The Velocity of Money
By Rob Minton
This lesson is really adapted from Robert Kiyosaki’s book, “Who Took My Money?” I strongly encourage people to read this book. He writes that the Velocity of Money is the one reason why rich get richer and the average investor risks losing it all. I agree. From Robert’s book:
“As a professional investor, I want to …
1. Invest my money into an asset.
2. Get my money back.
3. Keep control of the asset.
4. Move my money into a new asset.
5. Get my money back.
6. Repeat the process.
When I teach my real estate investing concept of having homes buy more homes, I am teaching Robert’s velocity of money concept. I read Robert’s book in the summer of 2005. Little known to me, I was already teaching the velocity of money and didn’t really realize it. Thankfully, I was already utilizing it with my investing.
To give you an example: Let’s assume you purchase a nice single-family home for $200,000. To purchase this home, you use a 5-percent down payment loan program and invest approximately $10,000. You use a fixed, interest-only loan program and your total monthly payment is, say, $1,400. You offer this home on a Rent to Own Program. Your new tenant/buyer gives you $6,000 up front on this lovely home and picks a program paying you $1,695 a month in rent.
After collecting your up-front payment, you would still have $4,000 invested in this property ($10,000 down payment less that $6,000 upfront payment received from your tenant/buyer). Your monthly cash flow would be approximately $295. (Rent of $1,695 less your payment of $1,400) It would take you another 13 1/2 months to recover your remaining $4,000 invested. ($4,000 divided by $295 monthly cash flow) In this example, it would take you around 14 months to complete steps 1, 2 and 3 above.
You would have invested in an asset, gotten ALL your money back and kept control of this same asset. Now you are on to step 4, which is move your money into a new asset. Robert continues his teaching as follows:
“A professional gambler wants to be playing the game with house money as soon as possible. While in Las Vegas, if I had put my money back in my pocket and only played with my winnings that would have been an example of playing with house money.
The moment I began betting everything, I lost the game because I lost sight of my goal, which is to stay in the game but to play with other people’s money … not my own money.”
When you come to a point in your investing at which you have gotten all of your money back and still own the asset, you are playing with house money. In this example, after Month 14, you would still receive a cash flow of $295 a month until the property sells. This is all house money. Now let’s move on and assume that the your tenant/buyer doesn’t purchase your home during the Rent to Own Program.
In four years, your $200,000 home would be worth $243,000 with a 5-percent appreciation rate. This appreciation would ALL be house money. You could then borrow a portion of this increase in equity tax-free. You could refinance this home at 90-percentloan to value. A 90-percent loan on a $243,000 home amounts to $218,700, less your current loan on the property of $190,000 would provide you with $28,700 tax-free (Current loan is $200,000 initial purchase price less your $10,000 down payment).
At this point in time, you would have recovered your $10,000 investment, plus taken in an additional $10,030 in positive cash flow and borrowed out another $28,700 tax-free. This amounts to roughly $48,000 in four years. Remember, you still own the original asset — the $200,000 home.
Now, here is where the fun starts to happen. What can you do with the $48,000? Could you use this $48,000 as a 10-percent down payment on a $480,000 asset? Let’s assume you do. What do you think the cash flow would be on this property? Maybe $10,000 a year? In a few years, both of these properties could be refinanced to pull out more money to invest into another asset, creating even more cash flow.
For example, at an appreciation rate of 5 percent a year, the $200,000 home would be worth $295,000, and the $480,000 property would be worth $583,000. You could borrow another $100,000 out of these properties and use as a 10-percent down payment on a million-dollar property. What would the cash flow be on a million-dollarproperty?
Your assets double when you separate your equity from your properties. Can you see what I mean? Can one property properly managed make you a millionaire?
Now if you really think about what happened in this example, you will see that you were making your money work extremely hard for you. You didn’t let it sit idle as equity in a property. The key point for you to realize is that equity in a home is idle money. Idle money provides zero return.
If you only take one piece of advice from this report, make it this one …
FUNNELL ALL YOUR INVESTMENTS THROUGH YOUR REAL ESTATE
Most people are making contributions to their company 401(k) plan or some kind of IRA account. These contributions are paid, in most cases, directly out of your pocket. If your company contributes automatically to your retirement plan from your pay check, this is still directly out of your pocket. I truly believe this is a massive wealth destroyer.
Instead take these contributions and invest them into real estate. Then invest the cash flow from the real estate into your IRA or retirement plan. To be clear, I am not saying don’t invest in your IRA. I am saying to insert real estate in between your direct retirement plan contribution. Buy an asset (real estate) and have that asset fund your retirement plan.
This is the advice that will get many people up in arms. I know Money Magazine tells you to maximize your 401(k) contributions. I know you parents would tell you to put everything into your 401(k). I know your company’s human resource department would tell you to invest into your company 401(k). I know. I have been there. I remember all of my co-workers at the international accounting firm I worked for talking about how much they were each contributing into their 401(k)s. They thought I was crazy for investing in real estate. They thought I was a real wacko when I next quit my high-paying job to invest in real estate full-time. I can still hear the jokes and snickers.
This will happen to you, too. Everyone will think you are making a big mistake. The reality is the other way around. You will be making a big mistake listening to everyone else. Please, please listen to this advice. I cannot tell you how powerful it is. I can hear you say, “Well my company matches my contributions.” I don’t care. Your first investing dollars go into real estate. Real estate dollars then go into your retirement plan. Don’t worry about your company match is because it is insignificant compared to what will happen if you follow this advice.
I bought real estate to create cash flow. I used the cash flow to quit my job and start my own company. The profits from the first company were used to start a new company. All of this while my “laughing” co-workers are still arguing over how much they should invest into the company 401(k) plan.
Now, I have all of the real estate, company No. 1 and company No. 2. All of these can funnel my retirement, living expenses, new companies and/or additional assets. This is the velocity of money in action. The key is where your FIRST investing dollars go. If they go to a traditional retirement plan, you aren’t creating velocity. You can’t leverage a 401(k) plan.
Now had I followed the traditional approach, I would still be working as a public accountant. I would be investing 10 to 15 percent of my income into the company 401(k) plan working at a job that I couldn’t stand.Yes, I might have more money in my 401(k) plan—yippee. I wouldn’t have any assets working for me. Funding the real estate first was the best decision I have ever made in my life. I really don’t care about the amount of money I have invested. I care about the assets I have working for me.
Most people are focused on the size of their portfolio. As Robert Kiyosaki’s book teaches, your focus should be getting your money back and reinvesting, not letting it accumulate. He writes, “In my world, the velocity and safety of my money is far more important than the amount of my money ... Only amateur investors put their money in their retirement plan and set the parking brake”
I like retirement plans. Don’t get me wrong. I just want you to fund your retirement plan from house money. House money is much better than your money. Don’t you agree?
There are many choices for you to invest your house money. Here are just a few:
1. Build an emergency fund for your family.
2. Invest in more real estate — houses buy houses
3. Pay off credit card debt or other loans
4. Invest into your retirement plan/IRA
5. Invest into a mutual fund/stocks or bonds
6. Start a new business
7. Buy and resell a mobile home
8. Invest into someone else’s business
9. Invest into a Whole Life Insurance Plan
10. Invest into seminars/books and audio programs
11. Hire people to assist you with your investments
12. And many more …
Ok, how do you decide from all of these choices? Where do you invest your real estate profits or house money? I don’t think there is any one correct answer. The answer depends on your current financial position and tolerance for risk.The safest option is to build an emergency fund for your family. An emergency fund is money set aside to cover several months of your family’s living expenses.
This money is parked in an interest-bearing liquid account, like a money market account. The emergency fund is for handling emergencies. A job loss, a big medical bill or a major expenditure you hadn’t planned on having. It is your family’s safety net.
This option probably provides the lowest actual return on investment, but it provides the absolute best peace of mind. I have around five months of my family’s living expenses tucked away for emergencies.Now, this wasn’t the case for many years. In the beginning of my journey, I operated without an emergency fund and invested everything back into real estate to build more cash flow. I have a very big tolerance for risk. This decision was truly risky for my family. However, at the time, I didn’t have any children. Now that I am a little older with a family, I have prepared for any unforeseen emergencies.
If you don’t want to save thousands of dollars for your emergency fund, you should at a minimum keep a line of credit open and available. You can access this line of credit to cover your emergencies. The problem occurs when you don’t have savings or access to money when rocky times hit. If you lose your job, the banks will not loan you any money.
You could put your family in massive jeopardy if you don’t have a credit line established before the emergency hits. When I was operating without an emergency fund, I kept credit lines open and available at all times. I used these credit lines from time to time to save me. In fact, I took cash withdrawals from credit cards to make payroll on several occasions!
The easiest way for you to acquire your emergency fund is to sell an investment property to your tenant/buyer and not reinvest the sales proceeds. You will have to pay taxes on your gain, but your emergency fund will magically appear. You could also refinance an investment property and put the proceeds of you new loan into your emergency fund. Now if you didn’t own any real estate, what would you have to do to build an emergency fund? You got it ... You would have to save it from your weekly paycheck. How long would it take you to save several months of your living expenses?
Forever. … Many people don’t have emergency funds because they don’t have a fast, painless way to build it. Can you see how funneling my first investing dollars into real estate helped me build an emergency fund quickly and easily? If my first investment dollars didn’t go into real estate, would I have an emergency fund? No.
The next option for your real estate profits is paying down debt. This option is also ultra-safe and highly recommended. Believe it or not, it provides a handsome return on your investment. A quick check on bankrate.com showed the average credit card interest rate at 13.64 percent. In my opinion, paying down your debt beats investing in the stock market every single day of the week. If you have credit cards in this range of interest rates, you would be investing your money at a fixed 13.64-percent interest rate. You can’t beat that in the stock market.
Maybe Warren Buffet can, but average folks like us can’t. There are many different strategies to debt reduction, which I won’t cover in this newsletter. But is a safe and profitable option to choose. When I say debt, I mean all car loans, credit cards, other consumer loans. These loans typically have higher interest rates and are not tax deductible.
By the way, you can quickly pay off large credit card balances from the sale of one of your investment properties to your tenant/buyer or from the loan proceeds when refinancing one of your properties.
Another option would be to investstarting your own business or investing into someone else’s business. Now, this is a very risky option. Everyone knows the failure rate of new businesses. Only around 4 percent of all businesses ever surpass a million dollars in revenue. However, a small business without much overhead could be good option for you. If you plan on taking this route, please learn marketing and sales skills. If you aren’t willing to learn these skills, don’t start your own business. You won’t make it. Sorry for the tough love, but you will thank me latter.
One word of caution when discussing where to invest your house money. Make sure that you don’t cut down your money tree. For example, last week one of my tenants bought out one of my rent to own homes. I got a check for $24,000.I didn’t use a 1031 exchange on this sale and actually received the money. This means I owe taxes on my gain.
However, I will not just take this entire $24,000 out of the game. By the way, the entire $24,000 is house money. If I were to take the entire amount and pay off debt or set up an emergency fund, I would be taking all of the money out of the game. The house money would completely disappear.
At a minimum, I would recommend that you invest at least half of the money back into more real estate. In this example, you could take $12,000 and use to pay off debt, start business or setup an emergency account. However, $12,000 MUST go back into real estate. Real estate is the goose that lays golden eggs. Don’t kill the goose.
I know that my way is the hard way. It is a lot easier just to make contributions into your company 401(k) plan and not think about it.
Let’s face it, you don’t have to go look at homes. You don’t have to show your properties. You don’t have to go through any evictions. But you do have to work until your 65. You more than likely won’t be able to live the life you really want in retirement.
I started investing in real estate around 1994. I started company No.1 in October of 2000. I started company No. 2 in August of 2005. The velocity of money has taken me to new levels every five years. My guess is that it will be the same for you. Where will you be in 2010?
To get more information on the strategies I used to begin my real estate investing, call the real estate information center at 1-888-845-9670 and enter ID ?. Leave a message with your mailing address.
Minton is a CPA who left the world of public accounting to pursue a career in real estate. The president of The Home Selling Team, Inc., in Cleveland, Ohio, he has since been a successful broker, author and consultant. An investor in all types of properties himself, his Income for Life program of deals with single-family homes in desirable locations bought and sold with a proven rent-to-own method outlined at www.quitworksomeday.com.