Liabilities
To confront the traditional definition of a liability, most accounting professionals will tell you that a liability is “an obligation to pay an amount you owe to creditors, be it an individual or an organization.”
Rich Dad defines a liability as something that takes money out of your pocket.
You can see the dilemma. Most people (and bankers) would consider their Mercedes an asset because it has value. However, I would list the Mercedes as a liability because it takes money out of your pocket every month.
“But it’s paid for,” you contest. The car loan may be paid for, but what about gasoline, maintenance, repairs, and insurance?
The biggest point of confusion I come across with people is when we say your house is not an asset. When I released Rich Dad Poor Dad, we received a lot of flack for that, especially when times were booming and people were taking loans out against their homes. It wasn’t until the real estate market crashed that people found out the owed more on their house than it was worth that they realized their home was not an asset.
That is why understanding your balance sheet is so important.
People call their liabilities, assets, and vice versa. When the economy turned, many people were faced with that harsh reality.
Simply put, if all you own is liabilities (and that includes your house since it takes money out of your pocket each month), then you will have a hard time getting rich, even if you balance your budget.
If, however, you have assets that produce cash flow each month, in addition to your other sources of income, you will have a much easier time getting rich.
The reason Kim and I paid ourselves first is because we needed that money to purchase assets that provided more and more passive income each month. We then used that income to purchase our liabilities—not our earned income from salaries. That is the simple way we budgeted to get rich, and it is a very different approach than other financial advice.
If you want to use the Rich Dad financial statement for your own budget planning, you can download it here.
B) Why savers are losers in the Rich Dad philosophy
Yes, you read that correctly. I believe that savers are losers. Not personally, but financially.
This may be confusing because I just covered the three piggy banks philosophy where I advocated for saving 10% of your income. However, as I wrote, “This account is a cushion for unforeseen emergencies or special opportunities that improve your life.” It is not something to be relied on for financial security or retirement. It is a last stop gap liquid account only.
Most financial “experts” advise people to save as their primary means of retirement. Saving comes in many forms. You can save money in a savings account with a minimal interest return, put your money into a 401(k) with the hope of some market gains, or put a big portion of your liquidity into your personal home.
Regardless, most financial advisors are big proponents of compounding interest, whereby each year the interest paid on your money includes the previous interest you made before. It is powerful with the right circumstance, mainly high interest rates and frequent compounding. However, most people have low interest rates or infrequent compounding.
Also, most people are not aware of compounding inflation. This simply means that over the same time your savings grows, the cost of buying goods grows as well. Essentially, you may have more dollars from saving, but the buying power of those dollars is less—a losing situation. You need to make money at a much faster rate than inflation to be rich and retire comfortably.
So, by saying ‘savers are losers’, I do not mean all savers. I mean a certain type of saver. That is, those whose primary financial activity is saving, hoping it will get them rich or prepare them for retirement.
To understand this, it is important to understand another Rich Dad personal finance essential: how to leverage assets to afford your liabilities.
B.i) Clarifying the difference between assets and liabilities
Many years ago, Kim wanted a giant 60-foot sailboat. We didn’t have the money for it, and we knew it was a huge liability. Rather than simply save for the boat, as many people would do, we wanted to find a more creative and financially intelligent way to afford it.
So, Kim did some research, found out how to contract the boat with a charter company, and the income from the charters covered our liability in the boat. We got to own a luxury liability, and it also became an asset for us. That is winning at money. Saving and then buying is not.
B.ii) Cash flow and capital gains
The second Rich Dad personal finance essential to understand in regards to why savers are losers is the difference between cash flow and capital gains.
As we mentioned in the previous section on budgeting, cash flow is income that comes without you working for it from an asset like an investment property, a business, a product like a book, etc. It is called passive income, and it is the lowest taxed income; it is steady and reliable.
Capital gains is income that comes based on the relative price of something going up. You do not recognize a capital gain unless you sell something, and only then does it put money in your pocket—if you were lucky enough to sell at a profit. Capital gains can be taxed very high. I don’t dislike capital gains, but they are more like frosting on the cake. If I earn them, I’m delighted, but I don’t invest for them.
B.iii) Why investors are the real winners in personal finance
I’ve said to the dismay of many personal finance experts that your house is not an asset. For these so-called experts, a house is considered your biggest asset. This is because they define an asset differently than we do at Rich Dad.
Remember, our simple definition is if it puts money in your pocket, it’s an asset. If it takes money out, it’s a liability.
Your personal home is a liability because it takes money out of your pocket. Only if you sell it for a profit does it produce capital gains, again, if you’re lucky.
With an investment property, however, you can get income each month in the form of rent, depreciation each year that reduces your tax liability, and all maintenance costs are tax deductible. That is the power of an investment vs. saving, which owning a house is basically a form of saving, albeit with more risk.
Not only that, I can refinance an investment property to remove the equity cash free and deploy it into even more investments in assets. That is a concept called the velocity of money, and it is how to become rich in today’s economy, which rewards smart users of debt (investors) and punishes savers of money.
Your first step towards financial freedom
So far I’ve explained how achieving financial freedom all begins with knowing where you are. Completing a personal financial statement is the first step of discovery. Understanding the differences between assets and liabilities, cash flow and capital gains, and why savers are losers, conclude the first part of our personal finance guide. Be sure to check out part two of our plan when we help you understand that all debt isn’t created equal, how taxes can make you rich, and why the old rules of money won’t help you retire happily ever after.