I have been trying to build my financial literacy for many years, starting about 15 years ago. It’s frustrating that these things are rarely covered in schools, and a lot of families don’t discuss financial matters. My parents raised me with some basic financial guidelines, but we never got too deep into matters to understand better how money works. A few years after I’d graduated college, my father emailed my siblings and me to recommend The Only Investment Guide You’ll Ever Need by Andrew Tobias, which got me started on this path to wanting to know more. About 7 years ago, I started listening to the Stacking Benjamins podcast, which is a laid-back but in-depth show on all aspects of financial literacy. They often refer to Robert Kiyosaki‘s book, Rich Dad, Poor Dad, which I recently started reading.
Kiyosaki also bemoans the lack of financial literacy education in mainstream schools, and his whole premise starts with the fact that most families, like his own, don’t discuss these matters. He speaks of a mentor, his friend’s father, who took him under his wing, and much of the book is comprised of conversations between them. The structure is a little tiresome: in the 18th century, Diderot was the master of using dialogue to lay bare dichotomous arguments, but when you go back and read him now, it’s a little bit… much. But, it does move the reader quickly through the book.
I’m only through chapter 3 at this point, but already I can see how his perspective will change the way I look at my overall financial health. He contends that “net worth”, although the standard measure of financial health, is a misleading way to consider your individual wealth. Net worth is calculated by adding up the common value of everything you own—bank accounts; investments, including retirement funds; your home, and everything in it; vehicles; etc.—and then subtracting everything you owe—mortgage, personal loans, student loans, consumer debt like credit card balances; etc. Assets minus liabilities yields net worth. Kiyosaki points out that in times of hardship like 2008 (I’m reading the 20-year anniversary edition of the book first published in 1997), those assets might not get you the value you’ve been counting on. If I have to sell off my expensive luxury items, but no one is looking to spend money on them, then I either can’t raise that money or I sell the asset off for less than it’s worth. This is a good point and well made, but I’ve never put too much stock in net worth anyway. It’s only interesting as a benchmark, a way to get my hands around “how I’m doing,” but it can fluctuate without changing my life, or even without me noticing. If I go on a shopping spree and add to my credit card debt, my net worth might not change much but my financial standing sure will—and I’ll know it if I need to apply for a loan at that time! If the stock market starts booming and the investments in my IRA do well, my net worth will increase, but I may not even know because my paycheck and other sources of income probably won’t change much.
Kiyosaki differentiates between judging if you’re rich and evaluating how much wealth you have. His key is to put aside net worth for cash flow. When I first encountered this term in a personal finance app, I took it to refer to the amount of money earned minus the amount of money spent. I could see how that would be useful for a business to know and track, but for an individual it didn’t seem too different from net worth. For me, it seemed to undervalue saving, and I didn’t pursue it. Kiyosaki reframes this however, by saying that cash flow should consider all means by which value is produced and subtracting everything you spend money on. In this light, the items which may be considered assets contributing to a higher net worth are often seen to be liabilities. My house costs money to own, maintain, and operate; my car lost value as soon as I drove it off the lot, and it costs money on a daily basis. By accounting for these expenses by tracking how they draw off of my regular income earnings, I can gain a better sense of what decisions I can afford. For example, if I see a high net worth based on my home’s (supposed) value, I’m more tempted to leverage that value by taking out a collateral loan and spending more money. By contrast, if I want to invest in a new property to start renting it out, I’m better served by calculating how much it will cost me to purchase and own, and then making sure I have enough money coming in to cover that.
Kiyosaki’s perspective is that net worth tells you how rich (or poor) you are, but your cash flow indicates your wealth because it tells you how much opportunity you have to purchase what you need or, ideally, to buy into sound investments that will keep growing that wealth. This makes a lot of sense to me, and provides an alternate way to evaluate “how I’m doing.” In the first example above—where I made purchases but my net worth calculates to pretty much the same total—I may technically own the valuable items I splurged on, but when I go to pay off that credit card, I may find I’m running out of money to purchase groceries later. In the other example—in which a bull market boosted my IRA value—my income hasn’t changed with my retirement gains, so even though I’m building assets through the stock market growth, it doesn’t have a real impact on my daily life. (OK, it might, but that’s a topic for another day…) How much money I have to spend in a given month will greatly affect my ease or stress, so it makes sense to have cash flow be the benchmark I track.
In Real Life: Principle in Action
When my wife and I had our first child, we suddenly were back to living like when we were first married and establishing our first home together, or like when we were dating and each maintaining separate homes. It was unsettling! Part of that was because we had started contributing to our daughter’s college savings, but that wasn’t enough to explain why I was suddenly considering a diet of rice and beans for us. The key lies in cash flow.
- Formula & diapers cost a lot and that regular expense chips away at your cash between every grocery run.
- Daycare costs a ton and absolutely has to be paid, right at the same time as our mortgage payment was due every month.
- And of course, there are all the toys and clothes and medications and everything else…
Kids are expensive! But when I tracked our monthly expenses and income, it all came out the way I had expected it to be—more or less—and planned for. So, why did we feel so much worse off? It was because we had to consider every purchase and make sure there would be enough to pay for everything, even on the last day before payday. I couldn’t just run out to the coffee shop or pick up more frilly, tutu onesies without considering whether I had the money. When it comes down to it, this is about cash on hand.
Of course, net worth is a data point that has its place in certain applications, but cash flow makes for an interesting goal, too. Cash flow affects not only how you feel, but it also impacts your actual financial stability, because it also determines what opportunities you can take advantage of, Kiyosaki says. If I don’t have cash on hand, I may not be able to invest in the next big thing. I’ve only gotten so far in the book, so maybe that will be a post for another day.