So here is the argument I put forth. I really don’t expect most people to agree with it because your home is an emotional thing and when it comes to money, high emotions tend to lower financial intelligence. I know from personal experience that money has a way of making every decision emotional.
• When it comes to houses, most people work all their lives paying for a home they never own. In other words, most people buy a new house every few years, each time incurring a new 30-year loan to pay off the previous one.
• Even though people receive a tax deduction for interest on mortgage payments, they pay for all their other expenses with after-tax dollars, even after they pay off their mortgage.
• My wife’s parents were shocked when the property taxes on their home increased to $1,000 a month. This was after they had retired, so the increase put a strain on their retirement budget, and they felt forced to move.
• Houses do not always go up in value. I have friends who owe a million dollars for a home that today would sell for far less.
• The greatest losses of all are those from missed opportunities. If all your money is tied up in your house, you may be forced to work harder because your money continues blowing out of the expense column, instead of adding to the asset column— the classic middle-class cash-flow pattern. If a young couple would put more money into their asset column early on, their later years would be easier. Their assets would have grown and would be available to help cover expenses. All too often, a house only serves as a vehicle for incurring a home-equity loan to pay for mounting expenses.
In summary, the end result in making a decision to own a house that is too expensive in lieu of starting an investment portfolio impacts an individual in at least the following three ways:
1. Loss of time, during which other assets could have grown in value.
2. Loss of additional capital, which could have been invested instead of paying for high-maintenance expenses related directly to the home.
3. Loss of education. Too often, people count their house and savings and retirement plans as all they have in their asset column. Because they have no money to invest, they simply don’t invest. This costs them investment experience. Most never become what the investment world calls “a sophisticated investor.” And the best investments are usually first sold to sophisticated investors, who then turn around and sell them to the people playing it safe.
I am not saying don’t buy a house. What I am saying is that you should understand the difference between an asset and a liability. When I want a bigger house, I first buy assets that will generate the cash flow to pay for the house.
My educated dad’s personal financial statement best demonstrates the life of someone caught in the Rat Race. His expenses match his income, never allowing him enough left over to invest in assets. As a result, his liabilities are larger than his assets.
The following diagram on the left shows my poor dad’s income statement. It is worth a thousand words. It shows that his income and expenses are equal while his liabilities are larger than his assets.
My rich dad’s personal financial statement on the right reflects the results of a life dedicated to investing and minimizing liabilities.
Why the Rich Get Richer
A review of my rich dad’s financial statement shows why the rich get richer. The asset column generates more than enough income to cover expenses, with the balance reinvested into the asset column. The asset column continues to grow and, therefore, the income it produces grows with it. The result is that the rich get richer!
Why the Middle-Class Struggle
The middle class finds itself in a constant state of financial struggle. Their primary income is through their salary. As their wages increase, so do their taxes. Their expenses tend to increase in proportion to their salary increase: hence, the phrase “the Rat Race.” They treat their home as their primary asset, instead of investing in income producing assets.
This pattern of treating your home as an investment, and the philosophy that a pay raise means you can buy a larger home or spend more, is the foundation of today’s debt-ridden society. Increased spending throws families into greater debt and into more financial uncertainty, even though they may be advancing in their jobs and receiving raises on a regular basis. This is high-risk living caused by weak financial education.
The massive loss of jobs in recent times proves how shaky the middle class really is financially. Company pension plans are being replaced by 401(k) plans. Social Security is obviously in trouble and can’t be relied upon as a source for retirement. Panic has set in for the middle class.
Today, mutual funds are popular because they supposedly represent safety. Average mutual-fund buyers are too busy working to pay taxes and mortgages, save for their children’s college, and pay off credit cards. They do not have time to study investing, so they rely on the expertise of the manager of a mutual fund. Also, because the mutual fund includes many different types of investments, they feel their money is safer because it is “diversified.” This educated middle class subscribes to the dogma put out by mutual-fund brokers and financial planners: “Play it safe. Avoid risk.”
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