Sunday, January 30, 2005
Sunday Book Review: Rich Dad, Poor Dad
There are two ways to build wealth. The way I've been talking about, the Dave Ramsey way, the Millionaire Next Door way, is to get rich on equity. In other words, with money you actually have.
The other way is to use leverage. In other words, become wealthy by going into debt. I'm sure that doesn't make sense to anybody--when's the last time you knew somebody who had made tons of money off Visa?
The trick is learning the difference between good debt and bad debt. Leverage is, in theory, "good debt." The best way to define good debt is "debt that pays for itself."
In this book, Kiyosaki does a good job of changing the way we define the terms "asset" and "liability." Traditionally, an accountant would say an "asset" was something you owned that had value. A "liability" was something to which we owed money.
Kiyosaki's very valid argument is that, by this definition, we categorize a lot of things as "assets" that don't help us financially. Is that boat in the driveway really an asset? Or is it costing you loan payments, gas, and repairs?
This book calls for a new definition of these terms. An asset is something that puts money in your pocket. A liability is something that takes money away from you. If you were to lose your job today, would this item bring you money, or drain money? That's how to tell if it's an asset or liability.
Instead of "Net Worth," Kiyosaki talks about "Cash Flow." His definition of wealth is whether you have enough money flowing in each month from assets to pay all your expenses, even if you quit working today. If you do, you're wealthy. Regardless of whether that's $1,000 a month or $100,000 a month, if it covers your expenses you're wealthy and free to do whatever you want--work or otherwise.
So good debt would be invested in an asset that pays for itself and puts money in your pocket. If you buy a coin-op car wash and the payments on the loan are $1,200 a month but the car wash makes you $1,500, you now have $300 in positive "cash flow." You've harnessed the power of that much-mentioned "OPM"--Other People's Money.
Can this work? You bet. There are dozens of people who can prove it. A lot of your "flashy" millionaires are this way. Trump's leveraged up to his hairpiece. I'm sure that's why he files bankruptcy week after week after week.
And while we all sit back, feeling smug to watch him making and losing fortunes over and over, you notice he still gets to have the big house, the big plane, and the fancy weddings no matter how many times he does it. There are advantages to leveraging.
But books like this always contain caveats. "Don't buy the first house you find!" "You'll have to put a lot of effort into finding the deals." "I shop for deals on homes the way your Mom used to shop for deals on groceries."
In other words, they have to put as much time, effort, and energy into this as you're already putting into your full-time job.
Operating leveraged isn't easy. It's very, very risky. If you find yourself in a money-losing investment, you're going to have to come up with that difference yourself, and even if you manage to bail out on it, it will often be at a loss since it proved to be worth less than you thought.
And there are plenty of not-so-flashy equity millionaires. Bill Gates is an equity billionaire. Microsoft, for all the problems people have with them, runs debt free.
I absolutely believe in the "Cash Flow" principles taught in this book. We need to learn to buy things that make us money instead of buying things that cost us more money. Your money can undoubtedly work harder than you can.
However, I still maintain the risk involved in leveraging is only worthwhile when you can afford to take it.
Posted by Erik at 4:52 PM