Rich Dad's Cashflow Quadrant
BY ROBERT T. KIYOSAKI
Do you work increasingly long hours with nothing to show for it, or struggle to have enough left to save after all the bills? Robert Kiyosaki, author of the viral book Rich Dad Poor Dad, explains how anyone can move to the other side of the Cashflow Quadrant and flourish with financial independence as a business owner or investor.
Read this book summary to discover a new approach to wealth and risk management and apply your learnings in real life so you can start with small steps that can eventually lead to substantial assets.
TOP 20 INSIGHTS
Everyone can be categorized according to how they get their money: Employee, Self-employed, Business owner, or Investor. Each of these four categories, or quadrants, has its strengths, weaknesses, and characteristics.
Employee, or the E-quadrant, values security above all else and seeks the safety of a long-term contractual agreement. This person works within someone else’s system to earn money.
The Self-employed person, or the S-quadrant, does not want their income to be dependent on other people. They essentially own their job and is likely a hardcore perfectionist who values independence and expertise.
Self-employed is the riskiest quadrant. Nationally, nine out of ten such businesses fail in the first five years, mostly due to a lack of experience and capital. The key to success in this S-quadrant is to know when to get out and move onto something new.
The Business owner, or the B-quadrant, has a system where other people do the work— like Henry Ford, who surrounded himself with smart people who knew all the answers so that he could concentrate on new ideas.
The Investor, or the I-quadrant, uses money to make money. The opportunity for real wealth lies in the I-quadrant.
E- and S-quadrant stock market investors focus on diversification. But as Warren Buffett advises, diversification is a way not to lose money, rather than a way to make money. The better strategy is to focus on a few investments, not on diversification.
To quote Buffett: “Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.” Don’t hand over your investment decisions to an “expert.”
The right side of the quadrant is the safe side. With a secure system that produces money for you, you don’t need to worry about unemployment.
The secret to wealth is the same as the secret to win the game Monopoly: buy four green houses and then trade up for a large red hotel.
Your mortgage is a liability and a debt that you have to service, not an asset. Even if you pay off your mortgage, your house is still a liability: it has to be maintained, and you have to pay taxes on it. Property is only an asset if it generates income through positive cash flow.
Gold is not necessarily the ultimate asset: “Even gold is only an asset if you buy it for less than you sell it for.”
The ideal path to financial independence is to move from quadrant E or S into quadrant B, and from there into quadrant I. A financially successful Business owner will have the skills, time, and money to support the ups and downs of the Investor.
You don’t become rich when you work hard to make money that you then spend, you become tired. Kiyosaki lived modestly for years and worked hard not to pay bills but to acquire assets.
People who fear loss buy a stock at $20, then sell it as it rises lest they lose what they gained. They also hold on when it slides down to $5 with hope that price will come back up. The Investor is neutral on wins and losses and only sell a stock when it has peaked or as soon as it starts to slide.
To start on your path to financial freedom, write down where you want to be financially one year from now and five years from now. Draw up personal income and balance sheet statements to show all your income, expenses, assets, and liabilities.
To eliminate your consumer debt, put aside $150-$200 every month to pay down credit cards, then car payments, then your mortgage. Most people can be debt-free in five to seven years. Put what you used to spend to service your debts into assets that generate income.
Educate yourself. Spend at least five hours a week to read the Wall Street Journal, listen to the financial news, read financial websites, magazines, and newsletters, or attend seminars on investment and financial education.
Become an expert at one particular type of problem. Bill Gates is an expert who solved software-marketing problems. Warren Buffett is an expert who solved stock market problems. Kiyosaki became an expert who solved problems in apartment housing.
Acquire assets that provide passive or long-term residual income. Start with small steps, the “green houses” of Monopoly, and gradually build up to larger investments.
The Cashflow Quadrant categorizes people based on where their money comes from—Employee, Self-employed, Business owner, or Investor. The greatest freedom comes from owning a Business where other people do the work for you or being an Investor who uses money to make more money. You can move from being an Employee or Self-Employed to being a Business owner or Investor, if you change your ideas about money and risk. Map out a plan to get control of your spending habits and minimize your debts and liabilities. Live within your means and start saving a small amount each month. Get financially educated and become an expert at solving one particular business problem. Focus on building assets that generate passive or long-term income. Take baby steps toward your goal. Seek mentors, learn from your disappointments, and believe in yourself.
WHAT IS THE CASHFLOW QUADRANT?
Growing up, Kiyosaki’s well-educated father recommended he aim for the E or S quadrants. But his father, who spent his life in these quadrants, was always relatively poor. On the other hand, Kiyosaki’s best friend had a father who was a high school dropout but made it into the B and I quadrants and was wealthy. It was this “rich dad” who explained the Cashflow Quadrant.
At its simplest, the Cashflow Quadrant is a way to categorize people based on where their money comes from: E, S, B, or I.
E stands for an Employee, someone who earns money by holding a job. S is Self-employed, earning money for themselves. B stands for Business, meaning someone who owns a company or system that generates money for them. And I is an Investor, someone who earns money from their various investments.
We all fall within at least one of these quadrants, and each quadrant’s members share common characteristics and have different strengths and weaknesses. You can find financial freedom in any of the four quadrants, and you can be rich or poor in any of them, but the particular skills needed in quadrant B or I will help you reach financial freedom more quickly.
The Employee values security above all else. They hate the feeling of fear that comes with economic uncertainty. The Employee could be a janitor or a CEO - it is not what they do that’s defining, but the fact that they seek the security of a long-term contractual agreement. The Employee tends to focus on income, not on assets and works within someone else’s system to earn that income.
The Self-employed person likes to be their own boss and does not want their income to be dependent on other people. They expect to be paid more if they work more and are fiercely independent about their money. Unlike the E, the S responds to fear not by seeking security, but by taking control and doing it themselves. The S is often a hardcore perfectionist who values independence and being respected as an expert in their field. An S essentially owns a job and is the system that makes money.
In many ways, this is the riskiest quadrant. Failure rates are high and success means working even harder and for longer. Nationally, nine out of ten such businesses fail in the first five years, mostly due to a lack of experience and capital. The wise S sells their business at its peak, before they run out of steam, to someone with energy and money, then takes the earnings and starts something new. The key to success in the S quadrant is knowing when to get out.
Unlike the Self-employed person, the Business owner does not want to do it all themselves, but to surround themselves with others who do the work. Henry Ford is a prime example of a B quadrant. There is an often-told story of what happened when some intellectuals condemned Ford, saying he didn’t know much. Ford challenged them to come and ask him anything they liked. The intellectuals lobbed several questions at him. When they were done, he called in his brightest assistants to give the answers. He told the intellectuals that he hired the smartest people to come up with answers so that his mind was clear to do more important tasks, like thinking.
The big difference between an S and a B is that a successful B can leave the business for a year and find it’s still running profitably. The B owns or controls a system that makes money. For example, many people believe they can make a better burger than McDonald’s. But McDonald’s is not just about the burger, it’s about the system that makes and serves the burger. Bill Gates didn’t build a great product, he bought someone else’s product and built a powerful global system around it.
The Investor makes money with money. The I quadrant is the playground of the rich, where money is converted into wealth. In the I quadrant, money works for you.
Types of investors
Some forms of investment, such as getting an education or saving money in a retirement plan, do not really belong in the I quadrant. Rather, the I quadrant is about investments that generate income on an ongoing basis during your working years. Ideally, everyone should put some money in the I quadrant, where it can make more money.
Many people are afraid to start investing because they are afraid of risk. They want to play it safe by keeping their money in a bank or handing over the decisions to a professional investment manager. But, most of these “experts” are themselves in the E-quadrant, working for a paycheck. As Warren Buffett said, “Wall Street is the only place that people ride to in a Rolls Royce, to get advice from those who take the subway.”
“Investing” in a pension plan means you don’t see your money for many years. Someone in the Investor quadrant doesn’t park their money, they recoup it quickly and put it to work again. Many investors in today’s stock market are E and S quadrant folks who are, by definition, security-oriented, buying into notions like diversification. But as Warren Buffett says, “diversification is a way not to lose money, rather than a way to make money.” The better strategy, he says, is to focus on a few investments, not on diversification.
ASSETS AND LIABILITIES
The key to being a successful Investor is learning how to manage risk. You have to get a financial education so that you can invest with your mind, not your eyes or your emotions. For example, being financially intelligent means recognizing that a mortgage is not an asset; it’s a liability, a debt that has to be serviced. Your mortgage is an asset for the bank, not for you. Even if you pay off your mortgage, your house is still not an asset—it has to be maintained, and you have to pay property taxes on it. Property is only an asset if it generates income through positive cash flow.
Your savings are an asset, but any debt is a liability. Most people believe that gold is the ultimate asset, but as Kiyosaki’s Rich Dad mentor put it, “Even gold is only an asset if you buy it for less than you sell it for.”
THE BEST PATH
The ideal path to financial independence is to move from quadrant E or S into quadrant B, and from there into quadrant I. A financially successful B will have the skills, time, and money to support the ups and downs of the I.
The goal of quadrant B is to own a system and have people work that system for you. There are three main ways to do this. The first is the traditional C-corporation, where you develop your own system. The second is to buy an existing system in the form of a franchise—this can be tough for someone with an S-mentality who wants to do their own thing but is still a way to learn a lot about running a business. The third way is network marketing, or direct distribution marketing, where you become part of an existing system. This can be a good way to generate enough income to begin investing; just make sure you pick a network marketing organization that is focused on educating you and helping you to succeed, and that has a proven track record and a strong mentorship program.
CHANGING WHO YOU ARE
The hardest part about migrating from the left side of the quadrant, the E and S side, to the right side, the B and I side, is changing the way you view and get money.
THE RISKY SIDE OF THE QUADRANT
The left side of the quadrant is the risky side. As an E, you are dependent on someone else for your income. If you are not financially educated, you are dependent on someone else’s opinion.
The right side is the safe side of the quadrant. With a secure system that produces money for you, you don’t need to worry about losing your job; if you want more money, you expand the system and hire more people.
Whenever people ask Kiyosaki the secret to his getting rich, he replies that he played Monopoly as a kid. The game taught him that the way to win is to buy four green houses and then trade up for a large red hotel. The same rule worked in his life. When the real estate market was in bad shape, the author and his wife bought as many small houses as they could, with the limited money they had. When the market improved, they traded up—now, the cash flow from their large red hotel, apartment houses and mini-storage units, pays for their lifestyle.
To move from the left side of the Cashflow Quadrant to the right side, the thing that has to change is not what you do but rather how you think. Working hard to make money that you then spend on stuff doesn’t make you rich; it makes you tired. Kiyosaki lived modestly for years, working hard not to pay bills but to acquire assets.
When anyone is thinking about moving from the left side of the quadrant to the B or I side, Kiyosaki tells them to start small, with the little green houses; take their time, and only move on to big red hotels after they’ve gained some confidence and experience.
Money is emotional. Just take a look at the stock market, where greed and fear dominate. When it comes to money, stop thinking emotionally; don’t focus on what you feel and especially not on what you fear. Remember, failure is inevitable. Eventually, you will stop worrying about failure because you will realize that you can always get up again.
People especially fear to lose—they will buy a stock at $20, then sell it at $30 because they are afraid of losing their gains; but if they’d held on for longer, the stock would have reached $100 or more. The same people will also hold onto a $20 stock as it slides down to $5, hoping the price will come back up.
A winner takes the opposite approach—as soon as a stock starts to go down, they sell and take their losses. When a stock is rising, they hold on until they know it has peaked. In other words, the key to being a great Investor is to act rationally and be neutral to winning and losing.
SEVEN STEPS TO FINANCIAL SUCCESS
Kiyosaki emphasizes the importance of starting your transition to financial success with baby steps: “You’ve got to walk before you can run.” But it’s equally important to bear in mind Nike’s slogan, “Just do it.” Sketch out your big goal, then start taking baby steps to get there, while educating yourself as much as you can.
STEP 1: MIND YOUR OWN BUSINESS
Start by figuring out your personal financial statement. Write down where you want to be, financially, in five years, and a smaller short-term goal of where you want to be in one year. Make sure your goals are realistic. For example, “In five years, I want to increase my monthly income from assets to $xx. In one year, I want to decrease my debts by $xx.”
Draw up an income statement for yourself, showing your current sources of income and your expenses; and a balance sheet that lists all of your assets (savings, investments, real estate, etc.) and liabilities (mortgage, loans, etc.).
STEP 2: CONTROL YOUR CASH FLOW
Look at your Step One financial statements. Which part of the Cashflow Quadrant does your income come from today? Which part do you want most of it to come from in five years? Now, draw up your two-part cash-flow management plan.
First, put aside a percentage of every paycheck into an investment savings account and don’t take any of it out again until you are ready to invest it.
Next, focus on reducing your consumer debt. Use only one or two credit cards every month and always pay off new charges every month. Figure out how to generate an additional $150-$200 every month and apply this to paying down the balance on one of your credit cards. Once you have paid off the first card, move on to the next one. Once your consumer debt is all paid off, do the same with your car and house payments—most people can do this within five to seven years. Once you are debt-free, take the monthly amount you were spending on your last debt and put the money toward investments that build your asset column.
STEP 3: GET EDUCATED
Learn the difference between an asset and a liability. At its simplest, an asset is something that makes cash flow into your pocket; a liability makes cash flow out of your pocket.
Spend five hours a week doing one or more of these things: reading the business section of your newspaper and the Wall Street Journal, listening to the financial news on TV or the radio, reading financial websites, magazines, and newsletters, and attending seminars on investing and financial education.
STEP 4: LEARN TO SOLVE PROBLEMS
Financially uneducated investors look for “experts” to tell them what to invest in, whereas educated Investors become experts at solving one particular type of problem. For example, Bill Gates is an expert at solving software-marketing problems. Warren Buffett is an expert at solving business and stock market problems. Kiyosaki and his wife are experts at solving problems in apartment housing.
Continue getting educated. For example, if you’re focused on apartment housing, look for For-Sale signs in your area. Call the agent and ask about the property’s current rent and maintenance costs, and what types of financing are available. Practice calculating the monthly cash-flow statement for each property. Every week, go to financial seminars and classes and study investment newsletters. Research companies recommended by stockbrokers and consider opening a trading account to make some small investments. Meet with business brokers in your area and learn what is for sale. Go to trade expos to see what franchises or network marketing companies are available in your area.
STEP 5: SEEK MENTORS
Kiyosaki’s Rich Dad mentor taught him to focus on passive income and spend his time acquiring assets that provide passive or long-term residual income. Remember, most of the people giving financial advice are themselves stuck in the E or S quadrants, so choose your mentors carefully. Look for people in the investment and business quadrants.
STEP 6: GROW FROM DISAPPOINTMENT
Expect to be disappointed and have a mentor standing by to help when you have a financial emergency. Be kind to yourself—you won’t learn anything new if you punish yourself for every disappointment.
Above all, take action! You cannot grow unless you start acting—make offers on real estate, join a network marketing company, or buy a stock you have researched. Just remember to start with baby steps and know that making mistakes is how you will learn.
STEP 7: BELIEVE IN YOURSELF
Listen to your doubts and fears, then dig down to find the real truth. You may say to yourself, “I’m too tired to learn something new.” But the real truth is: “If I don’t learn something new, I’ll be even more tired.” The even deeper truth is: “If I learn something new, I’ll get excited about life again.”