There is no doubt Robert Kiyosaki can be considered a founding father of modern personal finance. In this article, we’ll discuss his view of what an asset is as he demonstrates in his bestseller ‘Rich Dad, Poor Dad’.
A short theoretical reminder
In traditional finance and accounting, we consider possessions as assets; they constitute part of our total net wealth or net worth. Something we buy has value, and although it might be decreasing rapidly (a car loses 20-30% of its value within the first year), we, therefore, recognise its value into the realm of what we have. We view it as something we could trade or sell for an economic counterpart.
The traditional view of accounting (or bookkeeping) accounts for two columns that balance each other: Assets are “opposed” to equity and liabilities (see image below). By this view, our possessions (i.e. assets) are financed either by 1. liabilities (debt) or 2. equity (ownership, it has already been traded for cash or something else). A house that is not fully repaid for instance will be split between both categories: what has been acquired is equity, what is still owed is liability or debt. For those who do not have any basic accounting knowledge, it is worth pointing out that bookkeeping is done according to a double-entry mechanism. This means that the two columns must always be equal, at any given time. If you acquire a boat and write its value into the “assets” column, you have to specify how it has been acquired in the other column and if something is still owed for it.
So how does Kiyosaki’s view differ from traditional finance and accounting?
Although this view is a worldwide-accepted standard—and serves its purpose well as far as business reporting activities are concerned—Robert Kiyosaki proposes a shift of perspective when it comes to conceiving our own financial structure. He argues that although this system works on paper, it does not help us optimise our personal finances as individuals. This system tricks us to believe that adding possessions to our asset column is a good move since it increases our overall net worth, no matter the type of asset, and no matter how it is financed. This is one of the reasons why many people struggle with their finances. Let’s try to uncover why.
Not every possession should be considered an asset
This is especially the case for what has been acquired through debt. Imagine purchasing something that loses its value quickly, and doing so by contracting a loan. Not only will your possession lose its value fast, but your loan also requires you to pay extra interest (thus more than the initial book value of the possession). This is a fatal blow to your finances for two reasons. First of all, you are creating a gap in value, you end up paying much more than the remaining value of the possession as time goes on. Secondly, you are also creating a huge opportunity cost: you could have bought something that earns value instead. And with the value that was generated from it, you could have bought another asset, and another one, etc.
The best example to illustrate this is the one of a home. If you buy a house just to live in it—without renting any part of it and thus generating income—you are simply moving cash out of your wallet to build equity. Most people argue that this is a good move for your finances. “I now have my own house”, they declare as soon as they have provided the downpayment and gotten the keys to the property. However, there are more conditions attached for the purchase to be considered a good investment. For instance, would you have earned more if you kept on renting and bought a rental property on the side? What if you repeated the process several times across the years? How big is your opportunity cost because of this one single loan purchase if it prevents you from taking out other mortgages? To most, these questions will not appear simply because they have always believed that buying is always better than renting. Also because most people only ever own one property at most, so it seems natural to buy the one in which we live.
When you purchase your own home—you build equity—and it is understandable that many people desire it. However, it might set you back for decades as far as wealth creation is concerned. That single purchase might prevent you from acquiring other assets that would have generated cash instead and fast-tracked your wealth creation possibilities. In the end, you are left with more of a psychological benefit than a financial one: the one of “owning”. I would argue that this is debatable as there are many perks with renting or at least waiting for the right purchase. It should also not be forgotten that until a mortgage is fully repaid—usually in over 20 years or more—the home is not fully yours. Ownership can often be a mirage for financial independence, especially when there are maintenance costs associated with operating the said “asset“.
The wealthy understand that they have to reduce their opportunity cost to the maximum in order to accumulate cash-flow positive assets down the line. Then they simply repeat the process. They understand that it is really hard to become wealthy if their main investment is a mortgage they would have to pay back for 30 years, one that does not bring financial relief before the loan is fully repaid. The rich have become masters at using debt to acquire so-called “cash-flow positive assets” that ensure their immediate growth. Debt, when used the right way—i.e. to buy cash-flow positive assets—allows them to enjoy two main perks. 1) Leverage and 2) tax deductions or credits.
Now consider that you are buying a car, even in exchange for cash. Do you consider that to be a good investment? Most will say “yes since I use it twice a day to go to work. I cannot do without it, I need it anyway. And besides, I don’t have interest in it so it’s a good deal.” However the need for a car—or an asset of any sort—is not in question here. Again, it’s about the fact that you are generating a huge opportunity cost. Have you been through all the alternatives? Leasing? Purchasing a used car, or a new but least expensive one? Is there another way? A company car maybe? Car-sharing with others? Buying a bike? Could that money have been put toward an investment that could have grown your wealth instead? Once you become aware of how huge your opportunity cost can be, you have no excuse not to go through all the possible alternatives in order to reduce it as much as possible. That is because you understand how it can hurt you.
Let’s try to go through some numbers to gauge the financial impact of our life choices.
- You manage to save 5000$ on a car purchase and choose to invest the difference for 30 years at 8% APY.
- You earn 200$ extra per month by choosing to rent your home and get a rental property instead. You choose to also invest those 200$ for 30 years at 8% APY.
Disclaimer: For the sake of simplicity, we will not assume another rental property purchase nor any other extra investments on the side. You would have to imagine how much that could become if you invested extra on the side, which is highly recommended. The most you can turn in your favour, the more benefits you will reap over time. A 100$ investment every month is substantial money in several decades. For this exercise’s purpose, we are only going to look at the above number in isolation.
After 30 years, this is how much the difference you have saved and invested is now worth:
- 5,000$ become 50,313$.
- 200$ invested on a monthly basis over 30 years—that is 72,000$ in total—become 298,086$.
The 77,000$ invested over 30 years have become 348,400$.
Adjusted for inflation (say 3% a year on average), as opposed to losing 46,122$, you would have generated 226,086$. (Your 77,000$ would only be worth 30,878$ after inflation if you had held the money in cash.) Imagine if you were able to invest more of your income and perhaps accumulate more rental properties? In 30 years, you would likely be a millionaire, perhaps a multimillionaire.
Because you still bought real estate—you simply chose to buy a rental property and rent your home instead of buying it—you will still be able to enjoy the often formidable growth that it could potentially sustain over years. For the sake of our example, we could say that real estate grows by 5% per year. That gain would thus not be foregone if you bought a rental property instead of your home.
In conclusion, we could have created a much more complex example where you were to acquire more assets over the 30-year period. However, for the sake of simplicity, this was enough to demonstrate that it is not sufficient to own something to call it a good investment. If they only draw money out of your wealth, then surely, you did not pick the best investment (the one that reduced your opportunity cost) and should not consider it as an investment at all.
What you should remember from this article is that it is only really worth considering something as an investment when it is cash-flow positive, when it creates wealth on an immediate basis. Utility, taxes and depreciation are factors that come into play, but if you can stick to buying things that generate cash, you will dramatically increase your chances to be wealthy down the line.
Could this be the change in mindset you need to thrive in personal finance?
With this, you have an insight on why it is so important to properly define what a “good investment” is and to always ask the right questions as you aim to grow wealth. Many people choose to go for the obvious purchase that is getting into debt for their home. They make the choice of psychological safety which often doesn’t actually decrease the amount of stress in their lives. Because of that, they miss out on optimised solutions.
Through his Rich Dad, Poor Dad book, Kiyosaki has raised a point for the whole world to understand. That knowledge—which is definitely counterintuitive for the masses—can set them on the right track for financial success on a personal level if they only manage to adapt their mindset. As you combine such knowledge with other top personal finance tactics, that is when you get traction, and everything falls in place.