Unfair Advantage -The Power of Financial Education (26 page)

FIVE LEVELS OF INVESTORS

The Times They Are A-Changin’

There have been many changes in our economy and the investing landscape since
Rich Dad Poor Dad
was first published in 1997. Fourteen years ago, Robert Kiyosaki challenged conventional wisdom with his bold statement that, “Your house is not an asset.” His contrarian views on money and investing were met with outrage and criticism.

In 2002,
Rich Dad’s Prophecy
advised that we prepare for an upcoming financial market crash. In 2006, Robert joined forces with Donald Trump to write
Why We Want You To Be Rich
, a book that was inspired by their concern for the shrinking middle class in America.

Robert continues to be a passionate advocate for the importance and power of financial education. Today, in the wake of the subprime fiasco, record home foreclosures, and a global economic meltdown that is still raging, his words seem not only prophetic, but enlightened. Many skeptics have become believers.

In preparing the 2011 reprint of
Rich Dad’s CASHFLOW Quadrant
book, Robert realized two things: that his message and teachings have withstood the test of time, and that the investment landscape, the world in which investors operate, has changed dramatically. These changes have affected, and will continue to affect, those in the I (Investor) quadrant and have fueled Robert’s decision to update an important section in the
CASHFLOW Quadrant
book which specifically addresses investors.

The following special section in
Unfair Advantage
is a gift from Robert, a sneak preview of the new chapter from
Rich Dad’s CASHFLOW Quadrant:
“Five Levels of Investors.”

Special Section

FIVE LEVELS OF INVESTORS

My poor dad often said, “Investing is risky.”

My rich dad often said, “Being financially uneducated is risky.”

Today, most people know they should invest. The problem is that most people, like my poor dad, believe investing is risky—and investing is risky if you lack financial education, experience, and guidance.

Learning to invest is important because investing is the key to financial freedom. Five things happen to people who do not invest, or who invest poorly:

1. They work hard all their lives.
   

2. They worry about money all their lives.
   

3. They depend on others, such as family, a company pension, or the government, to take care of them.
   

4. The boundaries of their lives are defined by money.
   

5. They will not know what true freedom is.
   

Rich dad often said, “You will never know true freedom until you achieve financial freedom.” By this, he meant that learning to invest is more important than learning a profession. He said, “When you learn a profession, let’s say to be a doctor, you learn how to work for money. Learning to invest is learning how to have money work for you. The moment you have money working for you, you have your ticket to freedom.” He also said, “The more money you have working for you, the less you pay in taxes—if you are a true investor.”

Learning to Invest

My rich dad began preparing me for the I quadrant at the age of nine using the game of
Monopoly®
as a teaching tool. Over and over again, he would say, “One of the great formulas for wealth is found in the game of
Monopoly
. Always remember the formula: four green houses, one red hotel.”

The game of
Monopoly
is a game of cash flow. For example, if you had one green house on a property you owned and you received $10, that was $10 a month in cash flow. Two houses, $20. Three houses, $30. And the red hotel, $50. More green houses and more red hotels mean more cash flow, less work, less taxes, and more freedom.

A simple game, but an important lesson.

Rich dad played
Monopoly
in real life. He would often take his son and me to visit his green houses—green houses that would one day become a big red hotel, right on Waikiki Beach.

As I grew up and watched my rich dad play the game of
Monopoly
in real life, I learned many valuable lessons about investing. Some of those lessons are:

• Investing is not risky.
  

• Investing is fun.
  

• Investing can make you very, very, rich.
  

• More importantly, investing can set you free, free from the struggle of earning a living and worrying about money.
  

In other words, if you were smart, you could build a pipeline of cash flow for life, a pipeline that would produce cash in good times and bad, in market booms and market crashes. Your cash flow would increase automatically with inflation and, at the same time, allow you to pay less in taxes.

I am not saying real estate is the only way to invest. I use the game of
Monopoly
simply as an example of how the rich get richer. A person can earn income from stocks via dividends, from bonds via interest, or from oil, books, and patents via royalties.

In other words, there are many ways to financial freedom.

Financial “Experts”

Unfortunately, due to a lack of financial education in schools, most people blindly turn their money over to people they believe are financial experts: people such as bankers, financial planners, and stockbrokers. Unfortunately, most of these “experts” are not really investors in the I quadrant. Most are employees in the E quadrant working for a paycheck, or they are self-employed financial advisors in the S quadrant working for fees and commissions. Most “experts” cannot afford to stop working, simply because they don’t have investments working for them.

Warren Buffett said, “Wall Street is the only place where people ride to work in a Rolls Royce to get advice from those who take the subway.”

If people do not have sound financial education, they cannot tell if a financial advisor is a salesman or a con man, a fool or a genius. Remember, all con men are nice people. If they were not being nice by telling you what you want to hear, you would not listen to them.

There is nothing wrong with being a sales person. We all have something to sell. Yet, as Warren Buffet says, “Never ask an insurance salesman if you need insurance.” When it comes to money, there are many people desperate enough to tell and sell you anything, just to get your money.

Interestingly, the vast majority of investors never meet the person taking their money. In most of the Western world, employees simply have their money automatically deducted from their paycheck, in the same way the tax department collects taxes. Many workers in America simply allow their employer to deduct their money and put it into their 401(k) retirement plan, possibly the worst way to invest for retirement. (401(k) plans go by different names in different countries. In Australia they are called superannuation plans, in Japan they are also called 401(k)s, and in Canada they are known as RRSPs.)

I say the 401(k) may possibly be the worst way to invest for retirement for the following reasons:

1. TIME magazine is on my side.
TIME
magazine has run a number of articles over the years, questioning the wisdom of putting so many people’s retirement at risk.
TIME
has been predicting that millions will not have enough money to retire after a lifetime of turning their money over to strangers.

A typical 401(k) plan takes 80 percent of the profits. The investor may receive 20 percent of the profits, if they are lucky. The investor puts up 100 percent of the money and takes 100 percent of the risk. The 401(k) plan puts up 0 percent of the money and takes 0 percent of the risk. The fund makes money, even if you lose money.

2. Taxes work against you with a 401(k).
Long-term capital gains are taxed at a lower rate of around 15%. But the 401(k) treats any gains as ordinary earned income. Ordinary income is taxed at the highest rate, sometimes as high as 35%. And if you want to take the money out early, you’ll have to pay an additional 10% penalty tax.

3. You have no insurance if there is a stock-market crash.
To drive a car, I must have insurance in case there is a crash. When I invest in real estate, I have insurance in case of fire or other losses. Yet the 401(k) investor has no insurance to prevent losses from market crashes.

4. The 401(k) is for people who are planning to be poor when they retire.
That is why financial planners often say, “When you retire, you’ll be taxed at a lower tax rate.” They assume your income will go down in retirement into a lower tax bracket. If, on the other hand, you are rich when you retire and you have a 401(k), you could pay even higher taxes at retirement. Smart investors understand taxes before investing.

5. Income from a 401(k) is withdrawn at ordinary earned income-tax rates, the highest of the three types of income, which are:

1. Ordinary earned
   

2. Portfolio
   

3. Passive
   

The sad truth about most financial advisors and pension-fund managers is that they are not investors. Most are employees in the E quadrant. One reason why so many government pensions and union pensions are in trouble is because these employees are not trained to be investors. Most do not have any real-life financial education.

To make matters worse, most financial “experts” advise uneducated investors to “invest for the long term in a well-diversified portfolio of stocks, bonds, and mutual funds.”

Why do these financial “experts,” employees in the E quadrant or sales people in the S quadrant masquerading as investors in the I quadrant, advise you to do that? It’s because they get paid, not by how much money they make for you, but by how much money you turn over to them for the long term. The longer your money is parked with them, the more they get paid.

The reality is that real investors do not park their money. They move their money. It is a strategy known as the “velocity of money.” A true investor’s money is always moving, acquiring new assets, and then moving on to acquire even more assets. Only amateurs park their money.

I am not saying that 401(k)-type plans are bad, although I would never have one. For me, they are too expensive, too risky, too tax-inefficient, and not fair to the investor.

I am saying there are better ways to invest, but they require financial education.

What Is the Best Investment?

The average investor does not know the difference between investing for cash flow and investing for capital gains. Most investors invest for capital gains, hoping and praying the price of their stock or home goes up. As long as you have more cash flowing in than flowing out, your investment is a good investment.

Keep in mind that it’s not the asset class that makes a person rich or poor. For example, when a person asks, “Is real estate is a good investment?” I reply, “I don’t know. Are you a good investor?” Or if they ask, “Are stocks a good investment?” again my answer is the same, “I don’t know. Are you a good investor?”

My point is that it is never the investment or asset class that is important. Success or failure, wealth or poverty, depends solely on how smart the investor is. A smart investor will make millions in the stock market. An amateur will lose millions.

Tragically, most people do not think learning to invest is important. This is why most people believe investing is risky and turn their money over to “experts,” most of whom are not really investors, but sales people who make money whether the investor makes money or loses money.

There are five types or levels of investors found in the I quadrant.

Five Different Levels of Investors

Level 1: The Zero-Financial-Intelligence Level

Sadly, in America, once the richest country in the world, over 50 percent of the U.S. population is at the bottom level of the I quadrant. Simply said, they have nothing to invest.

There are many people who make a lot of money who fall into this category. They earn a lot—and spend more than they earn.

I have a friend who looks very rich. He has a good job as a real estate broker, a beautiful wife, and three kids in private school. They live in a beautiful house overlooking the Pacific Ocean in San Diego. He and his wife drive expensive European cars. When his son and daughters were old enough, they too drove expensive cars. They looked rich, but what they had was debt. They looked rich, but were poorer than most poor people.

Now, they are homeless. When the real estate market crashed, they crashed. They were no longer able to pay the interest on all the debt they had accumulated.