A bit a personal finance

It’s the well-know book “Rich dad, poor dad” from Robert T. Kiyosaki which allowed me to radically change the way I see the personal finance. I highly recommend that reading to anyone willing to regain control of their finance.

Basic concepts introduction

In his book, the author presents the differences between the balance sheets and income statement of people categorized as poor, middle-class and rich. Those concepts will enable us to gain a clearer and more complete picture of the multiple ways to manage our personal finance.

In order to simplify those two accounting terms, let’s imagine the balance sheet as a picture of your wealth at a certain time.

• The assets represent the goods, properties, … that you own and generate cash.
• The liabilities, for their part, are the debts that you have and thus create an outflow of cash.

This approach is not precisely the way it is used in the accounting approach. However, this allows a better understanding.

Added to this balance sheet, we are going to find the income statement. The latter represents a summary of all the in-flow (income) and outflow (expense) of cash during a certain period.

Comparison and explanations

In the context of this comparison, we will analyze in the sequence the least favorable situation categorized as poor, the one of the middle class to finish with the most adequate configuration which is the rich. This graphical representation includes an arrow which represents the flow of cash.

Poor

We can immediately note the absence of certain element within the balance sheet. This category characterize with a vision tuned to the here-and-now. Indeed, if we follow the arrow, we notice that the salary represents the revenue. Once the salary received, a couple of costs come in deduction too the available amount such as the rent, the food, travel costs, clothes, etc. Once everything has been included, there generally remains little to no cash on the account.

Many of my colleagues were living that way. At the end of the month, the latter had nearly no cash available and had to pay attention to their expenses waiting to get paid. Living that way can certainly suit many people. Nevertheless, if you wish to ensure a better life quality, a better future, it is necessary to fulfill that balance sheet.

Middle class

In the middle class situation, we can observe the apparition of debts on the liabilities side of the balance sheet. Those debts, such as the mortgage credit, the credit for the car, etc. create an out-flow of money.

It’s important to point out that in the economic reality, the counterpart of such debts is, for example, a house or a car in the assets side. Those effectively belongs to us provided our repayment of the debt that we find in the liabilities. But for the good of the current exercise, we will not include those in the assets. As a matter of fact, those assets do not directly produce cash for the person to which they belong. The house is used as a home and do not create cash in-flows. In the same idea, the car is used but only creates an outflow of money.

There is still an improvement in the sense that the type “Middle class” will invest in property. The investment in a house is the first step, the car is often needed to go to work. As we can notice in the graph, the flow of cash, the expenses, will be done in a more adequate way. For example, instead of simply pay a rent, they pay in order to repay a mortgage credit of a property which after a couple decades would allow to avoid a cost. This is what distinguish the middle class from the rich in the sense that the latter will aim to, not only avoid some long term costs, but especially to ensure new cash in-flows, a supplement or even a replacement of the salary.

Rich

We finally reach the “rich” category. As previously explained, it differs by its capacity to generate passive or semi-passive income that could come in replacement of the wage. To create such passive income, it is needed to acquire some cash creating assets such as :

• Real Estates : Acquiring a real property will allow to generate cash and this from two different ways. Not only the acquired property can create money from the rent but it can also increase in value over time.
• Stocks : Acquiring shares of a company allows to obtain a part of the revenues of the company through dividends or a rise in the share value.
• …

That way, the cash generated by the salary will mainly be used to acquire such cash-generating properties which might replace this wage. As the author explains in his book “The riches don’t work for money, they let their money work for them”. I would like to quote Warren Buffet here when he says :

Do not save what is left after spending, but spend what is left after saving.

Warren Buffet