Live Your Financial Life With Less Risk

Dear Reader,

Many financial advisors will tell you that higher returns mean higher risk. In other words, leverage is risky. That is absolutely false. Leverage is risky only when people invest in assets that they have no control over. If a person has control, leverage can be applied with very little risk. The reason most financial advisors say that higher returns mean the higher risk is simply because they sell only investments that allow very little control.

For example, Kim and I purchased a 300-unit apartment building in Tulsa, Oklahoma and because I have control, I am confident about using a lot more leverage. Due to control and leverage, I can achieve greater wealth, in less time, with very little risk, and minimize the effect of the booms and busts of markets on my investments.

Assets such as a business or real estate require more financial intelligence, allow for more financial control, and permit a higher degree of leverage with very low risk. The key to low risk is higher financial intelligence. This is why I recommend that people start small and stay small, as they allow their financial intelligence to increase. With an increase in financial intelligence, their returns on their investments increase. 

Leverage

In very simple terms, the definition of leverage is doing more with less. A person who puts money in the bank, for example, has no leverage. It’s the person’s money. A dollar in savings has a leverage factor of 1:1. The saver puts up all the money.

For my investment in the 300-unit apartment house, my banker put up 80 percent of the $17 million real estate investment. By using my banker’s money, my leverage is 1:4. For every dollar I invest in the deal, the bank lends me four dollars.

While savings and a diversified mutual fund portfolio are a form of leverage, there are better ways to leverage your money. If a person is truthful, he or she has to admit it doesn’t require much financial intelligence to save money and invest in mutual funds. You can train a monkey to save money and invest in mutual funds. That is why the returns on those investment vehicles are historically low. 

As I said earlier, many people think that higher returns on investment require higher degrees of risk. That is not true. I achieve exceptional returns, and pay very little, if anything, in taxes, all with very low risk. To me, having a well-diversified mutual fund portfolio and savings in the bank is a lot riskier than what I do. It is all a matter of financial intelligence.

Higher Returns with Less Risk

I’m going to further explain why I am willing to use a lot of leverage, why I believe the risk is low, how I make more money, and how I pay less in taxes. There are three more advanced investment strategies, investment strategies that require a higher level of financial intelligence. 

The three advanced leverage strategies are OPM, ROI, and IRR.

  1. OPM: Other people’s money. There are many ways to use OPM. With my 300-unit apartment building, I am using 80 percent leverage. First of all, the beauty of using the bank’s money is that it is tax-free money.
  2. ROI: Return on investment. A confusing concept for many investors is the return on their money, or ROI. For example, when you read financial publications, many mutual funds claim they have gone up by 10 percent. But my question is, did any of that 10 percent return to the investor? And how did they measure that 10 percent? Some funds measure the 10 percent by the price of the shares in the fund going up. For example, if a year ago the price per share in the fund was $10 and today it’s $11, they can claim a 10 percent return. In this case, the return was measured in capital gains.
  3. IRR: Internal rate of return. One of the more complex, sophisticated, and often confusing measures of ROI is the internal rate of return. If investors really know what they are doing, they can increase their ROI by understanding IRR. 

As an investor who invests for both capital gains and cash flow, the only return I count is the cash flow. For example, if I invest $10 and each year after taxes I put $1 in my pocket from cash flow, my return is 10 percent. I do not count the return on asset appreciation because it is an estimate and does not become a reality unless I sell the asset.

The difference is that one measure of the ROI is in the price of the stock, and the other measure of ROI is money in my pocket. I actually want both, 10 percent in asset appreciation and 10 percent cash in my pocket. But cash flow is the only return that can be tangibly measured while I hold the asset.

The reason leverage is so important is that the higher the leverage, the higher the return. For example,  if I buy a $100,000 rental unit with my money, and I receive $10,000 a year net income, my cash-on-cash return is 10 percent. 

If I borrow $50,000 and am still able to receive a $10,000 return, my cash-on-cash return is 20 percent. If I finance the entire $100,000 and still receive a $10,000 return, my return is infinite. Infinite returns mean money for nothing. Ten thousand dollars flows into my pocket, and nothing comes out. The renters cover my expenses, and I receive the income.

What Are You Investing For? 

The key to more sophisticated leverage, higher returns, and lower risk is focus. Focus requires more financial intelligence. Financial intelligence begins with knowing what you are investing for. In the world of money, there are two things investors invest for: capital gains and cash flow.

  1. Capital gains: Another reason so many people think investing is risky is that they invest for capital gains. In most cases, investing for capital gains is gambling or speculation. When a person says, “I’m buying this stock, mutual fund, or piece of real estate,” he or she is investing for capital gains, an increase in the price of the asset. For example, if I had purchased the $17 million apartment house hoping I could sell it for $25 million, then I would be investing for capital gains. As many of you know, investing for capital gains means a tax increase in some countries.
  2. Cash flow: Investing for cash flow is a lot less risky. Investing for cash flow is investing for income. If I put savings in the bank and receive 5 percent in interest, I am investing for cash flow. While interest is low-risk, the problem with savings is the return is low, taxes can be high, and the dollar keeps losing value. When I purchased the 300-unit apartment house, I was investing for cash flow. The difference is I was investing for cash flow using my banker’s money for a higher return on investment and paying less in taxes. That is a better use of leverage.

Solving Money Problems Makes You Smarter

When I was a young boy, rich dad said to me, “Money problems make you smarter… if you solve the problem.” He also said, “If you solve your money problem, your financial intelligence grows. When your financial intelligence grows, you become richer. If you do not solve your money problem, you become poorer. 

If you do not solve your money problem, that problem often grows into more problems.” 

If you want to increase your financial intelligence, you need to be a problem-solver. 

Regards,

Robert Kiyosaki

Robert Kiyosaki
Editor, Rich Dad Poor Dad Daily

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Robert Kiyosaki

Robert Kiyosaki, author of bestseller Rich Dad Poor Dad as well as 25 others financial guide books, has spent his career working as a financial educator, entrepreneur, successful investor, real estate mogul, and motivational speaker, all while running the Rich Dad Company.

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