Tuesday, September 22, 2009

Leverage by any other name

:en:NASCAR drivers :en:Mike Skinner (NASCAR) (...Image via Wikipedia
In "Retire Young Retire Rich" (Rich Dad book 5), Mr. Kiyosaki used the word "leverage" a lot, and indeed, it is a big topic. He is not only talking about financial leverage (i.e. OPM, "other people's money"), he also talks about how to use other types of leverage as well. Indeed, leverage can be found almost anywhere... if you look close enough.

In military, the equivalent term would be "force multiplier". Basically, it is an advantage you enjoy against the opposition.

For example, if you have machine guns, and they don't, you have a force multiplier. Having machine guns lets you hold ground with a much smaller force than the enemy, all other stuff being equal. Intelligence (as in gathering information, not IQ) is another force multiplier. If you know what the enemy is doing, you can anticipate his moves, set up ambushes, and so on, and defeat him with a smaller force. Basically, a tool no one else has that allows you superior SOMETHING (mobility, information sharing / coordination, firepower, and so on) makes your force more effective, and that is the definition of a force multiplier.



On the financial market, your "opposition" basically is everybody else. You want to be BETTER than everybody else. Don't you? And how do you measure financial success? Most people use the simplest definition: financial freedom -- when you no longer have to work for a living, that your passive income is enough to sustain your current lifestyle.

So how do you gain "leverage" (or advantage) over the rest of the "herd" financially? First thing is very simple: you need to become financially literate.

To be brutally honest, most people are financially illiterate. Most can't even balance their own checkbook without help. How many people use Intuit's Quicken, or Microsoft Money, or such software? Thus, learning to be financially literate immediately gives you an advantage over the rest of the "herd", so to speak.

(I am NOT suggesting that you throw away the software and go back to use calculator and such. I am merely saying that you should learn the WHY behind the HOW and all that. If you just use the software without understanding HOW to balance or WHY it works the way it works, you don't understand the numbers at all, and you won't understand assets and liabilities either)

Once you understand what is an asset, what is a liability, what is income and what is expense, and finally, what is good debt and what is bad debt, you are ready to learn about financial leverage, or how to use OPM (other people's money) to create good debt, which puts money in your pocket and increase your income.

Those of you who have read the previous Rich Dad books undrestand "cashflow", so this should be simple. For those of you who are reading this with no background, see if you can answer this question:

Let's say I found this amazing investment that will return 25% APY, no limit on investment amount, min or max. Who will get rich faster: A, who invests 10K of his own money, or B, who borrowed 100K at 10% interest and invested 110K (including 10K of his own money)? (at the end of 1 year)

Even without doing any math you should already see that B will make far more money than A. For those of you who are simply bad in doing mental math, or who want to see the numbers, here you go:

At the end of year 1, A would have 12500 (10000 + 25%). Gain is 2500.

While B would have 110K + 25% = 137500. Gain is 25700, but you have to subtract the interest paid, or 10000 (10% of 100K), so gain is 15700.

In other words, by leveraging other people's money, B has multiplied his gain more than five-fold. (550%, to be exact).

This is also a good example of good debt. A "good debt" is a debt being used for "leverage" in order to increase one's income. By going into debt of 100K, B was able to leverage OPM, and made far more money than he could have done with his money alone (and A used his own money).

And just imagine, if you can do that in just ONE year, what can you do with 2-10 years worth of leverage, using compound interest?

== LEVERAGE OF YOUR MIND ==

Of course, there are quite a few more types of leverage, and the first leverage that you need to work on is the leverage of your MIND.

Remember earlier we said you need to be financially literate? That's part of it. There are two parts to mental leverage: there's the knowledge part, which is financial literacy, and then there's the motivation part, which we wil discuss now.

Why the mind first? Very simple. It costs practically nothing to grow your mind. If you can't afford books, get a library card and go check out some books. it is as simple as that. Once you have mastered the motivation, the rest will follow.

In my first "observation", my re-interpretation of Rich Dad was that a lot of people may SAY they want to get rich, but they actually don't want it "bad enough", to use a modern expression. In other words, they want to be rich, but they don't want to pay the price for it, and one price you need to pay is constant reexamination of one's own core values.

And core value / core programming controls everything you do. So if you don't update it, you will simply become... obsolete.

For example, who likes NASCAR? I think we can all agree that NASCAR can be quite dangerous, driving 800 HP machines around an oval at up to 200 MPH in packs of cars, often just inches away from each other. it can be dangerous, and EXCITING to watch. Yet is it RISKY?

Perhaps not, due to all the safety features built into the chasis. Think about it... entire vehicle is basically tubular steel frame. Floor is welded with insulation, seat is locked in place. the HANS device protects the head and neck. Roof flaps prevents the car from going too high during total loss of control (such as going backwards), and roof hatch allows driver to escape if the car is no longer upright... I won't get too technical on you. Suffice to say that except for airbags NASCAR vehicles have more safety features than regular vehicles.

So what's my point? The point is risk can be MANAGED. NASCAR drivers work their way up through a series of other racing before getting invited to the "big leagues", so to speak. Some start from Karting, some start in Europe racing Formula cars, some even start from local dirt tracks. They have to accumulate a lot of racing experience before they can do 200 MPH in 800 BHP cars. It is not something you and I can do without training. Yet, most people don't see the training that went into making a NASCAR driver. They only see the glory (and the money), and the accompanying danger.

In other words, they look at NASCAR, and say "that's so dagenrous. I'll never do something like that." And they put it out of their mind. They don't think "Wow, he must have trained for years and years to make it this far. It may look dangerous to us, but he had the training to deal with it."

So what does all this have to do with finance? The relevance is actually quite simple... Most of you simply lack faith... in yourself.


== FAITH AND MENTAL LEVERAGE ==

Faith, yes, that's what I said. Call it belief in oneself with no logical reason if you wish. But faith is much simpler to say.

Yet you need faith to be rich. If you don't believe you can be rich, then you will NEVER be rich (barring some extremely unlikely circumstances, of course, like winning the lottery, etc.)

Yet most people, when asked to make a plan to retire in 10 years, they start stammering one excuse after another. Usually the excuses sound like this:

* I am too busy / I don't have time
* I don't see how that's possible / I have no idea how

and so on. Any one here still think that way? Oh, come on, admit it... You *do* think that way, you are just too embarassed to say it. However, you don't need to. The fact that you are here means you *do* want to change. However, that change must come within you. It's like your golf skills. You can hire Tiger Woods to teach you, but it's YOU who's swinging the club when it matters, NOT Tiger.

Or another Rich Dad saying: If you are arguing against a good idea, perhaps you should stop arguing.

Think about it... WHO here would like to retire in 10 years? Everybody, right?

Yet why do most people start giving excuses against such a good idea?

Which goes back to ANOTHER one of Rich Dad's sayings: "Don't ever say 'not possible'. Think of a way to make it possible. (without breaking any laws or do amoral things)"

Obviously there are some things that are currently not possible, like travel in time, travel faster than speed of light, and other Star Trek stuff. But predictably, some scientists have taken Rich Dad's advice and are already working on those! (Okay, maybe not his advice, but you get the idea)

The point is, there are very few things in life that are completely impossible. Most things are impossible due to lack of knowledge, lack of mindset, and lack of resources.

Remember, it used to be thought that humans will never fly. The Wright brothers was told that men are not meant to fly by no less than their own father.

Everybody else simply accepted the "fact" that "humans will not fly". The Wright brothers updated their core values so that they questioned the "fact". In other words, they changed their mindset first. They have the resources from their bicycle shop, and they gained the knowledge by repeated experimentation. The Wright brothers did not give up, and eventually found a way to create a flying machine.

In other words, Wright brothers used their mental leverage to create a new reality that lead to their success. If they did NOT update their core programming to allow the mental leverage, they would not have created the flying machines.


== PEOPLE'S RESPONSE TO CORE VALUE UPDATES ==

People react different when it comes to updating their core value. I classify them as follows: ostriches, deers, lemmings, parrots, and homo sapiens. Please keep in mind, if you do see yourself in one of these groups, no insult is intended.

Ostriches are the people who refuse to even acknowledge that their core values need to change. They bury their heads in the sand, and refuse to acknowledge the problems. They often reminisce about the "good ol' days". If you kick them hard enough or they got a hard jolt from life they may snap out of it and morph into something else, but it's VERY hard to get these people to change at all without some dramatic outside stimulus.

Deers are people who say they want to change, but never actually take the first step. They even convinced themselves they want to change. If you point it out they look like deer in front of heatlights: frozen in fear. They are conflicted inside. These folks collect "get rich" books, hoping to find the secret formula that would allow them to gain riches without changing their core values. I know, I used to be like that. :D

Lemmings need to see some examples to follow. Somehow just reading what needs to be done don't help them at all. For those of you who want some inspiration that way, please go read biographies of sucessful business people that are similar to you. Story of Michael Dell or Bill Gates should be inspiring to younger people. Colonel Sanders of KFC should inspire older people. Women should go read story of Anita Roddick.

Parrots need to see formulas. If you give them inspirational stories, they don't 'get' it. They expect a checklist, a recipe, a formula to follow. If they do A, B, C, and D, they expect to get X at the end. They are perfect at repeating things. Which is why I call them parrots. This type of folks will probably NOT understand Rich Dad books, as most of Mr. Kiyosaki's books are about how he had done it, and you can too.

And of course, some people simply needs some time to think about it. Once you show them the way, they will change themselves. Only humans are truly capable of updating their own reality through learning and sentience. That's why the smartest category is "homo sapiens", or human beings.

Just remember that you're not STUCK in a particular category, and can switch categories at will. The keyword here is WILL. You have the WILL, you have the way.



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