If you have ever read the classic Rich Dad, Poor Dad [1] you have seen Robert Kiyosaki assert that your home is not an asset but rather a liability (note: if you haven’t read this book, you should, it is a classic and helps establish the mindset required to become financially independent).   This is one of the more controversial, and misunderstood, assertions in the book. If you are like most people, you either dismissed that statement out of hand or argued to yourself that he clearly doesn’t know what he is talking about and moved on.

It took me a long time to understand the implications of that point – and while I am still learning more about it, I believe this is the critical insight to understanding the importance of passive income in your investments. The remainder of this article gives my interpretation of what Kiyosaki is trying to say (no, I haven’t talked to him about this personally J). If you have a different opinion, I would love to hear your thoughts – so send me an email at blog@mbc-rei.com.

When Kiyosaki is talking about an asset, he is focusing on what is often called an earning asset [2]. This is an investment that, when all costs are taken into account, provides a positive stream of income to the owner of the asset. That positive cash flow occurs without the asset being sold and, in a balance sheet, would be recorded on the income statement. Earning assets include cash flowing investment real estate and dividend paying stocks and bonds.

Unless you rent out part of it, your home does not generate positive income. In fact, it costs you money – on property taxes, insurance, maintenance, mortgage payments, etc. – every year. That makes it a liability from a cash flow perspective and would be recorded on the expense side of a balance sheet.

But wait, I can hear you arguing, I have equity in my home and it will be worth more when I sell it than I bought it for. That may, or may not, be true (home prices don’t always go up, ask anyone who bought a property in 2008). However, it is irrelevant based on the definition of an earning asset. That doesn’t mean that shouldn’t own your own home, or that you shouldn’t buy gold or silver or a non-dividend producing stock – which also don’t generate income streams. You may be paying less for your home than you would for rent. It is entirely possible to make money on your home (or stocks) using the buy low, sell high strategy. And gold and silver can be a great store of value, especially in an inflationary environment. So these can all be reasonable purchases. However, when you look to grow your net worth by buying these, you are looking for appreciation in your asset. Appreciation may or may not occur over the timeline you are considering, with the shorter the timeline the less likely that is to occur. More importantly, in order to realize your potential gain, you have to sell the asset at which point you no longer have it. Earning assets may also appreciate over time, but that isn’t their primary benefit.

Kiyosaki’s fundamental premise is that cash flow, not appreciation, is the key to wealth. That is why he repeatedly refers to balance sheets and how money moves differently for wealthy people (see his book Cashflow Quadrant [3] for more details). When you buy an asset that produces cash flow, you don’t need to sell it to pay your liabilities (like your mortgage or car payment), you can use the income stream it produces instead. That means you still have the asset and associated income stream even after you have paid off the liability. At that point, you can use the income stream for something else. He often talks about an example where he wanted to buy a new sports car, but instead of paying cash for the car or taking out a loan, he bought rental properties that would cover the cost of his car loan payment. Then, once the loan was paid off, he had the car (a liability, not an asset J) and the income from the rental properties could be used for something else. The rental properties may have also appreciated in value, but that is incidental since he didn’t sell them. By using income producing assets, he made his money do the work required to pay off the liability instead of having to spend his time to generate more money or sell an asset and reduce his overall net worth.

Having liabilities is not inherently bad. We all have them in some form or another. The key point being made in the book is to understand the difference between something that puts money into your pocket and something that takes it out, and how that ultimately affects your balance sheet. Then focus on buying things that generate money instead of things that that increase your cash outflow.

Because your house, unlike cash flowing investment real estate, takes money out of your pocket, it is a liability. And the advice to buy a more expensive house to increase your tax deductions just makes the outflow of cash larger. By increasing your liabilities, you must have more cash flow coming in to offset it. And, for most people, that means working more since they don’t have enough income from their assets to cover their expenses. This is the “rat race” that Kiyosaki often refers to – buying stuff that requires you to work more (ie sell your time for money) in order to pay it off. Even if your net worth ultimately increases, at least on paper, you will be stuck in your job because you have to keep working or your cash flow will go negative (which ultimately leads to selling off your assets under duress and potentially bankruptcy).

Instead of purchasing liabilities, by purchasing and keeping income generating assets, over time you eventually accumulate enough assets to cover all of your expenses and have the lifestyle you want. At that point, that you have the freedom to spend your time as you wish – you can exit the rat race as you no longer need to work for money.  From my perspective, that time freedom is the ultimate definition of success.

If you have any questions or comment about this post, please email them to me at blog@mbc-rei.com, I will reply to the questions that are straightforward and will turn the questions requiring more detailed answers into future blog posts.

 

[1] https://www.amazon.com/Rich-Dad-Poor-Teach-Middle/dp/1612681131

[2] https://www.investopedia.com/terms/e/earningassets.asp

[3] https://www.amazon.com/Rich-Dads-CASHFLOW-Quadrant-Financial/dp/1612680054

This article is my opinion only, it is not legal, tax, or financial advice. Always do your own research and due diligence. Always consult your lawyer for legal advice, CPA for tax advice, and financial advisor for financial advice.