Wisdom of Rich Dad

When I start talking to people about building a passive income business by following the teachings of financial freedom guru Robert Kiyosaki, I immediately hear about people’s plans for buying real estate.

Anyone who has read the book Rich Dad, Poor Dad thinks that Robert Kiyosaki is all about investing real estate and buying rental or commercial property in order to achieve the financial freedom of their dreams. So, they instantly start putting all their money into real estate.

Reality check: That’s not book’s message. I try to listen patiently (after all I also believe that real estate can be a great investment vehicle), but the reality is you need a solid plan to achieve financial freedom, not a one off strategy.

Authors Robert Allen, Robert Kiyosaki, David Bach, and many, many talk about building multiple streams of passive income, that means having more than one investment vehicle, and making sure all those vehicles deliver passive income.

For beginners: passive income is income that comes in day in day out without you having to work to get it. Put simply, you are not trading hours for dollars. A true passive income business is one that if you were to leave it alone for a period of time, such as a year, you could return and find it more profitable (or at least generating the same level of income) as before you left. Passive income investments are the true path to financial freedom.

So what is the principle that Rich Dad truly talks about. He calls it the Power Investing Principle.

1 – Start a part-time business for the cashflow & tax advantages.

2 – When the market is right invest in real estate. (Now is not the time.)

3 – Invest your excess cash from the real estate in paper assets.

Unfortunately, a lot of people jump into step 2, real estate, without a lot of background knowledge about how to make that investment a lucrative one.

Here’s a clue, the property needs to generate passive income (that means it should be putting money into your pocket not taking money out). Capital gains (betting on an increase in value) should be a bonus not your sole reason for buying.

One of the first steps in building a solid passive income plan is to identify how you plan to generate passive income. The plan should include a number of sources including businesses, real estate and paper assets. The reason for this is to create a stable platform on which to build financial freedom you need all the elements.

Now, lets go back to the power investing formula and look at number 1: Build a business. Why do you want to build a business first? Simple: businesses provide the financial backing (cashflow) to support real estate investing. Makes sense right?

While there are only three steps in the power investing principle, you need to take the time to understand the systems behind each one. For example, master the business building system then move on to the system for residential real estate investing.

Taking it step by step will lead to prosperity and reduce your risks along the way.

I think many of you would agree that a lot of us are employees. We have a definite working time schedule. We have a boss. We work on a particular role. Basically, we work hard to sustain our day to day living.

But if you want to achieve financial freedom, you should not just work hard but work smarter! Yes, you will earn more by working harder. You will work even harder if you got promoted because of the additional responsibilities and tasks that will be assigned to you. You will become probably rich because of overtime and pay raises but definitely you would sacrifice a lot.

You will risk your health because of stress. You will lessen the time for your family and friends. In short, you will not enjoy the fruits of your hard work if you will only just work harder. Added to that, the government is your number 1 beneficiary if you work harder. Your pay gets taxed first even before you get it.

Don’t just work hard, work smart too. How to work smart? Here are some of the the things that you could do to work smarter!

Work like a smart entrepreneur. If you have the capacity to become an entrepreneur, start a business. An entrepreneur leverages his resources and hires people who are smarter than him to work for him. Yes, he will work but on the supervisory level only. He delegates tasks and he gets rich by doing it. These are the tactics of taipans and tycoons.

Learn financial intelligence. If you would just work hard and even harder, you will definitely end up burnt out of your work. If you are financially literate, you would accumulate assets while you are working. And as these pile of assets accumulate over time, it would be sufficient to provide you with your needs without working. Choose to be the ‘rich person’ as Robert Kiyosaki said and not the ‘poor’ and ‘middle class’ persons who buy liabilities they think are assets.

Work for passive income. As I already mentioned in previous posts, passive income is your money working for you. Try to work little by little for passive income while you have your job. And as your passive income grows, then that would be the time to go full time for it.

Ultimately, working smarter is shifting from either the Employee (E) and Self Employed (S) quadrant of the Cashflow Quadrant to either Big Business Owner (B) and Investor (I) quadrants.

Financial freedom is the dream land of personal finance. It is the freedom to stop working anytime you want and still be able to live the lifestyle you desire.

To achieve it, the key is passive income, which is the income you earn without doing active work. For instance, the interest of your saving account is a kind of passive income. You do not need to work to earn it. You can sit and leave the account alone, and you will still earn the interest. To achieve financial freedom, your passive income should be greater than or equal to your expenses.

From what I learn, what we should do to achieve financial freedom can be boiled down to two rules:

1. When you work, work to build a system
2. When you buy, buy an asset

Pretty simple, aren’t they? They are simple but powerful. I might miss something (and feel free to let me know in the comments), but I think these two rules cover practically everything we need to do to build passive income and achieve financial freedom.

Let’s look at them in more detail:

1. When you work, work to build a system

This first rule deals with how you should spend your time. I first learned about this from StevePavlina.com podcast #006. Instead of spending your time working for money, you should spend your time building a system that will generate money for you. There is a big difference between them.

If you work directly for money, you always need to work to earn more money. There is no way you can earn money if you do not work. Here are some examples:

• A freelancer must work on a project to earn money.
• A doctor must work with the patients to earn money.
• An employee must work at the company to earn a salary.

When they stop working, their income will also stop. No matter how hard or how long they have worked before, when they stop working their income will also drop to practically zero.

Compare it with those who build a system. If you build a system, you can stop working anytime you want and the system will still generate money for you. Here are some examples:

• A business owner who has a system in place can leave the business to a manager and still earn income.
• A web site owner can stop working on the site and still earn income (e.g. from “automatic” advertisements like Google AdSense).
• A book writer can stop writing and still earn royalties from the books she has written.

When these people stop working, their income won’t just fall to zero. Instead, their system will continue to generate money for them. When they feel that the system they build is already strong enough, they can move on to create a new system and therefore a new income stream.

From these examples we can see in which category we currently fit. Are we now building a system or work directly for money?

Of course, if you find yourself working directly for money, it doesn’t mean that you should quit your job right away and start a business. There should be a transition period, or – if you love your job – you can work on both of them. The important thing is balancing your priorities. You should prevent yourself from being too absorbed in the job that you can no longer build a system, but you should also be sure that you have the financial resources to meet your needs.

2. When you buy, buy an asset

This second rule deals with how you should spend your money. I first learned about this from the book Rich Dad Poor Dad by Robert Kiyosaki. The definition of asset here is something that generates money. Based on this definition Kiyosaki said that house is a liability and not an asset because a house incurs costs (such as electricity, water, and maintenance) without generating income (unless you rent it).

So – in other words – this rule says that when you buy, buy something that generates money. Of course, it doesn’t mean that you may not buy a cup of coffee (which doesn’t generate money), but the idea is you should use your money as much as possible to buy assets.

Here are some examples of assets:

• Real estate (from which you earn rental income)
• Mutual fund
• Stock
• Business tools or equipment
• Education

Using this rule, you can see whether or not an expense is wise. If the expense allows you to generate more money in the future, then it is a wise one. Otherwise… well, you can guess.

One cause why many people never achieve financial freedom is they use their money mainly to buy liabilities and not assets. On the other hand, people who achieve financial freedom are those who are willing to postpone pleasures to first build their assets. It is the passive income from the assets that will eventually buy them luxuries.

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From these two rules, there are two questions you should ask yourself:

1. “Am I building a system?”
2. “Do I buy something that generate money?”

The goal is to answer “yes” to these two questions as often as possible. Spend your time to build systems, and spend your money to buy assets.

Most people out there always talk, or worry about how much money they make.  They compare salaries for jobs.  They get second jobs to supplement their income.  They leave jobs to go make more elsewhere.  Everything they do in life is based on the final end of year income.  How much did that W2 or 1040 claim you made for the year?

Well, I’ve learned that this is the absolute worst way to judge your financial situation.  In fact, it doesn’t matter how much you make.  Your financial situation has very little to do with your income.

It has everything to do, though, with your expenses, or what I like to call your ‘outcome’.

Expenses are the key to getting rich. As Robert Kiyosaki said in his book ‘Rich Dad, Poor Dad’, the definition of wealth is how many days you can live without working.  In order to live everyday without working, you must have more passive income than expenses.  Passive income is defined as income you gain without having to do any physical work (i.e. collecting rent checks, music royalties, stock dividends, etc.).

In our education system, they teach us to do well, go to college, and get a prominent job with a great salary.  However, let’s look at some of the jobs.  Most doctors go to school for umpteenth years, and then get out and have to build their practice.  They make nice incomes, but they also usually have very high expenses due to student loans and the cost of their education.

A doctor may make over $200,000 / year.  But add in a family, education bills, insurance cost, taxes, natural debt, and everyday expenses, and your ‘Outcome’ is maybe about $50,000/year.  Now let’s take a cop. A cop does not have to go to school for that long, if at all.  He makes a salary of somewhere b/t $60 -$100k (at least in NJ). That sounds like a lot less than the doctor, but it’s not.

The cop has very little, if any, expenses.  Being a cop, he gets a lot of ‘privileges’ and connections in the town.  He spends very little money on anything except everyday expenses.  He also only works 4 days/week, so he has 3 days to do something else to supplement his income.  At the end of the year, he probably had the same ‘outcome’, if not better, as the debt-ridden doctor.

Now, not every doctor is left with student loans.  Not every cop is debt free.  It is not necessarily the job I am criticizing.  I am speaking about the thought process this country teaches in its education Read the rest of this entry »

1. High Dividend Stocks

There are a lot of stocks that paying quarterly or yearly dividends. Over time, the power of compounding (with a little help from inflation) can substantially increase the value of your dividends. My mother bought the Indian subsidiary of Unilever (Ticker: UL) called Hindustan Lever about 20 years ago. She’s being reinvesting most of her dividends and today her annual dividends are larger than the value of the original stock purchase. American Capital Strategies (ticker: ACAS) has been growing its dividends approximately 10% every year. According to The Dividend Investor,

If we invested $100,000 in ACAS on December 31, 1997 we would have bought 6906 shares. Your first quarterly check would have been $1,726.50 in March 1998. If you kept reinvesting the dividends though instead of spending them, your quarterly dividend payment would have risen to $17,095 by December 2007. For a period of 10 years, the quarterly dividend has increased by 300 %. If you reinvested it though, your quarterly dividend income would have increased by 890%.

Yes, reinvesting the dividends in companies that have historically kept increasing their dividends is key. Even though you might get only 2.5% return today, eventually with the increase in stock price and rise in dividends, your annual return should be greater than 12%. This concept is very well explained in Prof. Jeremy Siegel’s excellent book, The Future for Investors, which I highly recommend.

2. Oil & Gas Royalties

While there is a lot of fraud and speculation in direct oil drilling programs, they can be very, very lucrative for investors. Charlie Munger invested about a $1,000 in such an oil drilling program in the 60s and he’s estimated that its paid out over $500,000 in royalty payments since then. Apparently it still pays out $2,000 a month. Of course, most people NEVER see these sort of returns, but for the average person, investing in Canadian Oil & Gas Royalty Funds (or Income Trusts) is the next best thing. I’ve invested quite a bit of money into both the direct oil wells and the Canadian Income Trusts (or Canroys) and the overall result has been pretty positive in both (which is in excess of 12%).

3. Royalties on Books and Patents

Royalties on Books and Intellectual Property Rights can be even more lucrative. However writing a best-selling book or creating a something thats worth patenting can extremely time consuming and expensive. For most authors and inventors, its a labor of love – something that they would pursue even if there was no monetary reward to it. But many ebook writers who sell get-rich-quick books about “making money online” are getting very wealthy. Most of these books are garbage and the only people getting rich are their authors and resellers. Not a very ethical way to make money.

4. Rental Income on Properties Bought at the Bottom of a Real Estate Cycle.

If you bought rental buy and hold property in California, Nevada, Arizona or Florida during 2005 and 2007, my heart goes out to you. A lot of smart people got suckered into buying at the top of the market and are paying for it. However, if you buy correctly, preferably at the bottom of a real estate cycle, real estate can provide excellent passive income and fantastic tax advantages as well. According to Charlie Munger at the 2008 Wesco Financial Annual Shareholder meeting, “most real estate investors don’t pay any income tax, except once every 20 years or so“. Bought correctly (that is based on value, not speculation), rental properties can provide a steady stream of cashflow that is somewhat inflation-indexed. I say somewhat, because in the short-term anything can happen, but over a long period of time, real estate is going to match the rate of inflation.

5. Investing In Timber

Similar to Canroys, there are companies that grow trees specifically for timber and pay pretty decent dividends. There are also direct tree-planting programs where you can invest a minimum of $5,000 and own a portion of a timber operation. The company does all the work for you and supposedly cuts you a check once a year after a specific time interval. The endowment funds of Harvard and Yale have apparently been investing in timber for several years now with great returns.