Introduction
American capitalism is one big game. There are winners (AKA the rich) and losers (AKA the poor) and a whole lot of folks continually circling the board in the rat race of life. It is to these latter two groups that this essay is addressed. If you’re already rich, you can hardly care what a middle-class yokel like me will say on the subject of wealth. This may be a worthwhile exploration for the rest of us, though, and I dare say that if you’re not already rich, you have nothing to lose by giving a read.
We’ll start with this mini-bombshell: The prevailing wisdom on what it means to be financially wealthy is wrong. If you’ve read even a couple of the mainstream books on the subject, you know that wealth is usually calculated by examining that something called "net worth." I’m here to tell you that this is a remarkably backward way to determine wealth and to propose a conceptually superior alternative which will leave you with no doubt as to your financial situation as it relates to being wealthy. Although it’s up to you to do what is required, I’ll even tell you how to become rich if you so choose.
First, all I need is for everybody to send me a dollar. (Note to FBI: Just kidding.)
Before we begin, you must have a firm handle on your income and expense numbers (preferably through a program like Intuit’s Quicken). If you can’t generate an Income Statement that breaks down what you’re making (and from where) and what you’re spending (and where), we can’t do business. You can read up on the rest how things should be done, but without these numbers at your disposal, you can’t play the game. So unless you’re calculating all this by hand, if you want to move down the road to financial freedom you must take the advice I’ve been giving for years: Buy Quicken and use it.
Beyond that, our discussion starts with definitions. Income and Expense are obvious enough, but I will note that there are different types of income and there are different types of expenses. More on both of those later. The terms we need to ponder right now are these: Wealth, Asset, and Liability.
Wealth
In a practical sense, what does it mean to be financially wealthy? Many people think it means making a lot of money. That’s incorrect. Plenty of very high wage earners are out there, nose to the grindstone, spending just as much if not more money than they make. Let’s say that Mr. X works 60 hours a week and makes $200,000 a year. A good salary by most measures, but Mr. X is on the road to bankruptcy court if he spends $250,000, isn’t he? Because income is not the full equation when it comes to figuring wealth.
Expense is a vital component, and as numerous financial gurus have said ad nauseum, you must live within your means if you ever want to get ahead. That’s not an earth-shaking revelation, but it’s true, and it’s stunning how many people continually mess up on it. Here’s a simple test: If you’re not paying off your credit card balance every month, you’re blowing it. Sure, there are occasionally extraordinary circumstances that necessitate carrying a balance. They’re also darn rare, hence the term "extraordinary." So learn to live within your means, or you might as well stop reading right now and go watch an old Charlie’s Angels rerun; this article and that show will be of equal assistance in making you rich, and frankly that means neither will succeed.
If you can make that commitment to living within your income, where does that leave us so far as defining wealth? If we look back at our beloved Mr. X and we equalize his income and expenses for our hypothetical example, have we achieved a picture of wealth? In other words, Mr. X works his 60 hours a week, makes $200,000, and spends $200,000. Is he living the good life, or is he a poor sap to be pitied? In truth, it probably depends on how much he likes his job, but regardless, would we now consider Mr. X to be rich? Is our picture of wealth to work like a dog and spend lots of money? I don’t think so, but if it is for you, well, than by all means knock yourself out. American capitalism loves you productive types, so you’re our boy.
Most of us, though, conceive of wealth for ourselves differently. Wealth means working if we want, when we want, how we want. It means not needing a paycheck. It means a removal of the financial fear inherent in working for someone else (or for ourselves). It means having the control and the power to live the life we want to live. It means dreaming the dreams.
Wealth, then, has everything to do with income versus expense because if we define wealth as above, the key to achieving it is to have the income to meet or exceed expenses without having to work for it. Don’t miss that last bit. It’s crucial.
I’m not saying that you can’t enjoy your job or that your work can’t be pleasurable. Don’t get embroiled in the semantics of whether a job is so fun that it seems like play. If you’re in a job you love, much of it should seem like play. But it’s still employment—a necessary thing to pay the bills and to have a reasonable standard of living. Being wealthy doesn’t mean you don’t have a job that you love; it means you don’t have to have a job if you don’t want it.
It’s worth the reminder that here I’m talking about monetary wealth and that there is also wealth of a non-financial nature. Of the two, believe you me that the non-financial kind is infinitely the more valuable. At the end of the day, money is only money, and as I’ll explain in a bit, that’s illusionary anyway. Here, when I say "wealth" or "rich" I’m referring to money. Spiritual enlightenment is outside the scope of this article!
So wealth: Having the income to meet or to exceed expenses without having to work for it. It’s an important definition in our quest to understand how things work, because if we don’t "start with the end in mind," as Stephen Covey says in his Seven Habits books, than we risk not knowing what it is we’re trying to achieve. When that happens, it’s usually harder to be a success.
Assets and Liabilities
Now a huge number of people have thought an awful lot about wealth through the ages, making it surprising that today, in the richest society the world has ever known, financial gurus are spouting off about ideas that have almost no relation to wealth as we’ve just defined it. I say this because, interestingly, the traditional measure of wealth is "net worth" and that is calculated based on assets and liabilities not income or expense. This is a fundamental error on the part of most financial professionals and by extension the people who believe what they preach. Net worth is not a good yardstick of wealth, which is to say that just about everybody is getting this wrong. But never mind that because it gets worse: They’ve also blown it on the components which make up net worth—that’s right, they’ve misidentified assets and liabilities.
Loosely stated, the conventional wisdom defines "asset" and "liability" as follows: An asset is something that has value, and a liability is something that has a value you owe. By taking a person’s assets and subtracting their liabilities, we arrive at their "net worth," a term which as I’ve noted is only slightly more useful or grounded in reality than Mary Poppins. That’s because "value"—what something is worth—is an inherently subjective determination.
Fact is that almost nothing has an inherent financial value, and that’s because we’re all in this very necessary mass delusion together. It’s one that says I will give you this good or service for money because the fellow down the road will trade his good or service to me for that money. At the end of the day, a dollar is worth what I say it is worth inasmuch as you agree with me. Otherwise it’s just a piece of paper with green ink.
This understanding is the driving force behind the world’s economies, and the second people start foisting off the blinders and saying, "Hey, all you gave me for my good or service is a piece of paper!" is the second everything goes to hell in a hand-basket. We need this subjective collective illusion, and we need it so badly that it will never go away. Given the alternative of financial chaos and political anarchy, I’m more than happy to accept your US government-issued currency for any debt you owe, and I’ll bet you feel the same way.
But the subjective nature of "value" is what makes it a poor term for use in definitions, particularly those as important as asset and liability. The first great insight of Robert T. Kiyosaki’s Rich Dad, Poor Dad is that assets and liabilities must be redefined using simpler definitions which should apply directly to the creation of wealth (which is, after all, the point). In other words, despite what financial professionals the world over tell you, an asset is not something that "has value" and a liability is not something that "has value that you owe." According to Kiyosaki, an asset makes money for you and a liability causes you to spend money. Put another way, an asset gives you income and a liability gives you an expense.
Because Kiyosaki’s definition of "asset" ties back into the notion of wealth, assets must also be things that do not require your working for them. So excluded are things like education, job skills, intelligence, etc. To be sure, these are all great things to have, but they require your work in order for you to make money from them, and that runs counter to our definition of wealth. Specifically, then, Kiyosako says that assets are absentee-owner businesses, stocks, bonds, mutual funds, income-generating real estate, notes (IOUs), royalties from intellectual property (books, music, software, etc.), and "anything else that has value, produces income or appreciates and has a ready market" (89).
That excludes an awful lot, including some things traditionally defined as assets. For example, if you’ve not immediately grasped the implications of these notions, try this one on for size: Under these definitions, your house is not an asset but a liability! Now a house is a pretty excellent liability to have, especially versus the alternatives of renting or being homeless. Given that you’ve got to live somewhere and that there are some sweet tax advantages to boot, why not own the place? But make no mistake: Your house is a dumping ground for cash that pays you nothing in return (unless it’s an investment or a rental property). A primary residence is only an asset if you sell it, but then you’ll be in the position of needing another, typically more expensive, home, and the liability factor kicks in all over again. Despite this, the plus side of home ownership is that when you eventually pay off the mortgage, you’ll have eliminated a major monthly expense. So don’t get me wrong: Owning a house is a great thing. We just need to understand it for what it is in terms of wealth, and that’s a financial liability not an asset.
In fact, so far as spotting liabilities goes, it seems like the world is your oyster. Darn near everything is a liability if it doesn’t bring you income: Cars, boats, guitars, and so on. Anything you’re tying up cash in where it’s not paying you back (or going to pay you back) is a liability. Again, a great many liabilities are utterly necessary liabilities, and I’m not recommending that, for example, you go without a car if you need one. All I’m saying is that we must properly conceive of that which we spend our money on; otherwise we’ll never get ahead.
Getting Rich and the Wealth Percentage
By now you may have figured out for yourself the simple and most profound truth of Kiyosaki’s book: Rich people buy assets, and poor and middle-class people buy liabilities. If you want to be wealthy, buy assets. That’s the secret to winning at American capitalism in a nutshell. It’s so easy that a third-grader could grasp the concept, yet most of America (myself included) has not effectively put it into practice. It blows the mind if you think about it (so try not to).
Now buying some liabilities is unavoidable, and there are any number of them which make life a whole lot of fun. I would tell you that spending $2,000 on a music keyboard has improved my life. But it’s also $2,000 that had I spent on an asset, could have safely returned me at least $150 annually without me working for a dime of it. I might still believe that the keyboard was worth it (heck yeah!), but who couldn’t use an extra $150 a year, every year, ‘til death do you part, without doing any work for it? The rich buy assets; the rest of us buy liabilities.
Having rightly disparaged next-to-meaningless net worth statement as a bungled method of determining financial success, I will now propose another, superior means of illuminating your financial condition. I call it the "Wealth Percentage." It’s not hard to figure, but you must have your Income Statement’s numbers available, or you’re out of luck.
All you do to find your Wealth Percentage is to simply take your assets and divide them by your expenses. The resulting Wealth Percentage will tell you exactly how close or far away you are from being wealthy, because once your assets cover your expenses (which sounds vaguely naughty), that’s it. Game over, man. You win. You’re rich.
What are your assets specifically? For me, it’s interest from savings and checking accounts and dividends from stocks and mutual funds. We also had a little rental income last year when my brother stayed with us. That asset total was divided by our annual expenses and there we have it, our Wealth Percentage.
As a rule, do not include retirement assets in your Wealth Percentage when making this calculation unless you are eligible to access those funds (usually meaning you’re 59.5 or older). You can also run the numbers with the retirement assets included, but that will only tell you if you’ll be rich when you hit 59.5. You will need to run the numbers with retirement funds included anyway once you approach retirement because that’s the only way you’ll be able to determine if you have sufficient funds on which to live, but until then I think they should be kept separate.
Having said all the above, I’ve calc’ed these numbers for myself, and I’m here to tell you that it’s not pretty. Up until recently I considered myself financially astute, but this Wealth Percentage thing can be powerfully depressing stuff. True to my Scottish heritage, I am one frugal dude, but for my own situation there is not one year in the last seven where our wealth percentage was at or above 3 percent. Optimistically stated, I have much room for growth, and if you’re like the vast majority of Americans, you do too. But understanding, as they say, is the first step.
Review
- Buy and use Quicken.
- Live within your means.
- "Value" is illusionary
- An asset gives you income, a liability give you an expense
- Assets are: stocks, mutual funds, bonds, IOUs, investment real estate, royalties from intellectual property, or anything else that generates income without your active participation
- Rich people buy assets, not liabilities
- Forget Net worth. Use the Wealth Percentage (Assets divided by Expenses). Get that to 100 percent and you win.
