One of the most important things to understand at the beginning of your financial journey is that there are huge differences in how poor people and rich people think about money and how they spend it.
The book ‘Rich Dad, Poor Dad’ from Robert Kiyosaki is a real eye-opener in this regard. In this blogpost we will try to explain the principle of cashflow and why it is important for you.
Let’s kick this off by understanding what assets and liabilities are.
What are assets and liabilities in simple terms?
An asset is something that puts money in your pocket, a liability is something that takes money out of your pocket.
Assets are valuable right now and/or will be more valuable in the future. Common examples of assets are stocks, bonds, real estate and intellectual property.
Liabilities are costing you money and/or will be costing you money in the future. Common examples of liabilities are loans and debts such as mortgages, car loans or student loans.
Now let’s look at the differences between a poor, middle class and rich household when it comes to their income, expenses as well as their assets and liabilities.
Poor household’s cash flow
A poor household has their salary as their only income and will spend everything they have on a monthly basis on basic living expenses. They do not own any assets.
The first steps you can make in a poor household is understanding your spending habits, looking for opportunities to have a greater income, start learning about personal finance, etc. Believe that you can change something about your situation. You won’t become financially independent overnight, but you can create a more comfortable situation for yourself and your family where you have to worry less.
Middle-class household's cashflow
You might think “oh but the middle-class has their ducks in a row. They know what do, right?” Not really.
The middle-class has an overall higher salary, but is spending all their hard earned dollars on liabilities that hey thought were assets. For example they buy a house with a mortgage or get a car with a loan. They are using their credit cards to buy what they want. It basically means they are in debt and are paying off a part of that debt every single month. On the other hand they don’t have or barely have any assets, something that brings in cash or increases in value.
They should reconsider what they spend their money on and look into buying assets as well. Another danger is lifestyle inflation. This means when their income is increasing, they will increase their spending as well.
Rich household's cashflow
The rich have multiple sources of income such as rental income from real estate, dividend payouts from stocks they have, royalties they receive due to intellectual property, etc. Notice how having a mortgage is not so much of a liability in this case, because they are creating a steady monthly income stream by renting it out.
The main difference between the rich and the middle-class is that they own income creating assets. As their income keeps growing, they can buy more and more assets which leads to more money left in the bank. And more money is more freedom!
Summary
Poor household’s rely only on salaries as their income, they own no assets.
Middle-class household’s rely on salaries as their income, they only own liabilities.
Rich household’s have multiple income streams, they own assets.
In which category do you fall? Do you belong to a rich household? Congratulations! I wonder why you stumbled upon this website. Do you belong to a poor or middle-class household? Then you are in the right place. If you are ready to learn more and start your personal finance journey, I hope you stick around our blog!
