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How Do You Build an Ark
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Many people already know they need to build their own ark. The need to build an ark and build it quickly is not news to them. But the question re mains, “How do you build an ark?” And the answer is, “It depends upon who you ask.” For example, if you ask a:

1. Politician. Many politicians today are saying that the way to save Social Security is to allow younger workers to invest 2 percent to 4 percent of their Social Security-taxed money into personal investment accounts and then re-duce the benefits promised to them by the Social Security Administration.

I don't know about you, but that solution sounds vaguely familiar. To me, it has a ring similar to defined contribution plans. Once again we are forcing people to become investors without the necessary financial education to help them. Not only does it sound familiar, if this law passes, it will mean that Social Security will begin to run negative before 2016 because less money will be coming in to pay for the older retirees. The politicians who are proposing this today, in 2002, know they will be out of office long before this happens. Again, the problem is pushed forward.

2. Union leader. Union leaders would recommend you find a job with a company that has a strong well-organized union, with a well-funded pension plan and benefits.

My poor dad, as head of the Hawaii State Teachers Association was a strong advocate of this idea. If you like this idea, get a job with the government.

3. Schoolteacher. A schoolteacher would probably recommend staying in school to get as high an advanced degree as possible. In fact, get several of them. Then go find a safe, secure job with benefits.

Our institutions of higher learning are filled with students who are in school because the job market is tight. Only a few years ago, during the dot.com mania, students were leaving school early in search of jobs with start-up companies offering stock options. Many of them are back in school or are looking for jobs.

4. Professional person. There are many people who recommend going to school so you can learn a profession such as doctor, lawyer, plumber, ac countant, electrician, or chef. People who believe in this course of action of ten say, “Get a skill or trade you can always fall back on.”

In other words, in this era of job insecurity, be sure you can work on your own. This group includes the millions of small business owners, often called mom-and-pop businesses.

5. Financial planner. We know what these people say. This group always recommends that you start early, invest for the long term, stick with the plan, and diversify, diversify, diversify.

While this is great advice for the average investor, it is what the financial planners don't tell the average investor that concerns me. Also, if you are a baby boomer over forty-five years of age, this advice may not work.

6. Religious person. They recommend attending church regularly and pray ing twice a day. They know God will save them and provide for them.

I am not knocking the power of prayer, but I believe this is an entitle ment mentality. I believe that God wants people to take control of their own lives and provide for themselves and their families.

7. Stockbroker. Many recommend picking individual stocks over mutual funds . . . but they are happy to sell you mutual funds also.

8. Real estate agent. Most real estate agents support the idea that your home is your biggest investment and your most important asset . . . even though in most cases a home is a liability.

9. Poor person. Many of this group believe that the rich and the govern ment should help care for the less fortunate.

10. Hardworking person. They believe in working until the day they cannot work any longer, saying, “I never plan on retiring.”

11. Animal lover. Since this group loves animals they would recommend buying a monkey. They would recommend training the monkey to first save money, then diversify with mutual funds, and after that, teach it to throw darts at a mutual funds dartboard.

12. Gambler. Wait till you feel lucky and then go to Las Vegas. But even if you do not feel lucky, always stop to buy a lottery ticket on your way home.

13. Gold digger . Find a rich person and do whatever it takes to marry them.

14. Optimist. What, me worry? In their mind-set the stock market always goes up.

15. Pessimist. Build a fallout shelter, hoard food, water, gold, guns, and cash.

16. Dreamer. The dreamer would suggest belief in magic and creative visu alization. They have crystals, aromatherapy candles, and wind chimes to keep away the evil spirits.

17. Banker. Bankers always recommend that you save, save, save. After you save some money, they call to inform you that they also sell mutual funds, stocks, insurance, annuities, and other financial planning products.

Today, even CPAs, tax preparers, and attorneys are also getting into the act. Many professionals such as accountants also have a financial planning service in the next room from where they do your taxes. All that separates them is a thin corporate wall and business license. It's hard to tell who's doing what in the financial world and they all have some advice on how to build your ark.

18. Rich dad. Take control of your own financial ark and buy or build assets that generate cash flow. Include real estate, businesses, and paper assets. As soon as your income from your assets (your money working for you) ex ceeds your expenses you are financially free.

All eighteen categories exist . . . some have more merit than others. So the real question is, which of the eighteen sounds best to you? Rather than getting into which of the eighteen possible answers works best, I think it impor-tant to say that there are many ways to build an ark. As Warren Buffett said:

“Happily there is more than one way to get to financial heaven.”

The point is, find a way that works best for you. We are all different. We have different strengths and different weaknesses. How I built my ark was very different from the way rich dad built his ark, although we often used similar asset classes to do the job . . . the job of building an ark. Rich dad used businesses and real estate and I too used businesses and real estate. The difference is we built very different businesses and invested in very different types of real estate. So a very important point in building an ark is to find the way that works best for you.

Years ago, rich dad said to me, “If you want to find true financial security, or even become financially rich, you must play your own game. Don't play someone else's game.” After ERISA passed into law, rich dad felt that millions of people would be forced to play Wall Street's game. Rich dad said, “The problem with playing Wall Street's game is that Wall Street is in control and you aren't. Find your own game, become good at it, and then take control of your life.”

On to Building Your Ark

The first thing I recommend is deciding how big an ark you want to build. Obviously, the poor person's ark would be a small and leaky boat. If all you desire is a poor person's ark, you really do not have to do that much. Social Security remains the most popular government program in the history of the

U.S. Personally I would not want to depend upon my family to care for me, nor do I want to be dependent upon the government or charities for support. The middle-class ark was a good ark for the World War II generation. All the middle class had to do prior to 1950 was go to school, get a job, work hard, buy a house, save money, and retire. This plan may still work if you get a job with the government, or a well-unionized business. But ever since the shift from the DB to the DC pension plan, this new middle-class ark may not be strong enough to survive the rough seas ahead. If this DC pension plan is all you want for your ark, then rigorously follow traditional financial planning advice, which is to have a plan, start early, work for years, and diversify. A middle-class ark can work but there may be rough sailing the next few years.

If you want to have a rich ark, obviously you will need to dramatically commit to increasing your financial education. There is one thing a person who wants to become wealthy must understand . . . and that is in building a rich ark, many of their traditional middle-class ideas and values will have to be expanded. For example, many people in the middle class think saving money, having a DC pension plan, and owning a home are the most intelligent financial decisions. While these are important to a person's overall financial wellbeing, the truth is that saving, DC pension plans, and a home are not cornerstones of a rich person's ark. The rich know that buying or building as-sets that generate passive income is the real foundation needed for a rich ark.

Why Savers Are Losers

One caution I put forth is to be careful about the word save. The act of saving worked well for the World War II generation . . . a generation that lived in an era of inflation. In fact, for the generation that lived before 1900, there was very little inflation and also no taxes. So saving worked even better for the parents of the World War II generation. But ever since 1950, savers have been losers simply because savings are taxed at a high rate and inflation wipes out most of the gains. In early 2002, the interest rate paid on saving is about 2 percent. Many savers have been severely crippled because of this drop in interest. For example, only a few years ago, if a person had a million dollars in cash in the bank, and the bank paid them 5 percent interest, the saver then received $50,000 in interest income, before taxes. But when the rate hit 2 percent, that same million dollars paid them $20,000 in interest income before taxes. That means in just a few years savers took a 40 percent cut in pay . . . before taxes. The point is, advising people to save used to be good advice . . . and it still is good advice for the poor and the middle class. But for anyone wanting to build a rich ark, simply saving money in the old fashioned way is bad advice.

7.75 Percent Interest Versus 1.85 Percent Interest

Even though the interest rates today are approximately 2 percent and taxable, by shopping around and knowing what questions to ask, it is possible to find higher rates of interest, often tax free. For example, on February 22, 2002, by having my stockbroker watch the market, Kim and I were able to find a tax free government bond paying 7.75 percent. Being that they are tax free, that is the equivalent of earning 12 percent taxable interest, while everyone else who has money in passbook savings is earning approximately 2 percent, 1.85 percent to be exact, interest that is taxable.

Obviously to receive a 7.75 percent tax free rate there is a little more risk . . . but very little. Earlier I wrote about how a person with a strong financial education could make more money with less money and less risk. This is an example of that. For Kim and me, this is a very low-risk investment simply because we understand the investment and its risks. For a person without much financial education, a traditional bank passbook savings account paying a 1.85 percent taxable interest rate would make more sense. Again the point is that your investment in your financial education can pay a greater percentage return, even on something as simple as a savings account.

If you feel you have a sound financial education and are interested in such types of investments, call your stockbroker and inquire about real estate development companies selling shares secured by low-income-housing new construction real estate, and using government tax free bonds to pay a higher tax free interest. A simpler name might be municipal mortgage REITS, real estate investment trusts. Basically, it is a real estate mutual fund that offers a tax free rate of return from interest and the potential of capital gains. But it also carries with it the potential of loss of investment.

A strong word of caution. If you do not like real estate, or understand low income housing, or understand municipal bonds, or how the stock market works, or you have limited amounts of money, I would not place money into these investments. Kim and I invest in these types because we have exten-sive experience in all of the relevant investment categories. In other words, this is more than a savings account that pays interest. As Warren Buffett says, “Investing must be rational; if you can't understand it, don't do it.” The point of discussing a 7.75 percent tax free interest return and a 1.85 percent bank passbook, taxable interest return is not to toot my horn or brag . . . but to make a point.

Without a financial education, it takes a lot more money to get rich and a lot more money to stay rich. The higher your financial IQ the less money it takes to get rich. The lower your financial IQ the more money it takes.

“My friend Dolf de Roos, author of the Rich Dad's Advisors book Real Estate Riches, says, “If you think education is expensive, you should try ignorance.”

In other words, don't invest in something you do not understand, even if it is paying 7.75 percent tax free interest with the potential of a capital gains play. Rich dad would say, “Before you invest in something, invest the time to understand it.” Kim has personally invested nearly fifteen years in this market and I have a few more years in the business. That is where financial intelligence comes from. It comes from investing time in the real world. Financial intelligence does not come from handing your money over to a fund manager and hoping and praying he or she does a good job. You do not increase your financial intelligence investing in that way. As stated earlier, many people invest but they fail to become investors. Investing in your fi-nancial education may not pay off early in the process but it does seem to pay off later. So I repeat that I am not recommending you call your stock broker and invest in municipal mortgage REITs, because as with all investments, there are good REITs and bad REITs. What I am strongly recommending is that you invest in your financial education . . . especially if you want to build a rich ark. In fact, I would say your financial education is mandatory for building a rich ark and keeping it afloat once it's built.

Why the Middle Class Is Risky Even Though They Play It Safe

Rich dad said to me, “The middle class plays it risky financially . . . and that is why they are such risky investors.” He went on to say, “The reason the middle class is taking a huge financial risk with a DC plan is because they invest a lot of money into the plan but they invest very little time learning to invest.

If you want to become rich, start out investing a lot of time before you begin investing a lot of money.” So before you switch your savings account over, in vest some time finding out about the investment.

Obviously, 7.75 percent return is not a high rate of return. But as I said, I used it as an example of the difference between a financially educated in vestor and a middle-class investor. I used the example only to point out the cost of the lack of financial education. In reality, as a professional investor, I like a minimum of 40 percent cash-on-cash return from my investments . . . which is why I do not invest any time saving money.

On many of our investments, Kim and I receive a return of infinity, which means we have no money making a lot of money. Our last real estate investment rental property yields a 45 percent return, cash-on-cash, most of it tax free. This 45 percent is actually received in two parts. We receive a cash-oncash return of 15 percent, which means that our net rental income exceeds the amount of cash we invested each year by 15 percent. Then when you add the impact of depreciation we have an additional tax savings, and therefore, additional cash return (cash we get to keep instead of paying the government) of 30 percent for this property. For us this 45 percent return is an average return on investment. Yet when I mention that rate of return to some of my friends, they think I am exaggerating or lying to them. Again, it is the difference in one's financial education.

So a 7.75 percent tax free interest return is interesting, but not particu-larly exciting. We use that rate simply to park excess money for periods of six months or more, while we work on putting the next investment together. When we need the money, we simply liquidate our position, often for a capital gain, and invest the cash. We sometimes use a vehicle called a C share annuity to park our money . . . and today a C share is paying 3.5 percent while a passbook is paying 1.85 percent. The advantage of the C share annuity is that it is as liquid as a Municipal mortgage REIT, it has lower risk, and for that lower risk, there is a lower rate of return. Since Kim and I do not need the money and we have time to play the share price or the REIT in the market, we prefer the REIT and its higher return. So far we have made money from the tax free dividends and the capital gains from selling the shares of the REIT. As I said, a financial education does pay in the long run.

Saving money in a bank may sound intelligent to many people, but for me it is a waste of both time and money. The reason I began with the subject of savings is because so many of the middle class think that saving money is intelligent . . . and it is for that class of people. But it is a financial drag for a rich person to save money because saving in the traditional ways makes no financial sense for a rich person. So before going into building a rich ark I want to bring up a few important points.

Point #1: If you plan on building a rich person's ark, saving money will eventually not make sense. Why? The answer is because the interest from savings is taxed at ordinary income levels . . . the highest tax rate there is. For example if you have a million dollars in savings, earning $20,000 from 2 per-cent taxable interest rate, and you earn more than $65,000 as a single person or $110,000 as a couple a year, that $20,000 will be taxed at approximately 30 percent, leaving you an effective return from your million dollars of about $14,000, which equates to an effective return of 1.4 percent before inflation. If you earn even more money, and are in the 40 percent tax bracket, that 2 percent interest rate return drops to a 1.2 percent effective interest rate. Let me assure you that inflation is running at more than 1.2 percent, so a rich saver is a loser. The point is if you are poor and at a lower tax bracket, the interest on your money is taxed at a lower rate. But if you are rich, your higher tax bracket causes that same interest rate to be taxed higher. So the more you save, if you are rich, the more you lose.

Point #2: If you plan on building a rich person's ark and you have a traditional DC plan, for example a 401(k), again, when you begin to withdraw money from your DC retirement plan, that income will be taxed at the highest levels. Again, the tax rates today are 30 percent for a single person earning over $65,000 a year. So for every $1,000 you receive in income from your 401 (k) after retiring, that $1,000 will be reduced to $700 due to taxes. Again, a 401(k) or most other traditional retirement plans do not make tax sense if you plan on retiring rich.

One of the reasons Kim and I use real estate is because with proper plan ning, we can reduce our taxes to 0 percent from our real estate income. That is why Dolf de Roos, my real estate advisor, states that the rich either made their money in real estate or hold their money in real estate. In other words, if you build a rich ark, income from real estate investments makes far more sense than income from a DC pension plan.

Point #3: Most people who aspire to higher income levels are not aware that they will lose the benefits of their itemized deductions as their income grows, including their home mortgage interest. A big house—the dream of the middle class—is not a write-off if you are rich. In America, if you earn less than approximately $137,300 in 2002, you are allowed by the tax code to write off some of your mortgage interest as a deduction from your taxes. But if you are rich, you lose that interest deduction. In fact, the higher your income the less you may deduct, to the point of not being able to deduct any of it.

The main point is that if you plan on building a big rich ark for retirement, you may have to let go of many of the traditional middle-class values . . . in vestments the middle class think are important. In other words there are some investments that work for the middle class, investments such as sav ings, DC pension plans, and interest deductions from your personal resi dence. But if you want to be rich, and plan on building a rich ark, those middle-class money values will have to go.

So the first step is to decide on what size ark you want to build. If you want to build a poor person's ark, or a middle-class ark, then stop here—the rest of this book is not for you. There are other books that will go into fur ther detail on how to build those sizes of financial arks.

This chapter started with the eighteen different opinions on how to build an ark . . . today almost everyone is handing out advice on ark building. That is because you and I are not the only ones that know the perfect storm is coming. You and I are not the only ones who know the problem has been pushed forward for too long. So after you decide on building an ark, then you decide if you want a poor ark, a middle-class ark, or a rich ark to ride out the storm in. As rich dad said to me years ago, “If you know the storm is com ing, the size of the ark really does not matter. The first step is to simply make up your mind to build one. After you have made that decision, then you de cide on the kind of ark you want to build, then begin building it, build it as quickly as possible, and don't stop until it's built.”

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