Blog | Personal Finance

Rich Dad Fundamentals: The CASHFLOW Quadrant

Why the rich get richer and the poor are getting poorer

When I graduated from the prestigious U.S. Merchant Marine Academy in Kings Point, NY, I had offers to work in the shipping industry making more than $70k working only six months or so a year. In the 1970s, that was a lot of money—and a lot of freetime!

My poor dad, my natural father, who spent his whole life as an employee in the educational system of Hawaii, was proud and encouraged me to do it. To him there was no better path to security and success than a good job.

Instead of listening to my poor dad, I joined the Navy and went to Vietnam. In the Navy, I learned how to fly. After my time in the war, I had the opportunity to become a commercial pilot or again to work for the shipping industry. Now, two good jobs were in front of me. Again, my poor dad was proud.

And again, I went my own way. After talking with my rich dad, my best friend’s father who was a successful business owner and investor, I knew I didn’t want to be an employee my whole life. I wanted to be an entrepreneur and investor like him.

Rich dad was thrilled that I wanted to pursue this path and told me I needed to learn how to sell. So, I took a job at Xerox to learn how to sell. I needed that skill to achieve my goals. Once I could sell, I quit that job, started my own company, and started investing. I never looked back.

My poor dad simply couldn’t understand. For him, a good job was the most important thing you could attain. He had no category for turning down a steady, high-paying job in order to start your own business and invest.

Two categories of people

In order to understand my rich and my poor dad’s different reactions, you need to understand that there are two categories of people in the world, those who see the world through the left side of Rich Dad’s CASHFLOW Quadrant and those who see it through the right side.

For years, I’ve taught on the CASHFLOW Quadrant. For some of you, this will be a review. My hope is that for others, it will be the beginning of changing your mindset about money.

The CASHFLOW Quadrant is divided into four types of people, two in each category.

The left side of the CASHFLOW Quadrant

On the left side of the quadrant are Es and Ss. They pay the most in taxes and trade their time for money. And each has a different mindset.

E is for employee

At the end of the day, the most important thing for employees is security. My poor dad was an employee his entire life and he craved nothing more than security. That is why he could not understand why I would want to be a business owner and investor. To him, there was nothing riskier than that.

Because employees shy away from risk, they don’t see the need to learn about money or how it works. For them, education is about learning the skills needed to get a steady, high-paying job with great benefits. Thus, why my poor dad loved working for the State of Hawaii.

When employees need more money, they look for a higher-paying job.

S is for self-employed

People in the self-employed quadrant are not good employees and often have the attitude that no one can do it better than them. While they still like the idea of security, they have a larger tolerance for risk, and thus don’t mind working for themselves. In fact, they like it that way because they feel in control of their future.

People in the S quadrant are doctors, lawyers, dentists, accountants, and other service-based businesses and consultants. They have very high-standards for their work and because of this they have a hard time delegating to others. Again, they don’t like to hire employees because nobody does it better than them. As a result, they only make money when they are working. This means they don’t own a business, they own a job.

When self-employed people need more money, they look for more hours they can bill.

The right side of the CASHFLOW Quadrant

On the right side of the quadrant are Bs and Is. They pay the least in taxes and create or invest in assets that produce cash flow for them even when they’re sleeping.

B stands for Business Owner

Unlike those in the S Quadrant, business owners don’t own a job. They own a system or a product that makes money even when they aren’t working. Because they know they can’t be successful on their own, business owners look to hire people who specialize in skills needed for the business and hire those who have more talent and skill than them. They look to delegate as much as possible, not keep all the work for themselves. The best business owners know they could leave their company for a year and come back to find it still profitable and running better than they left it.

Business owners are often seen as risk takers, but from the perspective of a business owner, being an employee is riskiest because employees have no control. A business owner can make the decision to do layoffs or fire an employee, but no one can take the business away from the business owner. And when the economy takes a down-turn, the business owner has the most control to make the business work and survive.

When business owners need more money, they create a new product or create or acquire a new system that produces money.

I stands for Investor

Investors have the highest financial education of anyone in the CASHFLOW Quadrant. They are adept at finding assets that provide steady income in the form of cash flow and they often use other people’s money (OPM) to attain those assets. They then use income from those assets to acquire even more assets, growing their wealth through this velocity of money. They enjoy the most in tax breaks, don’t have to work at all if they desire, and don’t have to deal with managing employees. The richest people in the world are investors, and as a general principle 70% of their income comes from investments with the other 30% made up of wages.

When investors need more money, they look for an opportunity to acquire an asset that produces more passive income.

The cost of choosing security over freedom

The dividing line between many who struggle financially and those who are prospering is the line between the two sides of the CASHFLOW Quadrant.

As I’ve written before, the wages of the poor and the middle class have either held steady or shrunk over the last couple decades. Yet, those on the left side of the quadrant continue to think they are living in security while looking at those who own businesses and invest as risk takers.

The sad reality is that those who operate on the left side of the quadrant pay more in taxes and pay more in interest on debt for liabilities the more they make. It is a vicious cycle that keeps them feeling poor—what I call the Rat Race.

To understand why Es and Ss don’t get rich, you have to understand the difference in financial intelligence between the two.

What really makes you rich

When I ask most people, “What is it that makes someone rich?”, the answer I usually get is, “They make a lot of money.”

How much money you make does not make you rich. Rather, how much money you keep is what makes you rich.

Those on the right side of the CASHFLOW Quadrant pay the least in taxes, know how to use debt to make money, and hedge against inflation through their assets. They not only make more money than employees and self-employed, but they also definitely keep more money.

Those on the left side of the quadrant work for what is called earned income. It is the highest taxed income. They have little-to-no tax shelters. Those on the right side work for passive income, the least taxed income. They have many tax breaks in the tax code they can use to their advantage.

What’s holding you back from moving from the left quadrant to the right quadrant?

When I talk about moving from the left side of the CASHFLOW Quadrant to the right side, I often hear people say, I wish I could do that but it’s just not possible for me right now.

When I ask why, I get many different answers. But the theme that runs through them all is a fundamentally different mindset than those who operate on the right side of the quadrant.

For instance, I had a classmate from the Merchant Marine Academy who, like me, knew he didn't want to spend his life at sea. Rather than take a job with a ship after graduation, he went to law school. After three years, he graduated and took a job as a lawyer with a firm in private practice.

He was miserable. Though he was very successful in his profession, he was very unhappy with his work. Although he hated being a lawyer, he felt he had no other option than to keep at it because he had a family, kids, a mortgage, and bills to pay.

When I met him years later at a class reunion in New York, his bitterness was apparent in the way he talked. "All I do is sweep up behind rich guys like you. They pay me nothing. I hate what I do and who I work for."

"Why don't you do something else?" I asked.

"I can't afford to stop working," he said. "My first child is entering college."

Unfortunately, this man died of a heart attack before his daughter graduated. He had made a lot of money via his professional training, but he was emotionally angry, spiritually dead, and soon his body followed.

The mindset we are taught vs. the mindset we create

In my book, Why "A" Students Work for "C" Students, I talk about how every child has a genius in them—the one thing that lights up their life, motivates them, feeds their dreams, and challenges them. Unfortunately, school often does not recognize the genius in our children. And even more, school may even crush a child's genius.

This is because our educational system teaches one way of doing things—one mindset—that of the left side of the CASHFLOW Quadrant.

Our kids are told to go to school and get a good job. The problem, of course, is that they don't know what they really want to do and are called to do yet when they hear this, so our kids chase down paths that are prescribed for them, like doctor, lawyer, teacher, and more—jobs in the E or S quadrant of the CASHFLOW quadrant.

As they grow older, they are trapped in the rat race. Because they go to college and take on debt, they have to get a high paying job. Soon they buy a house, and because of that debt, they must keep working. Then other expenses like kids, health care, and more paint them into a corner. Before you know it, the dreams of youth are gone, replaced with what for some is a miserable reality of work that is not soul-giving.

The school system does not help us discover our genius. And in the process of chasing other peoples' dreams for our lives, we often lose our genius. When that happens, we are crushed...and we become like my lawyer friend who made a lot of money but was miserable and died young from the stress of his work and responsibilities.

In my book, The CASHFLOW Quadrant, I talked about the importance of finding our own path—of changing your mindset about life and money. It's not easy. We can often get lost in the process, and it's not always simple to find our way back. But finding our path—releasing our inner genius, and the genius of our children—is essential to a happy life.

How about you? How is your path going? Do you find yourself making these types of statements?

• "I love what I do, but I wish I could make more money."

• "I can't wait for the weekend."

• "I want to do my own thing."

• "Is it quitting time yet?"

If so, it may be time to change your mindset and find a new path. To discover your life's purpose, why you were given this gift called life, and what the gift is that you should give back to the world.

Moving from the left quadrant to the right quadrant

If you want to move from to the right side of Rich Dad’s CASHFLOW Quadrant, here’s some help on changing your mindset.

A while back a study was conducted that showed the mindset of those who moved from poverty into wealth. Three things were seen to be a determining factor:

1. They maintained a long-term vision and plan

2. They believed in delayed gratification

3. They used the power of compounding in their favor

They also looked at those who were wealthy that became poor. These were the three factors that came into play:

1. They had short-term vision

2. They had a desire for instant gratification

3. They abused the power of compounding

Very simply, the path to the right side of the quadrant starts with thinking in terms of acquiring assets that produce passive income rather than living in a pattern of paycheck to paycheck. Start small, have patience, and watch as your wealth grows over time.

Very simply, the path to the right side of the quadrant starts with thinking in terms of acquiring assets that produce passive income rather than living in a pattern of paycheck to paycheck. Start small, have patience, and watch as your wealth grows over time.