6 Basic Rules of Investing

Understanding…and mastering the game of investing

When I was a young boy, my best friend Mike, the son of my rich dad, took up both the game of golf and investing. Both were games, in a sense, both were difficult to master, and both required understanding the rules of the game.

Fifteen years later, when we were both twenty-five years old, Mike was an expert at both golf and investing. I was just beginning to learn the rules.

I make this point because, regardless of how young or old you are, learning the basics of anything, is important. Most people take some kind of golf lessons to learn the basics before playing golf, but unfortunately, most people never learn the simple basics of investing before investing their hard-earned money.

The following are the 6 basics of investing taught to me by my rich dad:

Basic rule #1: Know what kind of income you’re working for

Most people think only of making money. They don’t realize that there are different kinds of money to work for. For years, rich dad drilled into Mike and me that there are three kinds of income:

  • Ordinary earned income: Generally earned from a job via a paycheck. It’s the highest-taxed income, and thus, the hardest to build wealth with.
  • Portfolio income: Generally derived from paper assets such as stocks, bonds, and mutual funds.
  • Passive income: Generally derived from real estate, royalties, and distributions. It is the lowest-taxed income, with many tax benefits, and is the easiest income to build wealth with.

Rich dad said, “If you want to be rich, work for passive income.”

Basic rule #2: Convert ordinary income into passive income

Most people start their life out by making ordinary earned income as an employee. 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.

To illustrate this, rich dad drew a simple diagram:

“That, in a nutshell,” said rich dad, “is all an investor is supposed to do. It’s as basic as it can get.”

Basic rule #3: The investor is the asset or liability

As we’ve discussed recently, 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!”

Basic rule #4: Be prepared

Most people try to predict what and when things will happen. But a true investor is prepared for anything to happen. “If you are not prepared with education, experience, or extra cash, a good opportunity will pass you by,” said rich dad.

Rich dad went on to say that it was most important not to predict what will happen but to instead focus on what you want, to keep your eyes open to what is happening, and to respond to opportunity. This is done through continual education and application.

Basic rule #5: Good deals attract money

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.

Basic rule #6: Learn to evaluate risk and reward

As you become a successful investor, you must learn to evaluate risk and reward. Rich dad used the example of a nephew building a burger stand.

“If you had a nephew with an idea for a burger stand, and he needed $25,000, would that be a good investment?”

“No,” I answered. “There is too much risk for too little reward.”

“Very good,” said rich dad, “but what if I told you that this nephew has been working for a major burger chain for the past 15 years, has been a vice-president of every important aspect in the business, and is ready to go out on his own and build a worldwide burger chain? And what if you could buy 5 percent of the company with a mere $25,000? Would that be of interest to you?”

“Yes,” I said. “Definitely because there is more reward for the same amount of risk.”

Learning and mastering the rules of investing takes a life-long investment in financial education. But these basics will get you started. Where you go from here is up to you.

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