follow the Poor Dad sometimes

If you spend any time on personal finance sites, you’ll hear about Rich Dad, Poor Dad. Personally, I would credit it with a tremendous amount of influence on my life since I read it in late 2003. This book changed the way I think about money, about priorities and even about life in general. I plan to review it in the near future.An important distinction, however, is that not all of this change was good. One of the main tenants of Rich Dad is ‘maximizing cash flow’, or attempting to push expenditures as far into the future as possible. A very common way of maximizing cash flow would be to take a balloon mortgage, for example, where payments are low or interest-only for several years then escalate.

At the height of the housing boom we bought our current house. Fervently embracing the concept of maximizing our cash flow, we attempted to get an interest-only monthly floating rate mortgage, which would (at the time) have resulted in sub-$1000 per month payments on our half-million dollar home. After 5 years, the payments would shoot up, but we were convinced we could easily refinance or move or somehow avoid that situation.

Fortunately for us, the neighborhood we were moving into did not meet the lender’s criteria for “aggressive” mortgages. It was too new, and there was not enough payment history for the neighborhood for them to measure the risk of default. Our mortgage application was rejected, and we proceeded to obtain a 30 year mortgage at 5.6%. This meant our payments were almost double what we had hoped, and we were not happy.

Three and a half years after being turned down for the adjustable rate mortgage, we still have regular payments. With the increase in interest rates we would be paying almost the same amount on the ARM that we are paying on our traditional mortgage, but it would all be interest. The balloon payment would be looming, and our cash flow would be no better than it is now.

So in retrospect we were saved from ourselves. Despite the fact that we think we are fairly savvy people about finance (she has a degree in finance and I have an advanced degree in accounting) we lucked out by being turned down for the ARM. I doubt we would have done much with the ‘maximized cash flow’ since our first thought would probably have been to invest in more real estate, again using ARMs. Doing so would have compounded our error, and now we would be facing a mounting avalanche of debt.

I think the moral I take away from this is that even when you follow a particular philosophy or guru, you should always consider a worst-case scenario. Sure, the traditional mortgage has cut into my income and made it difficult to consider vacations and larger purchases. That pales in comparison to the ARM worst-case scenario: being forced out of the house.

As a postscript, I still think that Rich Dad, Poor Dad is a critical read for anyone who lives in America. Kiyosaki makes excellent points about working for income versus investing, and made clear to me for the first time that what I wanted to be able to buy was time, not things. Financial freedom is the goal, although I had never heard it put so plainly. So please don’t read this as an indictment of his book. I highly recommend it, but as with anything else in this life you have to be cautious and conservative when dealing with your home, your family or your health. Without these three things all of the cash in the world will be useless.

Other reading:

Rich Dad, Poor Dad:  What the Rich Teach Their Kids About Money–That the Poor and Middle Class Do Not!

teaching risk tolerance

Tags: family, health, income, investing, life, money