Master the 6 Basic Rules of Investing
One of the things I love most about my work is seeing people move from the left side of the CASHFLOW® Quadrant to the right side of the quadrant.
The process of moving from being an employee or self-employed to a business owner or a sophisticated investor is a bit like that of a caterpillar turning into a beautiful butterfly. It takes time and often requires a total transformation in mindset and behavior.
One of these behavior changes is understanding what to do when you have more money suddenly at your disposal. Whether it’s from an inheritance, a raise or bonus, or some other source, the temptation for those on the left side of the quadrant can be to, at best, follow conventional advice about money, or, at worse, to spend it on liabilities like cars or vacations.
Such conventional advice could be to increase your contributions to your 401(k) or to continue to live below your means. I’ve written a lot about both of these topics, and it should come as no surprise that I don’t condone either of them.
If you’re facing a windfall in new money, now is the perfect time to put into place the rich dad fundamental: invest in cash-flowing assets.
But in order to do that, you need to understand the investing fundamentals. Here are six basic rules of investing to master, taught to me by my rich dad.
#1 Use debt to get rich
I never use my own money to invest. I use debt. It’s a fundamental that I call O.P.M.—Other People’s Money.
For example, Those who are the most successful investing in real estate understand that the best way to get a high return is to have as little of their own money in a deal.
Rich real estate investors spend their time finding the best deals and then present them to other investors who are willing to use their money to fund the deal. When structured right, OPM allows a real estate investor to secure a valuable, high return, cash-flowing asset for little-to-nothing.
My wife, Kim, invested with OPM for her first investment—a rental house in Portland, OR. Today, she owns thousands of apartment units. She used this method of good debt to increase the velocity of her money from one small house to a huge portfolio. And you can too. It starts with thinking differently about money, increasing your financial intelligence, and getting to work today.
#2 Know what kind of income you’re working for
Most people grow up to believe that earning a paycheck is the only kind of income. They don’t realize that there are different kinds of income.
For years, rich dad drilled into me that there are three kinds of income:
Ordinary earned income: This is the type of income that most people think of when they talk about making money. This is the income of the working 9 to 5 set. It is generally earned from a job via a paycheck. It’s the highest-taxed income, and thus, the hardest to build wealth with due to the government taking money out of your paycheck before you even get it and the fact that you’re trading time for money. Your ability to earn is based on how long you can work. Earned income is the income you have the least control over. It is determined by your employer, and it can be cut or you can be fired. And if you want to make more money, you have to either find a job or hope that your employer will decide to pay you more.
Portfolio income: Most high-paid employees also have some form of portfolio income, usually in the form of a 401(k) and various paper assets like mutual funds managed by a financial advisor. Portfolio income is generally derived from paper assets such as stocks, bonds, and mutual funds. It is the second-highest taxed income and is moderately hard to build wealth due to low returns. Most experts say you can expect about 7% a year in returns for your portfolio income over a long period of investing. There are of course big ups and downs that can happen during that time. A return of 7% might seem like a lot to a person with low financial intelligence, but the rich would balk at an investment strategy that only promised that much in return. Much like earned income, you have little control over your portfolio income. You are at the mercy of the ups and downs of the stock market and the skill of your advisor.
Passive income: People with a high financial IQ have an investment strategy that aims to create passive income. Passive income is generally derived from real estate, royalties, and business distributions. If you receive rent from a property, that is passive income. I get royalties from my books. They are cash-flowing assets that provide passive income. If you own a business that distributes profit to you, that is also passive income. In short, it is income that comes to you whether you are working or not. It is the lowest-taxed income, with many tax benefits, and is the easiest income to build wealth with thanks to its combination of low taxes and potentially infinite returns.
Rich dad said, “If you want to be rich, work for passive income.”
The path to building wealth then starts with understanding that there are other types of income and then converting your earned income into the other types of income as efficiently as possible.
“That, in a nutshell,” said rich dad, “is all an investor is supposed to do. It’s as basic as it can get.”
This is why when someone gets a raise, I don’t tell them to put it in a 401(k) or to live below their means, which essentially means saving. Rather, I tell them to pay themselves first and invest that money in cash-flowing assets. In short, convert your pay raise into passive income.
The easiest way to do this is to make your investment spend an expense and to make it your most important expense. Kim and I did this for years, baking our money for investments into our budget expense column. Even when we couldn’t afford to pay all our expenses, we always paid that expense first (much to the despair of our bookkeeper). We always found a way to pay our other expenses too, even if it was a little late. In this way, we changed our mindset about money and investing.
#3 Get a financial education
As a young man, my rich dad said to me, “If you are going to be successful in the real world, you and your generation will need more than just academic and professional education.”
Rich dad was speaking, of course, about financial education. Financial education is about how money works and how to make it work for you. It teaches you about debt and how to leverage it, the history of money, what a financial statement is and how to read it, the difference between an asset and liability, and so much more.
To be clear, I’m not saying that financial education is more important than academic and professional education. In fact, those who are financially educated need the help of those who benefited from both. You can’t be successful without the help of great lawyers, accountants, brokers, and more.
But the fact remains that if you want to be rich in today’s world, you need financial education in addition to academic and professional education. In fact, the professionals that I work with also have a great financial education. That’s why we get along so well. And together we become rich.
#4 Invest for cash flow
“The rich don’t work for money” is the title of the first chapter of Rich Dad Poor Dad. See, the rich don’t work for money, instead, they work to acquire assets.
When I played Monopoly® as a kid, my rich dad wasn’t simply playing a board game with his son and me to pass the time. He was teaching us the cash flow formula, “4 green houses 1 red hotel.”
Real estate investing for cash flow is putting that simple formula into action in the real world.
So while the poor and middle-class go to a job and earn their income through a paycheck, the rich make passive income by acquiring assets.
#5 The investor is risky, not the asset
Many people think investing is risky. The reality, however, is that it’s the investor who is risky. The investor is the asset or liability.
“I have seen investors lose money when everyone else is making it,” said rich dad. “In fact, a good investor loves to follow behind a risky investor because that is where the real investment bargains can be found!”
What this means is that your financial knowledge can either be an asset or a liability. If you have a low financial IQ but decide to dive into big-time investments anyway, you’ll make a lot of mistakes that investors with a high financial IQ will capitalize on.
If you want to move from being a risky investor to a good investor, first invest in your financial education. As part of your education—because nothing beats real-life experience—start small with your investments, learn from your mistakes, and then make bigger and bigger investments.
#6 Learn how to raise capital
One of my big concerns as a beginning investor was how I would raise money if I found a good deal. Rich dad reminded me that my job was to stay focused on the opportunities in front of me, to be prepared.
“If you are prepared, which means you have education and experience,” said rich dad, “and you find a good deal, the money will find you or you will find the money.”
Rich dad’s point was that getting the money was the easy part. The hard part was finding a great deal that attracted the money—which is why so many people are ready to give money to a good investor.
Editor, Rich Dad Poor Dad Daily