Here’re the 2 things from Rich Dad that I have to disagree:-
Return on investment (ROI)
Rich Dad provides with a lot of examples showing the returns from rental properties. Here’s an example:- a unit at cost NZD 500,000, requires downpayment for NZD 200,000 (40% for NZ investor), thus NZD 300,000 bank loan at interest rate 5% pa.
Rental income is NZD 2,500 per month, Mortgage payments approximate NZD 1,500 per month (NZD 1250 and NZD 250 for Interest and Principal respectively); other outgoings amounting to NZD 100 per month.
Here’re the ROIs in the 1st year:-
Rich Dad = 6.9% pa; ErnieWong = 6.8% pa;
And the ROIs in the 2nd year:-
Rich Dad = 6.9% pa; ErnieWong = 6.7% pa
So why in the 1st year that Rich Dad’s ROI is larger than ErnieWong’s? And how come in the 2nd year the difference becomes more apart?
The cause lies in the treatment of principal from the table loan. Rich Dad simply ignores the principal paid each year and just divide the net profit by the initial investment (the downpayment of NZD 200,000).
ErnieWong’s ROI includes the principal paid (NZD 3,000 pa) and adds these to the initial investment of NZD 200,000. As the investment or equity increases while the net profits stay the same, the resulting ROI decreases.
Insurance not equal to hedging
When discussing about investments/trades on paper assets, eg. options, Rich Dad has mentioned that hedging is like property insurance. The concept is “roughly” correct, ie you spend a little amount to protect the existing much larger assets. However the actual things that these little amount protect are very different. Let me explain below:-
Property insurance covers properties when they are damaged or sabotaged; they do not cover the value of the same properties when they are going down.
Hedging employed in financial derivatives, however covers in part or in full (depends on your hedging ratio) of the initial investments, regardless of the values going up or down.
Take the same property from the ROI example; the cost is NZD 500,000, when value dropped by 5% its mark-to-market value is $475,000, the property insurance in this circumstance does not cover any loss in value at all.
For the same amount NZD 500,000 on FX straddle 1:1 NZDJPY – I am buying $500,000 NZDJPY and am selling $500,000 NZDJPY. When NZDJPY depreciates by 5%, my buying position lost by 5% but this is well covered by my selling position. And therefore no loss in value.
It’s very easy to blindly accept lessons and ideas from specialists or experts. From the above 2 examples, you are now able to understand truth and facts.
Just because it’s commented by so-called experts it does not mean that they are telling the truth. Just because some economists forecast that the Fed will hike rate and USD will therefore strengthen or gold will weaken, and we should be “blindly” following their “tips” to invest or trade.
To become financially literate, we need to learn and think!
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