The 5 Most Important Words In The Rich Dad Glossary
Information is the single greatest asset of this era. In previous ages, you owned factories, cattle ranches, gold mines, oil wells, or skyscrapers to be rich. In the Information Age, information alone can make you very rich. You don’t need tangible resources like land, gold, or oil. The young entrepreneurs who created Facebook and YouTube have proved that. With just a few dollars, some information, and the leverage of technology, these 20-year-olds have become billionaires.
Likewise, poor or mistaken information is a liability. Poor information creates poor people. One of the reasons so many people are struggling financially is simply because they have obsolete, biased, misleading, or erroneous information powering their most powerful asset, their brain. Many people who are struggling are doing so because they are using Industrial or Agrarian Age information in the Information Age.
The American Dream is dead for most people; especially people who believe in going to school, getting a job, saving money, and investing for the long-term in a retirement plan.
Yet the dream of becoming a millionaire is alive and well if a person invests in a real financial education, which this book is about.
When I was a young boy, playing Monopoly® with my rich dad, I knew I wanted to become a cash flow millionaire. I knew that four green houses led to one red hotel, which increased my cash flow and my net worth. Being a cash flow millionaire allows me to use debt as money, pay less in taxes, legally, without selling assets, which would decrease my net worth.
As a part of your financial education, below are the five most important words to learn:
1. Financial Statement
The financial statement is at the core of financial literacy. That is why rich dad often said, “My banker never asks me for my report card. My banker does not care what school I went to or my grade point average. My banker wants to see my financial statement. Your financial statement is your report card after you leave school.”
Financial literacy—the basics, at a young age—gave me a clearer direction for my life.
People who cannot read financial statements are financially illiterate. As you know, there are many highly-educated people that cannot read financial statements. This is the real financial crisis we face.
There are several types of financial statements. An Income statement shows a detailed account of income and expenses for a particular period of time. A balance sheet includes the assets and liabilities at a particular time. A statement of cash flow details cash coming in and cash going out. Individuals, properties and businesses all have their own financial statements.
Another way to describe a financial statement is a “statement of financial condition.” A person’s financial condition is good if their cash inflows exceed their cash outflows. If you had no job to rely on, your cash inflows would be determined solely by your assets and your cash outflows would be determined solely by your liabilities. So assets can very literally be defined as something that creates cash inflows and liabilities can be defined as something that creates cash outflows. The difference between your assets and liabilities, or cash inflows and outflows, is called your net worth, or wealth.
Many people believe taxes are unfair. What is unfair is the lack of real financial education that would help people to better understand taxes. The fact is that tax laws are for everyone. Anyone can pay less in taxes… if they have real financial education to use the tax law to their advantage.
Without financial education, most people are financially ignorant about taxes. Many of these people vote for politicians who promise to “tax the rich.” Then they wonder why their taxes keep going up. The problem is not taxes; the problem is spending.
One of the reasons for wealth and income inequality is tax. Simply stated, the rich do know how to make more money and pay less in taxes than the poor and middle class—legally. The rich are not always smarter, they simply prefer not to be ignorant.
Here’s an explanation about tax inequality from my tax advisor, Tom Wheelwright:
“Think of the E, S, B, and I quadrants in terms of consuming and producing. Someone in the E quadrant produces whatever they can produce by themselves and consumes an equal amount. Someone in the S quadrant produces a little more (if they have some employees) and consumes a little less than they produce. Someone in the B or I quadrant, however, produces much more than they consume. In the B quadrant, they are creating hundreds or thousands of jobs, and in the I quadrant they are producing energy, food, and housing. They still only consume the same amount as someone in the E or S quadrant. The government encourages and rewards these activities through tax breaks because the producers stimulate the economy and produce the food, fuel, and housing that the rest of the citizens need to live happy and productive lives.”
In the I quadrant, I receive tax breaks for investing in apartment complexes. If I did not provide housing, the government would have to, costing taxpayers a lot of money. So rather than ask taxpayers to pay higher taxes, the government offers entrepreneurs like me tax incentives—I become a partner with the government.
The difference is the mindset, skill sets, and financial education. If you want to live your life in the B and I quadrants, you must know how to use debt and taxes to get richer.
Most people view debt as a four-letter word. We have been conditioned that all debt is bad. We’ve been taught to fear debt. But not all debt is bad. There is good debt too. Understanding good debt, and utilizing it, is an essential part of attaining financial independence.
Debt is money. One reason why the rich grow richer is that they use debt to become richer. Unfortunately, without financial education, debt makes the poor and middle class poorer.
Donald Trump summed it up, saying: “You know I am the king of debt. I love debt, but debt is tricky and it is dangerous.”
When I speak to groups around the world, I’m often asked this question: How does debt make the rich richer?
I will use credit cards as an example to illustrate this. Let’s say you receive a new credit card. There is no money on that credit card. All you have is credit. You go shopping and buy a new pair of shoes that cost $100. You use your new credit card and—like magic—$100 of “money” has been created. At the same time, $100 in debt has also been created. The $100 flows into the economy and people are happy.
If you want to grow richer, invest in your financial education before you practice using debt as money. Learning to use debt to make you rich gives you unbelievable power, a power very few will ever experience.
Assets put money in your pocket whether you work or not. If you stopped working today, meaning your salary stopped, from where would money flow into your pocket? The rich focus on assets more than income and they use debt to acquire and grow those assets.
There are four basic asset classes. They are:
- Real estate
- Paper Assets: Stocks and Bonds
The reason people get into trouble financially or never get ahead in life is that they have liabilities that they have been led to believe are assets.
One of the most important lessons I learned from rich dad was to know the difference between an asset and a liability.
5. Cash Flow
Cash Flow is an ongoing stream of income you receive from an investment. You may receive this money on a monthly, quarterly or annual basis, depending on the investment. The strategy behind cash flow is to buy and hold, whereas the strategy behind capital gains is to buy and sell.
So, let’s say you buy a stock that pays you a dividend every year. That dividend is cash flow. You loan money to a new start-up business. Each month the business pays you interest on your loan. That interest is cash flow
I purchased my first property, a 1-bedroom /1-bath condo across the street from a beautiful beach on the island of Maui. The property market had crashed. Buyers were in hiding. The property was in foreclosure. It was perfect for an investor. The price of the condo was $18,000—and I needed a down payment of 10%. I pulled out my credit card, charged the $1,800 down payment, purchasing the property with 100% debt. I made only $25 a month in positive cash flow—but it was an infinite return because I used 100% debt and none of my own money.
Learning to be rich is not much different than learning another language. When I took my 3-day real estate course years ago, I was learning to speak the language of real estate—words like cap rate, net operating income, and discounted cash flow. Today, I make millions every year “speaking” real estate.
The best thing about the language of money is that words are free.
Editor, Rich Dad Poor Dad Daily