CHAPTER THREE

Lesson Two: Why Teach Financial Literacy?

In 1990, my best friend, Mike, took over his father's empire and is, in fact, doing a better job than his dad did. We see
each other once or twice a year on the golf course. He and his wife are wealthier than you could imagine. Rich dad's
empire is in great hands, and Mike is now grooming his son to take his place, as his dad had groomed us.
In 1994, I retired at the age of 47, and my wife, Kim, was 37. Retirement does not mean not working. To my wife and me,
it means that barring unforeseen cataclysmic changes, we can work or not work, and our wealth grows automatically,
staying way ahead of inflation. I guess it means freedom. The assets are large enough to grow by themselves. It's like
planting a tree. You water it for years and then one day it doesn't need you anymore. It's roots have gone down deep
enough. Then, the tree provides shade for your enjoyment.
Mike chose to run the empire and I chose to retire.
Whenever I speak to groups of people, they often ask what I would recommend or what could they do? "How do they get
started?" "Is there a good book I would recommend?" " "What is the secret to success?"
I simply say to them what my rich dad said back to me when I was a little kid. "If you want to be rich, you need to be
financially literate."
That idea was drummed into my head every time we were together. As I said, my educated dad stressed the importance
of reading books, while my rich dad stressed the need to master financial literacy.
If you are going to build the Empire State Building, the first thing you need to do is dig a deep hole and pour a strong
foundation. If you are going to build a home in the suburbs, all you need to do is pour a 6-inch slab of concrete. Most
people, in their drive to get rich, are trying to build an Empire State Building on a 6-inch slab.
Our school system, having been created in the Agrarian Age, believes in homes with no foundation. Dirt floors are still
the rage. So kids graduate from school with virtually no financial foundation. One day, sleepless and deep in debt in
suburbia, living the American Dream, they decide that the answer to their financial problems is to find a way to get rich
quick.
Construction on the skyscraper begins. It goes up quickly, and soon, instead of the Empire State Building, we have the
Leaning Tower of Suburbia. The sleepless nights return.
As for Mike and me in our adult years, both of our choices were possible because we were taught to pour a strong
financial foundation when we were just kids.
Now, accounting is possibly the most boring subject in the world. It also could be the most confusing. But if you want to
be rich, long term, it could be the most important subject. The question is, how do you take a boring and confusing subject
and teach it to kids? The answer is, make it simple.
My rich dad poured a strong financial foundation for Mike and me. Since we were just kids, he created a simple way to
teach us. For years he only drew pictures and used words. Mike and I understood the simple drawings, the jargon, the
movement of money, and then in later years, rich dad began adding numbers.
Rule One. Most importantly You must know the difference between an asset and a liability, and buy assets. If you want to
be rich, this is all you need to know. It is Rule No. 1. It is the only rule. This may sound absurdly simple, but most people
have no idea how profound this rule is. Most people struggle financially because they do not know the difference between
an asset and a liability.
"Rich people acquire assets. The poor and middle class acquire liabilities, but they think they are assets"
When rich dad explained this to Mike and me, we thought he was kidding. Here we were, nearly teenagers and waiting for
the secret to getting rich, and this was his answer. It was so simple that we had to stop for a long time to think about it.
"If it's that simple, how come everyone is not rich?" I asked.
Rich dad smiled. "Because people do not know the difference between an asset and a liability."
I remember asking, "How could adults be so silly. If it is that simple, if it is that important, why would everyone not want to
find out?"
It took our rich dad only a few minutes to explain what assets and liabilities were.
To teach pre-teen boys, rich dad kept everything simple, using as many pictures as possible, as few words as possible,
and no numbers for years.
My rich dad simply drew a vertical box with a line through the middle, the top half was for income and the bottom half was
for expenses then underneath that box he drew another box horizontally , which he divided into a left half for assets and a
right half for liabilities, the income statement, often called the profit and loss statement, it measures income and
expenses, money in and money out. The second set of boxes is the balance sheet It is called that because it is supposed
to balance assets against liabilities. That relationship is vital to understand.
The primary cause of financial struggle is simply not knowing the difference between an asset and a liability. The cause of
the confusion is found in the definition of the two words. If you want a lesson in confusion, simply look up the words
"asset" and "liability" in the dictionary.
So my rich dad simply told two young boys, the following:
An asset is something that puts money in my pocket.
A liability is something that takes money out of my pocket.
This is really all you need to know. If you want to be rich, simply spend your life buying assets. If you want to be poor or
middle class, spend your life buying liabilities. It's not knowing the difference that causes most of the financial struggle in
the real world.
My rich dad then drew three arrows on his diagram, he explained, the arrow represents the flow of cash or cash flow
In 80 percent of most families, the financial story is a story of working hard in an effort to get ahead. It is not because they
don't make money. But because they spend their lives buying liabilities instead of assets.
The first arrow should be cash flow pattern of a poor person, or a young person still at home: The arrow goes into the
income box from the job or salary, it then continues into the expense box, expenses include taxes and all of the living
expenses, it goes out of the expense box and is gone. The second arrow rich dad drew represents the cash flow pattern
of a middle class person, the arrow flows from the job into the income box, it the flows into the liabilities box. Most middle
class people acquire many liabilities such as mortgage, a car loan and credit card debt. From the liabilities box, it flows to
the expense box, when the monthly payments are made for the liabilities as well as taxes and living expenses, from there
it flows out the expense box and is gone.
The third arrow is the pattern of a wealthy person, this arrow simply flows from the asset box into the income box, the
cash flow is not generated by a job or salary but by assets, remember assets are things that put money in your pockets,
additionally the rich have few expenses and liabilities, or if they do, those liabilities are more than covered by their assets.
Examples such as these are oversimplified. Everyone has living expenses, the need for food, shelter and clothing.
The diagrams rich dad drew, show the flow of cash through a poor, middle class or wealthy person's life. It is the cash flow
that tells the story. It is the story of how a person handles their money, what they do after they get the money in their
hand.
I cringe whenever I hear people ask me how to get rich quicker. Or how do they start? I often hear, "I'm in debt so I need
to make more money."
But more money will often not solve the problem; in fact, it may actually accelerate the problem.
Money often makes obvious our tragic human flaws. Money often puts a spotlight on what we do not know. That is why,
all too often, a person who comes into a sudden windfall of cash-let's say an inheritance, a pay raise or lottery winnings-
soon returns to the same financial mess, if not worse than the mess they were in before they received the money. Money
only accentuates the cash flow pattern running in your head. If your pattern is to spend everything you get, most likely an
increase in cash will just result in an increase in spending. Thus, the saying, "A fool and his money is one big party,"
Because students leave school without financial skills, millions of educated people pursue their profession successfully,
but later find themselves struggling financially. They work harder, but don't get ahead. What is missing from their
education is not how to make money, but how to spend money-what to do after you make it. It's called financial aptitude-
what you do with the money once you make it, how to keep people from taking it from you, how long you keep it, and how
hard that money works for you. Most people cannot tell why they struggle financially because they don't understand cash
flow. A person can be highly educated, professionally successful and financially illiterate. These people often work harder
than they need to because they learned how to work hard, but not how to have their money work for them.
The moving-picture show of hard-working people has a set pattern. Recently married, the happy, highly educated young
couple move in together, in one of their cramped rented apartments. Immediately, they realize that they are saving money
because two can live as cheaply as one.
The problem is, the apartment is cramped. They decide to save money to buy their dream home so they can have kids.
They now have two incomes, and they begin to focus on their careers.
Their incomes begin to increase.
As their incomes go up...their expenses go up as well. So there is little or no money to flow into the asset box, this means
the only income they get, comes from their jobs.
The No. 1 expense for most people is taxes. Many people think it's income tax, but for most Americans their highest tax is
Social Security. As an employee, it appears as if the Social Security tax combined with the Medicare tax rate is roughly
7.5 percent, but it's really 15 percent since the employer must match the Social Security amount. In essence, it is money
the employer cannot pay you. On top of that, you still have to pay income tax on the amount deducted from your wages
for Social Security tax, income you never receive because it went directly to Social Security through withholding. Then,
their liabilities go up.
This is best demonstrated by going back to the young couple. As a result of their incomes going up, they decide to go out
and buy the house of their dreams. Once in their house, they have a new tax, called property tax. Then, they buy a new
car, new furniture and new appliances to match their new house. All of a sudden, they wake up and their liabilities
column is full of mortgage debt and credit-card debt.