How to Invent Money
Early this week, I got an email from one of my podcast listeners.
His name is also Rohit.
He was reading this book, 'Rich Dad Poor Dad', written by Robert Kiyosaki.
In that book, he was reading chapter number five.
And there was a concept in that chapter, which he did not understand.
The concept was about: how to invent money.
So, he wrote me an email, asking me to explain that concept.
This is the reason why; I took up this topic for this particular post.
In chapter five, Robert is giving an example of a real estate transaction that he had done, just to illustrate the fact that, we can actually invent money.
So, the transaction goes like this:
The property was in Phoenix, Arizona, in the US.
There was this guy who owned this property, which was worth $75,000.
However, for some reason, he had declared personal bankruptcy, which means, he was not in a position to repay the mortgage on that property.
Who knows, maybe he was going through a divorce, or maybe he lost his job.
Whatever be the reason, the property ultimately landed in the bankruptcy lawyer's office.
Robert is a smart investor.
He was not shopping for real estate in the normal market.
He was shopping for real estate in the bankruptcy lawyer's offices.
That is how he found this property.
So, Robert offers to pay $20,000 for this property, because he knows, that the seller is not in a position to bargain.
He knows that the seller needs to get rid of the property, to get rid of the mortgage he has on the property.
This was the reason; the seller and the bankruptcy lawyer were more than willing to accept this deal.
So, Robert was getting a property for $20,000, which originally was worth $75,000.
But there was one problem here.
Robert did not have the $20,000 to pay for the property.
Forget about $20,000.
Robert did not even have the 10% down payment to pay for this property.
10% of $20,000 is $2,000.
So, Robert goes to his friend to borrow $2,000, for three months at an interest rate of 10%, which by the way, is a very expensive loan from a friend.
He makes a promise to his friend that, he will return the $2,000 and an additional $200, in three months.
That was the deal.
That's how Robert came up with the $2,000 down payment for this property.
The remaining $18,000: He borrows from the bank to complete the deal.
Robert is a smart investor.
He runs an ad in the newspaper that this property is now available for sale at $60,000.
He offers a $75,000 property in the market for $60,000, without requiring the buyer to put up any money upfront.
Basically what that means is that: the buyer can take control of the property without making a down payment.
But, he has to make a promise to Robert, through a 'promissory note', that the money will be paid over a period of time.
Now, those days the stock market was rising.
People were making money in the stock market.
Those people who were making money in the stock market suddenly see that the $75,000 property is available for $60,000.
They began rushing to buy this property from Robert.
Robert says in the chapter that, he was able to sell the property in just a few minutes.
So now, the buyer agrees to pay $60,000 for the property, not immediately, but over a period of time, because the property was advertised by Robert as a 'no money down' deal, which means, the buyer is not required to make any payment upfront.
However, in the deal, Robert puts a condition that the buyer must pay $2,200 as a processing fee to complete all the formalities.
This means, the buyer has to pay $60,200 in total, out of which $2,200 needs to be paid immediately in cash and the rest could be paid later.
So, Robert gets to keep the $2,200 cash.
Robert simply takes that money and gives it to his friend, as agreed.
That's $60,200 minus $2,200 cash: that's $58,000 remaining.
Now remember, whoever is the buyer, has to take control of the $18,000 mortgage, that Robert has on the property, if the buyer wants to take control of the property.
If you look at this deal from the buyer's point of view, he is first paying $2,200 in cash to Robert as a processing fee.
Then he is taking on a debt of $58,000, out of which, $18,000 goes to repay the debt that Robert had taken.
And the $40,000 is the remaining amount that the buyer actually owes to Robert now.
And this $40,000 need not be paid today.
It can be paid over a period of time, through a promissory note, as per the deal.
A promissory note is nothing but a bond.
It is a promise made by the buyer to the seller, that the buyer will pay the $40,000 to Robert, but over a period of time at a rate of 10% per year.
It's like the buyer has taken a $40,000 loan from Robert at 10% interest rate.
It is as simple as that.
The $18,000 debt that Robert had on the property is gone, because the buyer has taken the responsibility to repay that loan.
Plus, the $2,200 that Robert owed to his friend is also gone, because that money was paid in cash.
Now, if you look at this deal carefully, how much money did Robert have of his own, in this property?
But, he ends up creating an asset of $40,000 for himself.
That promissory note is nothing but an asset for Robert, because it puts money in his pocket every year.
If he would have sold the property for $60,200 cash, then Robert would have been liable to pay capital gains tax on his $40,000 profit.
That's a lot of money to pay, in terms of tax.
The promissory note avoids the problem of paying tax.
Another point is the property was not bought by Robert in his personal name.
If he would have done that, any gain on selling the property would be taxed directly to Robert.
Instead, Robert had done the deal through his real estate company.
So now, the income from the promissory note is not personal income, its business income for Robert.
Whenever you make business income, you can use that income to pay for normal business expenses, which are legally allowed, so that you can reduce your tax liability.
Because, business income minus business expense, is the remaining profit and you have to pay tax on the remaining profit only, not on the entire business income.
Whatever interest Robert is earning from the promissory note, he is using it to pay for his business expenses.
So basically, he is legally avoiding paying tax on the property deal.
This is the reason why Robert says, by investing no money of his own, he was able to create a $40,000 asset for himself, on which he is not liable to pay tax.
That was how, he was able to invent money.
This is like creating money out of nothing, right?
I have simplified this example to a great deal, so that you can understand this.
If you look at this deal in totality, the guy who initially owned the property was bankrupt.
So he was happy to do the deal with Robert to get rid of the property.
The bankruptcy lawyer was happy too, because he was able to get rid of the property and finish up the formalities.
He never owned the property in the first place.
Robert is of course happy, because he is able to create a $40,000 asset for himself.
Even the new buyer who bought the property is also happy, because he is getting a $75,000 worth of property for only $60,000.
And that is the money that he has probably made in the stock market.
And of course, the bankers who own the mortgage on the property were happy too, because now, the property is with someone who can actually repay the money.
Bankers are never interested in the property itself.
Bankers are always interested in the interest income they earn on the property mortgage.
So this deal made everyone happy.
That's how money was created by Robert.
It was invented out of nothing.
This was the example I wanted to discuss with you.
This example opens up our mind to opportunities available out there.
This example also helps us understand that, it doesn't take money to make money, or it doesn't take money to create an asset.
If you have not yet read the book, 'Rich Dad, Poor Dad', please go grab it as soon as possible.
Buy the hard copy.
Don't read it on Kindle.
You need that book physically with you, because you must read that book multiple times.
I have been reading that book for over 20 years now.
Yes, I had first read it, back in 1999.
Go to chapter number five.
This example is clearly mentioned there, with the help of a diagram, so that you can understand it better.
Rohit Musale, CFA
29 December 2022