greater the effect.  This can lead into a discussion about investing and how certain investments can have a greater ability to compound over time. 

Teaching your children about our complex financial system may seem daunting, but you can help put your child on the right track by encouraging smart habits now.

Is it worth your time and effort to help your children learn about money? As Benjamin Franklin once said, “An investment in knowledge always pays the best interest.” Answering your children’s questions honestly and in terms they’ll understand can help them begin life on sound financial footing.

Robert Kiyosaki listed 6 top personal obstacles that can block your path to financial success.  In the previous 3 installments, I have covered 4 of them.  In this last installment, I will be talking about the rest of the 2 personal obstacles – Arrogance and Disappointment.

Arrogance
Robert Kiyosaki’s definition of arrogance is ego plus ignorance.  The ignorance is hidden behind the ego.  Because of the ego, many people will try to bluster their way through financial discussions when they do not know what they are talking about.  They are not lying, but they are not telling the truth either.  There are full of people who do not know what they are talking about in the world of finance.

It is very easy to stumble and fall over your own ignorance and fail in financial matters.  When you are arrogant, because of your ego, you believe that what you know is important and what do not know is not important.  However, in reality, what you do not know is as important as what you do know.  Instead of arrogantly hiding your ignorance and bluffing your way to failure, start educating yourself for success.  Find an expert in the field or learn from books on those subjects.

Disappointment
When things don’t go as you have wished for, do you react with disappointment? 
Robert Kiyosaki’s Rich Dad knew Robert Kiyosaki was shy and that learning to sell would help him to succeed. So when Robert Kiyosaki left the Marine Corps, Rich Dad recommended that he get a job that will teach him to sales and marketing skills. 

Robert Kiyosaki took up a salesman job and for the next two years, he was the worst salesman in the company.  Naturally, his tendency was to put the blame of his failure on the economy, or the product he was selling and even the customers.  Each time, Rich Dad would remind him that “When people are lame, they love to blame”.  To learn to sell, he had to face the pain of disappointment.  Eventually, he did pick up the skills and along with the skills of salesmanship came a priceless lesson of how to turn disappointment into an asset rather than a liability.

Many people are turning disappointment into a long term liability.  “I should have known I would fail.”  These are the words of those who have let disappointment hinder them from their learning.  As you get ready to embark on your journey to financial freedom, listen to the same advice Rich Dad offered Robert Kiyosaki.  “Prepare yourself for disappointment”.  If you are prepared for disappointment, you will have a chance to turn disappointment into an asset, instead of a liability.

Remember that preparing yourself for disappointment does not mean you will not still be frustrated or upset.  If you are prepared for disappointment, you will not take upon yourself too hard.  This is important, as, if you are being too hard on yourself, it will lead you to be overly cautious about taking risks or trying out new ideas.  When encountering failure, control your emotion and don’t let them affect you too much.  Put the disappointment away and start learning new financial skills.

Be mindful of these 6 obstacles listed by Robert Kiyosaki.  Do not let them block you from your journey to your financial freedom.  If you do, you will find yourself working harder and harder for money, and yet further and further from financial goal.  You then will be like Robert Kiyosaki’s Poor Dad in the book “Rich Dad, Poor Dad”.  Learn to overcome them, and follow the path of the Rich Dad, having money to work for you instead.  You will then be on the fast track to your financial success.