Free Money: How the rich use investing to generate wealth

Free Money: How the rich use investing to generate wealth

Growing wealth by focusing on Return on Investment (ROI) and increasing financial intelligence

In 1974, Ray Kroc, the founder of McDonald’s, was asked to speak to the MBA class at University of Texas at Austin. My friend was a student in that class. After a powerful and inspiring talk, the class adjourned and the students asked Ray if he would join them at their favorite hangout to have a few beers. Ray graciously accepted.

“What business am I in?” Ray asked, once the group all had their beers in hand. No one answered, so Ray asked the question again. "What business do you think I am in?”

The students laughed, and finally someone said, “Ray, who in the world doesn't know that you’re in the hamburger business.”

Ray chuckled. “That is what I thought you would say.” He paused and then quickly said, “Ladies and gentlemen, I’m not in the hamburger business. My business is real estate.”

Ray knew that his primary business focus was to sell hamburger franchises, but he never lost sight of the location of each franchise. He knew that the real estate and its location was the most significant factor in the success of each franchise. Basically, the person that bought the franchise was also paying for the land under the franchise for Ray Kroc’s organization.

Today, McDonald’s is one of the largest owners of real estate in the world, owning some of the most valuable intersections and street corners in the world. And the amazing thing is McDonald's gets all this real estate for free. Their franchises pay for it.

Free money starts with financial education

In the world of the asset column, getting something for nothing is vital to building lasting wealth. Sophisticated investors first ask: "How fast do I get my money back?" They also want to know what they get for free, also called a "piece of the action." That is why ROI, or return on investment, is so important.

For example, I found a small condominium that was in foreclosure a few blocks from where I lived. The bank wanted $60,000, and I submitted a bid for $50,000. The bank accepted my bid because they knew I was serious—I included a $50,000 cashier's check with the bid.

Most investors would say, "Aren't you tying up too much cash? Why not get a loan?" The answer is, "Not in this case."

My investment company uses this condominium as a vacation rental in the winter months when the "snowbirds" come to Arizona. It rents for $2,500 a month for four months of the year. During the off-season, it rents for $1,000 a month. After three years, I had my initial investment back. That was years ago. Today, I get money each month in my pocket and the money I spent to buy the condominium has been returned many times over. That’s a great ROI. In fact, now it’s infinite returns—or as I like to call it, printing money legally.

When McDonald’s franchises pay for their real estate, that is an example of “piece of the action”. They sell their intellectual property and brand to a franchise owner and in return they get income from the operations plus the land costs covered by the operations. Something for nothing is built right into the deal.

Isn't investing your money risky?

When I talk about the rich getting something for nothing through smart investing, I'm always asked, "Isn't that risky?" The answer is yes and no.

My poor dad often said, "Investing is risky." And for him it would be. He had a low financial IQ. As my rich dad often said, "Being financially uneducated is risky."

Most people know they should invest. The problem is that most people, like my poor dad, believe that investing is risky. The reality is that it's not—if you are financially educated, have experience, and have good guidance.

In today's economy, it's much more risky to rely on your employer for your well being than it is to become financially educated and to invest your money wisely. It's also risky to put your money in the bank and collect interest that barely covers inflation...and if inflation really takes off, you'll actually lose money. As many people learned over the last decade, it's risky to consider your personal home as your primary investment. And it's risky to put all your hope in a broker and a 401(k) for your retirement investments.

Today, if you want to be financially secure and free, you must be financially educated and learn to invest well.

The consequences of not learning to invest

Learning to invest is important because it's the key to financial freedom. Five things happen to those who don't know how to invest, who do not invest, and who invest poorly.

  1. They work hard all their lives

  2. They worry about money all their lives

  3. They depend on others, such as family, a company pension, or the government to take care of them

  4. The boundaries of their lives are defined by money

  5. They don't know what true freedom is

Investing is true freedom

My rich dad said, "You will never know true freedom until you achieve financial freedom." By this he meant that learning to invest is more important than learning a profession.

Unfortunately, learning a profession is what most education in our schools is built to do. Our schools are good at training employees but not investors who understand how money works. The result is an army of people who are afraid of money and investing, and who, for their living, rely on those who understand money and investing, like their employer or their landlord. For them investing truly is risky.

Investing well means making money work for you

Rich dad said, "When you learn a profession, let's say to be a doctor, you learn how to work for money. Learning to invest is learning how to have money work for you.”

My poor dad didn't know how to make money work for him. He spent his whole life working for money. He was a good man and a hard worker, but he struggled financially all his life. If he had been my only example on how money works, I would have grown up to be like him. Thankfully, my best friend's dad, my rich dad, taught me different things about money and investing.

One way he did this was through the game Monopoly. Over and over again, he'd say, "One of the great formulas for wealth is found in this game: four green houses, one red hotel."

Monopoly is a cash flow game. For example, having one green house on a property you own could make you $10 when someone lands on it. Then, two houses could make you $20. Three could make you $30. And a hotel could make you $50. Basically, more green houses and red hotels means more cash flow. It’s a simple game, but an important lesson.

The rich know investing is the key to building wealth

My rich dad played Monopoly in real life, and he often took his son and me to see his real life houses and hotels. Watching my rich dad, I learned many valuable lessons about investing, some of which are:

  1. Investing is not risky

  2. Investing is fun

  3. Investing can make you very, very rich

  4. Investing can set you free from the struggle of earning for a living and worrying about money

In other words, if you are financially educated, you can build a pipeline of cash flow for life by investing—a pipeline that produces cash in good times and bad times, in markets that both boom and bust.

The rich eliminate risk by investing in the fundamentals

One of the biggest mistakes I see average Joe investors make—those who are not financially educated—is that they fall for investment schemes that are truly risky.

For example, in 1986, the U.S. government changed the rules for investors with the passage of the Tax Reform Act. Literally billions of dollars were lost. The investors who lost the most were speculators who had purchased high-priced real estate. They made their purchases with the assumption that the price of real estate would go up and the government would always give them a tax break for their losses.

In other words, the government was subsidizing the difference between the rental income and the higher rental expenses. After 1986, that all stopped.

After the rules were changed, the stock market crashed, savings-and-loan institutions went broke, and a huge transfer of wealth occurred between 1987 and 1995 as professional investors in the I quadrant scooped up the remains of poor investment decisions by those in the S quadrant, high-income earners like doctors, lawyers, engineers, accountants, and architects.

The rich don’t rely on others to make the rules

The reality is that governments can and will change the rules. Some people refuse to accept this reality. In a few countries today, the government still has laws that allow investors to “negatively gear” their investment real estate. In other words, you are encouraged to lose money on your rental real estate with the idea of gaining a tax break from the government.

I often hear howls of protest when I tell people in those countries that their governments could change the laws, just like they did in the U.S. I just shake my head. They don’t realize how painful the law change was to millions of investors.

The point is why subject yourself to the risk? Why not find a property or investment that makes money? Anybody can find one that loses money. It takes skill to find investments that make money.

The idea behind investing is to make money, not to lose it. The best part is that if you know what you’re doing, you can still gain many tax breaks and make money.

Sadly, many people don’t want to take the time and effort it requires to find such deals. Unfortunately, that mindset can be costly.

Even the rich lose money...but they make more in the long run

The truth is that I have lost money on many occasions, but I only play with money I can afford to lose. And I never go into an investment to intentionally lose money.

I would say, on an average of 10 investments, I hit a home run with two or three, while five or six do nothing, and I lose on two or three. But I limit my losses to only the investment I have in the deal at the time—money I can afford to lose.

If you don't like any risk, you're better off putting your money in the bank for long-term savings. It's better than nothing, though you make next to nothing. It takes a long time to get your money back, and you generally don't get anything free with it.

Appropriate risk + financial intelligence = financial freedom

On every one of my investments, there must be an upside, something for free—like a condominium, a mini-storage, a piece of free land, a house, stock shares, or an office building. Getting "a piece of the action," something for free, is essential to attaining financial freedom. I also look for limited or low-risk ideas. I only want to lose the money I'm willing to lose, not a penny more.

Wise investors look for more than just ROI. They look at the assets they get for free once they get their money back. That is financial intelligence, and that is why the rich get more free things than the poor.

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Original publish date: February 26, 2013