Today, I am still challenged on the idea of a house not being an asset. And I know that for many people, it is their dream as well as their largest investment. And owning your own home is better than nothing. I simply offer an alternate way of looking at this popular dogma. If my wife and I were to buy a bigger, more flashy house we realize it would not be an asset, it would be a liability, since it would take money out of our pocket.
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So here is the argument I put forth. I really do not expect most people to agree with it because a nice home is an emotional thing. And when it comes to money, high emotions tend to lower financial intelligence. 1 know from personal experience that money has a way of making every decision emotional.
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2. Even though people receive a tax deduction for interest on mortgage payments, they pay for all their other expenses with after-tax dollars. Even after they pay off their mortgage.
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1. When it comes to houses, I point out that most people work all their lives paying for a home they never own. In other words, most people buy a new house every so many years, each time incurring a new 30-year loan to pay off the previous one.
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4 Houses do not always go up in value. In 1997, I still have friends who owe a million dollars for a home that will today sell for only $700,000.
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3. Property taxes. My wife's parents were shocked when the property taxes on their home went to $1,000 a month. This was after they had retired, so the increase put a strain on their retirement budget, and they felt forced to move.
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5. The greatest losses of all are those from missed opportunities. If all your money is tied up in your house, you may be forced to work harder because your money continues blowing out of the expense column, instead of adding to the asset column, the classic middle class cash flow pattern. If a young couple would put more money into their asset column early on, their later years would get easier, especially as they prepared to send their children to college. Their assets would have grown and would be available to help cover expenses. All too often, a house only serves as a vehicle for incurring a home-equity loan to pay for mounting expenses.
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In summary, the end result in making a decision to own a house that is too expensive in lieu of starting an investment portfolio early on impacts an individual in at least the following three ways:
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1. Loss of time, during which other assets could have grown in value.
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3. Loss of education. Too often, people count their house, savings and retirement plan as all they have in their asset column. Because they have no money to invest, they simply do not invest. This costs them investment experience. Most never become what the investment world calls a "sophisticated investor." And the best investments are usually first sold to "sophisticated investors," who then turn around and sell them to the people playing it safe. I am not saying don't buy a house. I am saying, understand the difference between an asset and a liability. When I want a bigger house, I first buy assets that will generate the cash flow to pay for the house.
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2. Loss of additional capital, which could have been invested instead of paying for high-maintenance expenses related directly to the home.
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Income -> Assets -> More Income
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Educated Dad's Financial Statement
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My rich dad's personal financial statement, on the other hand, reflects the results of a life dedicated to investing and minimizing liabilities:
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Income > Expense
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Rich Dad's Financial Statement
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The following picture is worth a thousand words:
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Income = Expense
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Asset > Liability
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Why the Rich Get Richer
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The result being: The rich get richer!
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Expenses are low, Liabilities are low
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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.
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Asset < Liability
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My educated dad's personal financial statement best demonstrates the life of someone in the rat race. His expenses seem to always keep up with his income, never allowing him to invest in assets. As a result, his liabilities, such as his mortgage and credit card debts are larger than his assets.
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Income goes up, Expenses go up
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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.
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Assets do not increase, Liabilities do increase
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Why the Middle Class Struggle
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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.
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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.
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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.
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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."
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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.
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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".
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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.
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Income = Work for Owner
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If you do what the masses do, you get the following picture.
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Expense = Work for Government
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Liability = Work for Bank
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As an employee who is also a homeowner, your working efforts are generally as follows:
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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.
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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.
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Asset = (none)
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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.
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3. You work for the bank. After taxes, your next largest expense is usually your mortgage and credit card debt.
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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.
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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.
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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?
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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?
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Wealth is the measure of the cash flow from the asset column compared with the expense column.
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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.
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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.
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When I have achieved $2,000 a month cash flow from my assets, then I will be wealthy.
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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.
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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.
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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.
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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.
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For instance, this is the cash flow pattern of a poor person, or a young person still at home:
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