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If I Could Re-Write Rich Dad, Poor Dad

Posted by admin on January 8, 2008 in Investment Strategy

As a personal finance topic of debate, the whole “is your primary residence actually an asset” debate appears to have taken on a new life recently. The Financial Blogger is an example of the latest bloggers to comment on whether calculating your primary residence in net worth is, indeed, correct. I agree with his findings- you have to include your primary residence as part of your net worth calculation (as a complete side-note, I would recommend an interesting debate between Brip Blap and the Money Gardener on even the relevance of calculating net worth). On a liquidated basis, a primary residence, stripped of the fact it use to be your primary means of shelter, has value in the market regardless of whether it produced any cash flow during the time you owned it.

There are those who argue that a house is not an asset; some of these supporters cite the book Rich Dad, Poor Dad  as an authority on why a house is not an asset. Respectfully, these supporters are mixing apples and oranges. While attempting to prove a point, I sometimes wonder if the enduring legacy of the book Rich Dad, Poor Dad is to confuse a generation of investors on the difference between balance sheet items and statement of cash flows. Robert Kiyosaki, the c0-author of the book, does plead guilty to the fact he is not a writer by nature and his often clumsy attempts at getting across his point muddles the waters more than helps it. In Homer Simpson-esque fashion, I am going to take a new job for a day without any formal training and be an editor and re-word his thesis:
To begin with, Rich Dad, Poor Dad argues the following (this is a condensed version of his argument):  the difference between the rich and the poor is that the rich think of assets as those that produce income and a liability as anything that creates an expense. This is a very simple version of the book.

I do not argue for a second that positive cash flow is the key to all personal finance. If you have read my blog for any period of time, you know I like looking at two things in a business: cash on hand and cash generated from operating activities. You also may have picked up in some of my blogs about small business, I always talk about looking at cash and not sales.

Here’s the problem: an “asset” in an accounting sense is a balance sheet item (a balance sheet balances assets to liabilities). Cash flows go into the statement of cash flows. They are two different concepts in accounting and, by effectively removing the barrier between balance sheet analysis and cash flow analysis, it stands to reason in Kiyosaki’s world that you remove assets from the balance sheet that do not contribute to the statement of cash flows. This leads to the interesting phenomenon of not including a primary residence as an asset since it produces no cash flow. I am a supporter of technical accounting accuracy- keep the barriers between balance sheet and statement of cash flows. They measure different things but you should pay more attention to cash flows than balance sheet.

Thus, if I was the editor of Rich Dad, Poor Dad, I would rewrite the thesis as follows to be much clearer:

Do you want to know the difference between the rich and the poor? Despite what Hollywood would make you believe, the rich do not subscribe to the theory that “whoever dies with the most toys wins.” The rich do not accumulate for the sake of accumulating. Instead, the rich purchase assets that produce income- whether they be stocks, bonds or income-producing real estate. Do the rich own a lot of assets? Of course they do, but they own assets which are income producing. The poor buy assets but the wrong kind. They keep buying assets which produce no income or little income such as cars, big-screen televisions and time-shares in Mexico. The result is that the assets which the poor buys ends up owning them because they cannot produce cash from it. Worse still, the poor buy these assets by using debt. The assets of the poor don’t actually own the poor- their bank does!

What about a house? Many middle class people think their house is an asset. It is. But the difference between the rich and the poor is that the rich do not focus on how much their house is worth on the market and, instead, focus on how much cash flow they can produce from other assets they own. The poor focus on how much their house is worth on the market. Meanwhile, they own assets which produce no cash flow. What would you rather be- asset rich (a big house, fancy car, lots of electronics) but dependent on your job as the sole source of income (i.e. poor cash flow) or asset rich and cash flow rich because the assets you buy produce investment income for you?  Of course we all want to be asset rich and cash flow rich!

If you want to think like the rich, think about buying assets which produce cash on hand. Avoid assets which produce no cash or the value of the asset is based on subjective valuations which do not give you cash on hand until you sell the asset.  Good luck buying those cash flow producing assets!

I believe this restates the Rich Dad Poor Dad thesis without overly confusing the issue and putting the emphasis on producing cash flow rather than debating whether a house is an asset or not.

Anyone else care to be an amateur editor and take a crack at rewriting Rich Dad, Poor Dad?