Educated Dad's Financial Statement
Income=Expense
Asset < Liability
My rich dad's personal financial statement, on the other hand, reflects the results of a life dedicated to investing and minimizing liabilities:
Rich Dad's Financial Statement
Income > Expense
Asset > Liability
A review of my rich dad's financial statement is why the rich get richer. The asset column generates more than enough income to cover expenses, with the balance reinvested into the asset column. The asset column continues to grow and, therefore, the income it produces grows with it.
The result being: The rich get richer!
Why the Rich Get Richer
Income -> Assets -> More Income
Expenses are low, Liabilities are low
The middle class finds itself in a constant state of financial struggle. Their primary- income is through wages, and as their wages increase, so do their taxes. Their expenses tend to increase in equal increments as their wages increase; hence the phrase "the rat race." They treat their home as their primary asset, instead on investing in income-producing assets.
Why the Middle Class Struggle
Income goes up, Expenses go up
Assets do not increase, Liabilities do increase
This pattern of treating your home as an investment and the philosophy that a pay raise means you can buy a larger home or spend more is the foundation of today's debt-ridden society. This process of increased spending throws families into greater debt and into more financial uncertainty, even though they may be advancing in their jobs and receiving pay raises on a regular basis. This is high risk living caused by weak financial education.
The massive loss of jobs in the 1990s-the downsizing of businesses-has brought to light how shaky the middle class really is financially. Suddenly, company pension plans are being replaced by 401k plans. Social Security is obviously in trouble and cannot be looked at as a source for retirement. Panic has sei in for the middle class. The good thing today is that many of these people have recognized these issues and have begun buying mutual funds. This increase in investing is largely responsible for the huge rally we have seen in the stock market. Today, there are more and more mutual funds being created to answer the demand by the middle class.
Mutual funds are popular because they represent safety. Average mutual fund buyers are too busy working to pay taxes and mortgages, save for their children's college and pay off credit cards. They do not have time to study to learn how to invest, so they rely on the expertise of the manager of a mutual fund. Also, because the mutual fund includes many different types of investments, they feel their money is safer because ii is "diversified."
This group of educated middle class subscribes to the "diversify" dogma put out by mutual fund brokers and financial planners. Play it safe. Avoid risk.
The real tragedy is that the lack of early financial education is what creates the risk faced by average middle class people. The reason they have to play it safe is because their financial positions are tenuous at best. Their balance sheets are not balanced. They are loaded with liabilities, with no real assets that generate income. Typically, their only source of income is their paycheck. Their livelihood becomes entirely dependent on their employer.
So when genuine "deals of a lifetime" come along, those same people cannot take advantage of the opportunity. They must play it safe, simply because they are working so hard, are taxed to the max, and are loaded with debt.
As I said at the start of this section, the most important rule is to know the difference between an asset and a liability. Once you understand the difference, concentrate your efforts on only buying income-generating assets. That's the best way to get started on a path to becoming rich. Keep doing that, and your asset column will grow. Focus on keeping liabilities and expenses down. This will make more money available to continue pouring into the asset column. Soon, the asset base will be so deep that you can afford to look at more speculative investments. Investments that may have returns of 100 percent to infinity. Investments that for $5,000 are soon turned into $1 million or more. Investments that the middle class calls "too risky." The investment is not risky. It's the lack of simple financial intelligence, beginning with financial literacy, that causes the individual to be "too risky,"
If you do what the masses do, you get the following picture.
Income = Work for Owner
Expense = Work for Government
Asset = (none)
Liability = Work for Bank
As an employee who is also a homeowner, your working efforts are generally as follows:
1. You work for someone else. Most people, working for a paycheck, are making the owner, or the shareholders richer. Your efforts and success will help provide for the owner's success and retirement.
2. You work for the government. The government takes its share from your paycheck before you even see it. By working harder, you simply increase the amount of taxes taken by the government - most people work from January to May just for the government.
3. You work for the bank. After taxes, your next largest expense is usually your mortgage and credit card debt.
The problem with simply working harder is that each of these three levels takes a greater share of your increased efforts. You need to learn how to have your increased efforts benefit you and your family directly.
Once you have decided to concentrate on minding your own business, how do you set your goals? For most people, they must keep their profession and rely on their wages to fund their acquisition of assets.
As their assets grow, how do they measure the extent of their success? When does someone realize that they are rich, that they have wealth? As well as having my own definitions for assets and liabilities, I also have my own definition for wealth. Actually I borrowed it from a man named Buckminster Fuller. Some call him a quack, and others call him a living genius. Years ago he got all the architects buzzing because he applied for a patent in 1961 for something called a geodesic dome. But in the application, Fuller also said something about wealth. It was pretty confusing at first, but after reading it for awhile, it began to make some sense: Wealth is a person's ability to survive so many number of days forward... or if I stopped working today, how long could I survive?
Unlike net worth-the difference between your assets and liabilities, which is often filled with a person's expensive junk and opinions of what things are worth-this definition creates the possibility for developing a truly accurate measurement. I could now measure and really know where I was in terms of my goal to become financially independent.
Although net worth often includes these non-cash-producing assets, like stuff you bought that now sits in your garage, wealth measures how much money your money is making and, therefore, your financial survivability.
Wealth is the measure of the cash flow from the asset column compared with the expense column.
Let's use an example. Let's say I have cash flow from my asset column of S"J,000 a month. And I have monthly expenses of 52,000. What is my wealth?
Let's go back to Buckminster Fuller's definition. Using his definition, how many days forward can I survive? And let's assume a 30-day month. By that definition, I have enough cash flow for half a month.
When I have achieved $2,000 a month cash flow from my assets, then I will be wealthy.
So I am not yet rich, but I am wealthy. I now have income generated from assets each month that fully cover my monthly expenses. If I want to increase my expenses, I first must increase my cash flow from assets to maintain this level of wealth. Take notice that it is at this point that I no longer am dependent on my wages. I have focused on and been successful in building an asset column that has made me financially independent. If I quit my job today, I would be able to cover my monthly expenses with the cash flow from my assets.
My next goal would be to have the excess cash flow from my assets reinvested into the asset column. The more money that goes into my asset column, the more my asset column grows. The more my assets grow, the more my cash flow grows. And as long as I keep my expenses less than the cash flow from these assets, I will grow richer, with more and more income from sources other than my physical labor.
As this reinvestment process continues, I am well on my way to being rich. The actual definition of rich is in the eye of the beholder. You can never be too rich.
Just remember this simple observation: The rich buy assets. The poor only have expenses. The middle class buys liabilities they think are assets. So how do I start minding my own business? What is the answer? Listen to the founder of McDonald's.
CHAPTER FOUR
Lesson Three: Mind Your Own Business
In 1974, Ray Kroc, the founder of McDonald's, was asked to speak to the MBA class at the University of Texas at Austin. A dear friend of mine, Keith Cunningham, was a student in that MBA class. After a powerful and inspiring talk, the class adjourned and the students asked Ray if he would join them at their favorite hangout to have a few beers. Ray graciously accepted.
"What business am I in?" Ray asked, once the group had all their beers in hand.
"Everyone laughed," said Keith. "Most of the MBA students thought Ray was just fooling around."
No one answered, so Ray asked the question again. "What business do you think I'm in?"
The students laughed again, and finally one brave soul yelled out, "Ray, who in the world does not know that you're in the hamburger business."
Ray chuckled. "That is what I thought you would say." He paused and then quickly said, 'ladies and gentlemen, I'm not in the hamburger business. My business is real estate."
Keith said that Ray spent a good amount of time explaining his viewpoint. In their business plan, Ray knew that the primary business focus was to sell hamburger franchises, but what he never lost sight of was the location of each franchise. He knew that the real estate and its location was the most significant factor in the success of each franchise. Basically, the person that bought the franchise was also paying for, buying, the land under the franchise for Ray Kroc's organization.
McDonald's today is the largest single owner of real estate in the world, owning even more than the Catholic Church. Today, McDonald's owns some of the most valuable intersections and street corners in America, as well as in other parts of the world.
Keith said it was one of the most important lessons in his life. Today, Keith owns car washes, but his business is the real estate under those car washes.
The previous chapter ended with the diagrams illustrating that most people work for everyone else but themselves. They work first for the owners of the company, then for the government through taxes, and finally for the bank that owns their mortgage.
As a young boy, we did not have a McDonald's nearby. Yet, my rich dad was responsible for teaching Mike and me the same lesson that Ray Kroc talked about at the University of Texas. It is secret No. 3 of the rich.
The secret is: "Mind your own business/' Financial struggle is often directly the result of people working all their life for someone else. Many people will have nothing at the end of their working days.
Again, a picture is worth a thousand words. Here is a diagram of the income statement and balance sheet that best describes Ray Kroc's advice:
Most people
Your Profession -> Your Income
The Rich
Your Assets -> Your Income
Our current educational system focuses on preparing today's youth to get good jobs by developing scholastic skills. Their lives will revolve around their wages, or as described earlier, their income column. And after developing scholastic skills, they go on to higher levels of schooling to enhance their professional abilities. They study to become engineers, scientists, cooks, police officers, artists, writers and so on. These professional skills allow them to enter the workforce and work for money.
There is a big difference between your profession and your business. Often I ask people, "What is your business?" And they will say, "Oh I'm a banker." Then I ask them if they own the bank? And they usually respond. "No, I work there."
In that instance, they have confused their profession with their business. Their profession may be a banker, but they still need their own business. Ray Kroc was clear on the difference between his profession and his business. His profession was always the same. Me was a salesman. At one time he sold mixers for milkshakes, and soon thereafter he was selling hamburger franchises- But while his profession was selling hamburger franchises, his business was the accumulation of income-producing real estate.
A problem with school is that you often become what you study. So if you study, say, cooking, you become a chef. If you study the law, you become an attorney, and a study of auto mechanics makes you a mechanic. The mistake in becoming what you study is that too many people forget to mind their own business. They spend their lives minding someone else's business and making that person rich.
To become financially secure, a person needs to mind their own business. Your business revolves around your asset column, as opposed to your income column. As stated earlier, the No. 1 rule is to know the difference between an asset and a liability, and to buy assets. The rich focus on their asset columns while everyone else focuses on their income statements.
That is why we hear so often: "I need a raise." "If only I had a promotion." "I am going to go back to school to get more training so I can get a better job." "I am going to work overtime." "Maybe I can get a second job." "I'm quitting in two weeks. I found a job that pays more."
In some circles, these are sensible ideas. Yet, if you listen to Ray Kroc, you are still not minding your own business. These ideas all still focus on the income column and will only help a person become more financially secure if the additional money is used to purchase income-generating assets.
The primary reason the majority of the poor and middle class are fiscally conservative-which means. "I can't afford to take risks"-is that they have no financial foundation. They have to cling to their jobs. They have to play it safe.
