5 Pillars of Financial Education
Financial literacy & increasing your financial IQ are the only ways to take charge of your life and money. Unfortunately, most people don’t make the time to learn and immerse themselves into the world of financial education.
When it comes to financial planning, most people give these responsibilities to financial planners and accountants. They would rather pay someone to take that responsibility and spend the time to determine how they can succeed and become financially free. That’s a real shame because getting financially educated is a sure-fire way to financial freedom and early retirement.
Unfortunately, most people are not willing to spend the time to financially educate themselves. Financial education and literacy take time and effort…most things of importance take time and effort. When things go awry, people will blame their financial planners or other people, rather than blaming themselves for their own lack of effort in improving their financial IQ.
By being proactive and learning about money and finances, people can take charge of their own lives and that of their family. The financially educated are able to make big and tough financial decisions to improve their lives through financial freedom. Those with high financial IQs are also able to mitigate risk and find investments and assets that will give their family a safety net, passive cash flow and enough to retire early.
So what are you waiting for? Here is the start to your financial education journey.
Pillar of Financial Education #1:
Cash Flow versus Capital Gains
Most people invest for capital gains (also called ‘portfolio income’) because it is highly accessible and doesn’t require a high financial IQ. Essentially, you ‘buy low and sell high‘ and then you trade the capital gains for money. This can include stocks, cryptocurrencies and even flipping real estate. However, these investors are banking on an asset appreciating in value, which does not always happen.
On the other hand, investing for cash flow involves securing assets that provide a consistent source of income regardless of whether you work or not. This type of investing requires a much higher financial IQ, time and effort. It also involves a much lower tax rate. Investing for cashflow will help you become financially free.
Pillar of Financial Education #2:
Asset versus Liability
Most people think that they know what assets and liabilities are. Oftentimes, there are two trains of thought.
The first definition is from financial planners and accountants who classify an asset as anything that has value and a liability as anything that you owe.
Let’s take your home as an example. The house and land would be considered the asset whilst the mortgage, secured line of credit, expenses (property taxes, utilities, water & sewage etc) are considered liabilities. If your property value (sales price) is higher than what is owing, then you have a ‘net asset‘. A second example would be your car. The car itself is considered an asset whilst your car financing, insurance and maintenance are liabilities. If you can sell your car for more than what is owing, then your car is a net asset.
However, this doesn’t explain everything as the focus of this first definition from financial planners and accountants has to do with ‘future benefit‘ that may or may not materialize. This future benefit is in the form of ‘portfolio income‘ or what is also known as ‘capital gains‘. This is not assured as the ‘value’ of your home and car will fluctuate, while the liabilities associated with each perceived asset are constant or may increase over time.
The second definition is from financially educated people with high financial IQs who classify an asset as anything that puts money in your pocket and a liability as anything that takes money out of your pocket. For us, this definition makes much more sense.
Let’s revisit the example of your home. In the second definition, your house is actually a liability and not an asset. There is no income or cash flow coming in but there are lots of liabilities and expenses going out. Oftentimes, expenses associated with home ownership increase over time. A house takes money out of your pocket. In regards to your car, it’s also a liability as it does not put any money in your pocket.
A great example of how your home should be classified as a liability is what happened during the 2008 Global Financial Crisis. Many homeowners owed more money they their house was worth. Not only that, they still had to pay their monthly expenses. No money came in. Money just flowed out.
However, your home can become an asset if you can rent out a basement suite or room, storage or garage for consistent monthly cash flow. The same can be said about your car if you rent it out or use it as a business (car sharing or home delivery).
Pillar of Financial Education #3:
Good Debt versus Bad Debt
Not all debt is equal. Many financially uneducated people will scoff at the idea of taking out a home equity line of credit or secured loan against an asset because they deem all debt as equally risky. However, this is why they are financially uneducated, and likely not financially free. We agree that certain types of debt (like credit cards) and debt used for doodads (like extra clothes you don’t need or a boat that you can’t afford) are risky. This is called ‘bad debt‘ as it creates no value and becomes a liability (sometimes lifelong).
However, debt used in the correct way through leveraging with risk mitigation, can multiple your returns. You not only keep your existing assets (that may appreciated in value over time), but you also purchase more assets that may appreciate in value -and- provide consistent positive cash flow. This is how savvy investors with high financial IQ can get out of the ‘rat race‘ much faster and become financially free.
Here’s a simple comparison between good debt versus bad debt. Bad debt is when you max out your credit card buying ‘things’ that you simply don’t need. You pay upwards of 20-25% yearly interest and the debt never seems to go away. On the other hand, you can get a secured line of credit against your house, use the proceeds to purchase a rental property and make consistent passive income from collecting rent. Not only have you transformed your home from a liability to an asset, but you now have a second property that acts like an asset as well.
Pillar of Financial Education #4:
Most people assume. They assume that numbers won’t work or that there’s no way passive income (cashflow) is better than portfolio income (capital gains). They also assume that using debt of any kind is detrimental to their financial well-being and risky. Some also assume that one asset class is better than others. In most instances, these people are not financially educated and don’t have high financial IQs. They just assume, and keep propagating the same stories without actually doing research and crunching numbers.
Our advice to those who want to learn more is to look at the bigger picture whilst also looking at the numbers in detail. Some numbers are apparent and clearly easy to understand, like how much a rental property costs and how much rental income you can get. Other numbers are more ‘hidden’. These can include tax advantages (like how is your rental income being taxed in comparison to other forms of income -or- even write-offs like your cell phone, utilities, property taxes etc). Other more hidden numbers include mortgage principal paydown (i.e. how much of your mortgage payment is actually paying down your mortgage principal versus interest?). All of these numbers will give you a clearer indication and source of comparison to determine what investment is better.
For number crunching, we’ve included some great calculators for you to use on our website.
Pillar of Financial Education #5:
Make Your Own Financial Decisions
Most people with low financial IQs will follow or pay others to make the most important financial decisions of their lives. On the contrary, wealthy people who are financially educated have confidence in making the right investment choices to multiple their returns while mitigating their risks. This is the key to financial freedom and early retirement. They don’t follow crowds or the new and exciting investment trends popularized in mass media.
People who have high financial IQs will make their own financial decisions. Your financial education journey starts right here. Take the time and put in the effort and you will reap the rewards.