Just Because You Invest Does Not Mean You Are An Investor

Of all the flaws of pension reform, rich dad felt the biggest flaw of all was that it forced people who were not investors to invest. To rich dad, the assump-tion that a change in the law would suddenly turn people into overnight ex-pert investors was an oversight of epic proportions. He said, “How can you take someone who has been programmed from birth to be a job-seeking employee to suddenly becoming a risk-taking investor? A security-seeking person is not the same person as a risk-taking investor.” To rich dad, this assumption was the biggest flaw of all and would ultimately lead to the biggest stock market crash in history.

Those of you who have read Rich Dad's CASHFLOW Quadrant (book number 2 in the Rich Dad series of books) are very familiar with the follow ing diagram of the quadrant:

For those not familiar with the CASHFLOW Quadrant, or who have not read the book, I will briefly explain what the four letters of the quadrant stand for.

S stands for self-employed or small business owner B stands for big business owner

These are the four ways you earn money, or the four types of people. Each quadrant represents a different way of thinking about money and financial security.

Rich dad said, “The biggest flaw with ERISA is that the law assumes that people on the left side of the quadrant can easily switch to becoming people on the right side of the quadrant. People in each quadrant are different . . . very, very different. To assume someone in the E quadrant can become an in vestor in the I quadrant just because a law mandates the change . . . is ab surd. You can change laws with the stroke of a pen but you cannot change people with the stroke of a pen.”

They required millions of employees to become professional investors . . . and as we have seen, did so without developing an educational system to support this small but monumental change.

Our public school system trains people primarily for the E or S quadrants, which is why most people are either Es or Ss. My poor dad, the head of education, constantly said, “Go to school, get good grades, so you can get a safe secure job.” In other words, my poor dad was advising me to find safe sanctuary in the E quadrant. My mom, knowing that I wanted to become rich, often said, “I know you want to become rich, so go to medical school and become a doctor.” She was advising me to find sanctuary in the S or selfemployed quadrant. My response to her was, “There is only one problem with that idea, Mom . . . I'd have to be smart to be a doctor and you know what my grades are.” The point being, often the S quadrant could stand for the smart quadrant since that is where doctors, lawyers, accountants, engi-neers, and so on often reside, although any profession or intelligence level could reside in any of the four quadrants. S can also stand for specialists, people with some unique trade or skill, and it also stands for the millions of small independent business owners.

My rich dad trained his son and me to be people who operated in the B and the I quadrants. For those of you who read my previous books, you may recall rich dad having his son and me do almost every job possible inside his businesses, training us to know how many different types of jobs it took to keep a business running. He also played Monopoly with us by the hour, teaching us to think like investors. One of the primary reasons I have had a normal job for only four years is simply because rich dad trained me to op erate on the right side of the quadrant, not the left.

When I was still a boy, rich dad said, “People gravitate to the different quadrants because people are different. A person who seeks the E quadrant wants security. That is why most people in the E quadrant, regardless if they are the president or the janitor of the company, will often say the same thing, which is ‘I'm looking for a safe secure job, a steady paycheck, and excellent benefits.' Safety and security are paramount to people in the E quadrant. The world of the I quadrant, the investor quadrant, is not a world perceived as a world of safety and security. It can be but not without proper training.”

Again, there is a vast difference between the words security and freedom. Adding to this difference, rich dad pointed out that people in the E and S quadrants often wanted security, security from a job for an employee, and se-curity of doing it on your own, not depending upon other people, for people in the S quadrant. People on the B and I side wanted freedom, so they focused on assets that worked for them. Now I can hear the howls of protest from the people in the S quadrant, generally people who want to do their own thing. But before you protest, consider that while most people in the S quadrant are free to be doing their own thing, the problem is they still have to be doing it, regardless of whether they love doing it. A person who is truly in the B or I quadrants is free to do nothing and still get paid and that is the difference in freedoms. (Again, for those who have not read Rich Dad's CASHFLOW Quadrant, you may want to because the book goes into far more detail about the core differences between the different people in the different quadrants. It is a very important book for anyone serious about making changes in their life, rather than simply going from job to job in the E quadrant or working hard all your life in the S quadrant.)

The other day, I was at an investment conference and I was talking to a young man who told me he was an investor. I then asked him what he was invested in. His reply was, “I have a company 401(k) plan that has a welldiversified portfolio of large cap, small cap, a few sector funds, and of course a bond fund.”

As I nodded my head, I silently said to myself, “Wall Street has done a good job educating this lifelong customer.” Not wanting to burst his bubble, I asked, “How much income do you receive a month from your investments?”

“Income?” he replied. “Why none. I don't have any income. Each month I send a portion of income, through payroll deduction, to these mutual fund companies.”

“And when do you expect to receive some income from these invest ments?” I asked.

“Oh, I'm twenty-seven now. I plan on letting my money grow tax free until I retire, hopefully by age sixty. Then I'll switch my portfolio to a selfdirected account and live off my investments. You see, I'm investing for the long term.”

The point is, this young man may be investing, but I would not call him an investor . . . at least not from the definition rich dad used when referring to the Cashflow Quadrant. According to rich dad, investors receive money from their investments on a regular basis. Until you begin receiving money, you may be investing . . . but you are not an investor. To prove to rich dad that I was an investor, I had to prove to him that money was flowing in . . . and had stopped flowing out. Recently, millions of DC plan investors found out that the money they have been investing flowed out of their pockets and then flowed out of their DC plans . . . that is why there are so many upset in-vestors today. They may have invested but they did not become investors.

When it comes to investing, many people are excellent at having money flow out . . . but only a few are excellent at having money flow in . . . and having money flow in is what makes you a good investor. When it comes to investing, most people have money flowing out and almost nothing flowing back in. After ERISA was passed, millions of people began investing but we do not yet know if they will become investors. Only time will tell how many make the transition from the E, S, or B quadrant to the I quadrant once their working days are over.

In the movie Jerry Maguire there is a classic line that goes “Show me the money.” My friends who are hard-core investors consider that line sacred. The reason is they know investing money does not mean the investment will return the money. For my circle of friends, an investment is not real until the invested money comes back . . . and once the money comes back, that investment should have more money flowing in. Right now, for millions of people, with DC pension plans, money is flowing out and millions are won dering if it will flow back. Many have called their brokers and asked them to “Show me the money.”

The other night, my wife and I were at a party, and the hostess asked my wife what she did for a living. Kim simply said, “I invest in real estate.” The hostess's eyes lit up and said, “So do I. My husband and I started with a small house, and sold it when it went up in value. We have done this three times and now look at our home. We kept investing in real estate and now we live in this lovely home.”

I know in her mind our friend thinks she is a real investor . . . and technically she is. Yet in our circle of friends, she would not be called a real estate investor, she would be called a homeowner who got lucky. Although she did have a lovely home, there is a tremendous difference between a real estate investor who owns a home that costs them $5,000 a month and a real estate investor who earns $5,000 a month in net income. By our investment group's definition, a real estate investor has income coming in every month from rental homes, commercial property, warehouses, office buildings, and so forth. In other words, regardless if we work or not, we can show them the money . . . the money coming in.

So why did rich dad feel that people in the E quadrant being forced into the I quadrant was the biggest flaw of all? The answer again is because they have completely different personalities. A person in the E or S quadrant works for money and people in the B and I quadrants work to build or acquire assets. This may seem like a small difference on paper, but after a person retires, the differences are substantial. As a professional investor with years of training, learning to show the money on a monthly basis from my investments is not the easiest thing to do . . . and that is what ERISA has asked people to do. Once a person with a DC plan retires, they will be shoved out of the safe sanctuary of their job. For many, they will have to face the real world for the first time in their life . . . the real world rich dad faced at thirteen, I faced at thirty-two, my dad at fifty-three, and the Enron employee on the front page of USA Today at fifty-eight.

In the good old days, once an employee retired, there may have been a re tirement party, a gold watch, and a DB pension plan to watch over them for the rest of their lives. In other words, they could retire and count on the check being in the mail. That is all they had to do.

Also in the good old days, if the retiree had worked for a generous company or the company had a strong union, they might have received a COLA, a cost-of-living adjustment. As inflation went up, so did their defined benefit payments. Some also had medical plans for as long as the retiree lived. As long as the retiree lived, he or she could go to the doctor and the company would show the doctor the money. In other words DB pension plans became very, very expensive as more people retired and lived longer through improved health care. These large liabilities are some of the real reasons why ERISA was legislated. Employees with DB and medical plans were simply too expensive in a world of increasing global competition.

In today's world, once an employee retires, there may still be a retire ment party and a gold watch, but once they retire they may very likely find themselves on their own. Some may keep their money with the company's pension plan, others may elect to roll it over into an IRA, an individual retirement account, and still more will sell their financial assets for cash and put the money in the bank.

The following are the three real reasons why rich dad saw the coming of the biggest stock market crash in history. They are:

1. There will be a market sell-off caused by baby boomers converting to cash. Rich dad said, “Es and Ss work all their lives for money, not for financial assets. Most Es and Ss do not trust the stock market. Once they leave the company, all the fear and insecurity that has always been there—the fear and insecurity that caused them to be an E or S all their lives—will only increase. Once they leave they will cling to what they know and trust and that is cash . . . not stocks or mutual funds.”

According to Business Week magazine, in 1990 there was $712 billion in 401 (k) and similar plans. Only 45 percent of that money was in stocks. By the end of 2000 that amount had swelled to $2.5 trillion, with 72 percent in stocks or similar equities. In other words, as the money from retirement funds came in, a market boom was underway. As the boom increased, socalled investors became more confident and began taking their cash and buying equities with it, simply because they could get a much higher return from equities instead of cash. As the boom progressed, many so-called in-vestors entered the party late and began taking money out of their savings and putting it into the market, primarily into stock mutual funds, swelling that asset class to $4 trillion. About that same time, reports came out that the family savings rate of America had dropped to less than 1 percent. A mania was on and people who should never have been in the market were now in the market.

Many people who were investing in their DC pension plans saw their plans increasing in value. Immediately they believed that they were now real investors, and began taking their savings and putting it all into the market. Most of these people came from the E and S quadrants. People who should have remained savers suddenly starting investing. But they were not investors.

Rich dad believes that the biggest stock market crash in history will be caused when millions of people begin to sell financial assets they do not un-derstand and do not trust. Rich dad said, “People in the E quadrant love security. If they feel their security threatened, they will not hold on to their financial assets. If they feel insecure, there will not be any systematic withdrawal as pension reform calls for . . . Instead, there will be a wholesale panic . . . a panic caused by baby boomers converting financial assets back to cash . . . cash for their savings accounts . . . as fast as possible.”

At first I did not understand what rich dad was getting at. Now that I am older I am more aware of that subtle difference. Today, I am very aware of that difference whenever I hear people saying, “I am saving for my retirement.” Or they say, “I am saving for my child's education.” Rarely do I ever hear people saying “I am investing for my retirement.” Or “I am investing for my child's education.” As rich dad said, “Savers and investors are not the same people. Savers feel secure with money, not with mutual funds. When push comes to shove they will sell, and when millions of them begin to sell . . . the market will crash. There will be no systematic withdrawal.”

Japan has teetered on the brink of a banking and financial disaster for some years now. At the same time, Japan's banks are bursting with money because most Japanese are employees and savers. In fact, Japan has the highest savings rate in the world. Because the banks are so flush with money, the interest rate paid on those savings is nearly 0 percent. Even though the banks pay the Japanese nothing for their savings, the money sits in the banks. Why? The reason is because employees and savers would rather have money earning nothing than take a risk. I predict in a few years U.S. banks will also be flush with money. If banks are filled with money, it's going to be tough for them to pay 10 percent interest to savers on that money. As I write, the U.S. banks are paying 2 percent interest on savings. Two percent is not a very good return on your investment.

So the primary reason for the coming crash is that most people today do not naturally feel secure with mutual funds and stocks. Once they begin to retire, millions of baby boomers will cash in their stocks and mutual funds and return to what they have spent their lives working for . . . cash. As rich dad said, “You can change the law but you cannot change people.”

2. The cost of living and medical costs will go up. As stated earlier, with many DB pension plans, there was a cost-of-living adjustment. With a DC pen sion plan, after retirement, when the cost of living goes up and medical costs go up, the retiree will sell their assets to pay for these life expenses. Again this will blow the systematic withdrawal theory out the window. These slight differences between a DB plan and a DC plan will also add to the coming mar ket crash. People have to have money to live on, not mutual funds. So the mutual funds will be sold for cash.

3. The number of fools will increase. Quoting Warren Buffett: “The fact that people will be full of greed, fear, or folly is predictable. The sequence is not predictable.”

Most of us know that any market is run on greed and fear. The reason the market went up in the 1990s was because of greed, and the reason it will go down is because of fear. In the near future, one more reason people will turn their retirement account into cash is because of folly.

I will give you an example of investment folly. During the 1990s, I happened to meet many rich employees who thought they became rich because they were investors . . . but in reality, they were lucky employees. One person I met was an employee of Intel. In 1997, just as the market was climbing, he cashed in his options for nearly $35 million. He thought for sure he was an investor rather than just a lucky employee, and was soon out investing in investments only reserved for what the Securities and Exchange Commission classifies as an accredited investor. By definition, an accredited investor is a person with over $1 million net worth or a high paying job. Now, how that qualifies a person to be an accredited investor is beyond me, but those are the rules. I have a better way of a person proving they are an accredited investor, but the SEC has not called to ask me for my opinion.

In any event, this ex-Intel investor with his millions of dollars let the money go to his head and he began investing in anything that moved. He bought private placements, he bought partnerships in companies, he bought companies outright and had his sons and daughters run them, and he bought doodads that only truly rich people buy, doodads such as a private jet, a yacht, and two large homes. On top of that he met a woman younger than his daughter and then divorced his wife, who received a sizable sum of money. Rich dad often said, “A fool and his money are one big party.” And let me tell you, this guy could throw a party. Today, he is bankrupt. How do I know? I know because he came asking me for a job. He needs a job because his second ex-wife got the rest of the money. He is only one of dozens of such people I met during the roaring 1990s. They were employees who got lucky and thought they were investors—but found out they were fools who threw big parties. Nothing wrong with big parties . . . but just make sure you can afford to throw another one.

This example of investment folly is found with sports stars, movie stars, rock stars, lottery winners, people who suddenly inherit a large sum of money, and anyone else who is fooled into believing that investing money and becoming an investor are the same thing. In a few years from now, as some of the luckier baby boomers begin retiring with large sums of money in their DC pension plans, you will begin reading in the paper about fools being swindled out of their retirement money. Many will be swindled because they did not make the distinction between investing money and becoming an investor.

In conclusion, the biggest flaw of all, according to rich dad, was that although people invested, they did not become investors. He said, “This small and seemingly trivial point has the potential to bring down the stock market.” So rich dad's prophecy was that sometime in the near future, millions of people will slowly wake up and realize they were forced by law to buy something they really did not want (a DC plan), and could not sell unless they were willing to pay a huge tax penalty for early withdrawal. On top of that many are encouraged to invest in products they do not really value, do not understand, and think they paid too much for. He said, “At that point, savers will begin converting their investments back to what they have worked all their lives for . . . and what they worked for was cash . . . not stocks, bonds, or mutual funds. The market crash will take place because people were encouraged under law to invest but they never learned to become investors. Remember, investors love assets and savers love cash. And that is why you hear so many people say, “Safe as money in the bank.”

Rich dad once explained to me that his definition of financial mania is an irrational conversion of cash to financial assets such as stocks, bonds, real estate, and mutual funds. Over the centuries there have been many manias. One of the more famous or infamous is the tulip bulb mania in Holland from 1634 to 1637. The tulip bulb mania was caused when the Dutch fell madly in love with this new flower imported from China. Soon they began to create

new varieties and it was not long before a mania was on. Certain tulip bulbs were commanding more than a hundred times their weight in gold. Sud denly the mania was over and a panic began, the panic to convert their bulbs back to cash. Today, the tulip bulb mania sounds as ridiculous as the dot.com mania of just a few years ago.

Rich dad's definition of a financial panic was an irrational conversion of financial assets back to cash. In other words, people suddenly wake up and realize that what they bought is not worth what they paid for it and they want their money back. It's often called “buyer's remorse.” When millions of people who invested in mutual funds and other financial assets experience buyer's remorse and demand their money back a panic will occur and that panic will lead to a crash . . . the biggest crash in the history of the world. As rich dad said, “Just because you invest does not mean you're an investor.”