Putting Debt to Work for You

I attended my first real estate investment class in 1974. The two-day program cost me $385, which was a fortune at the time since my salary was less than $1,000 a month.

After months of searching for my first investment property, I found a tiny, one-bedroom, one-bath condo in Lahaina, Maui, the world famous beach resort. The condo was priced at $18,000. Not having any money, I used my credit card to finance the 10 percent down payment of $1,800.

In other words, I used 100 percent debt to buy the property.

Even though I was leveraged 100 percent, which I do not recommend even though I did it, I was netting approximately $20 a month positive cash flow after all expenses and debt were paid. At the age of 27, I owned a condo in Waikiki, in which I lived, and a condo in Lahaina, which I rented. My real estate investing career was launched -- and I was in debt up to my eyeballs.

The 'Credit Card Tycoon'

Being single at the time, several friends and I would get together regularly at a popular downtown Honolulu watering hole on Friday afternoon to have a few drinks and, if we were lucky, meet some of the pretty women who worked in downtown Honolulu. The Friday after closing on my Maui condo, I told my friends about my investment.

"Are you crazy?" asked one friend, a young attorney fresh out of law school.

"You're nuts," said another friend. "You purchased a condo with a credit card? Do you know how risky and foolish that is?"

"Yeah, but it's a great deal," I replied defensively.

My friends just continued to laugh at me, calling me the "Credit Card Tycoon." The more I defended myself, the more they ribbed me and the more they laughed. I finally gave up and went to talk to a group of pretty women.

About a year later, we were all together again at that same watering hole where we met almost every Friday.

"Well, how is the Credit Card Tycoon doing today?" asked a friend who was a young attorney. "Buy any more property with your credit cards?"

"No." I replied with a grin. "I sold one for $48,000. I made about a $30,000 profit in a year."

Although it was good to have the ribbing stop and to win my point, the most important lesson was that I had learned how to use debt to get richer.

From $25 a Month to $29,000 a Month

My wife had a similar experience. She bought her first property in 1988. It was a small two-bedroom, one-bath home in a great neighborhood in Portland, Oregon. The purchase price was $45,000. She put $5,000 down and earned approximately $25 a month after expenses and debt service.

Some of her girlfriends made the same comments my friends did. They thought $25 a month was not worth the risk of borrowing money. What her girlfriends failed to understand is that it wasn't the money that was important at that point. It was the experience.

Using that experience, my wife bought a piece of commercial property 16 years later for $7 million. Since the property was such a great investment, a banker gave her most of the money -- yes, as debt. Every month, after paying all expenses, the net income into her bank account is approximately $29,000. That's more than many people earn in a year.

In her talks, she often asks people, "How long would it take you to save $7 million?"

Most people admit that it would take a while to save that much money, if they could do it. She then points out that to save $7 million would require earning nearly $14 million before taxes to net $7 million in savings. The thought of earning $14 million is beyond what most people can do in a lifetime. She tells her listeners that it took her two weeks to find the $7 million as debt financing, which is tax-free money.

She closes by asking, "Will your banker loan you $7 million to invest in mutual funds?"

Debt Is Not the Problem

"My banker is my best partner," my rich dad used to say. "He loans me 90 percent of the money and I control 100 percent of the property, 100 percent of the profits, and 100 percent of the tax breaks. All I have to do is find great investments he wants to be a partner in."

There are many financial experts who say "get out of debt," "pay off your credit card bills," or "pay off your mortgage." Many of them seem to think all debt is evil.

"Debt is not the problem," my rich dad said. "It's what you buy with debt that can cause you problems."

Between 1995 and 2005, savers -- people who saved money in bank accounts or in mutual funds -- were the big losers. They lost because the stock market crashed. Between 1995 and 2005, many of the debtors who took advantage of low interest rates to invest in real estate made fortunes in the biggest real estate boom in the history of the world.

Understanding how to use debt to increase their fortunes is another reason the rich get richer.

Work Hard, Earn Less?

American workers have been getting the short end of the stick since 1943.

That's when the United States Congress, in response to the costs of World War II, passed the Current Tax Payment Act. The act requires employers to withhold taxes from their employees' paychecks, overturning the previous system in which workers were paid first and settled their tab with the government later.

The Current Tax Payment Act is why so many people look at their paychecks and wonder where all their money has gone.

My poor dad -- who also happened to be my real dad -- often said to me, "Go to school, get good grades, so you can find a good, secure job with benefits." My rich dad, on the other hand, had a different point of view.

Instead of advising me to work hard for money, my rich dad said, "If you want to earn more and pay less in taxes, you need to have people and your money work hard for you." In other words, my rich dad encouraged me to be an entrepreneur and investor.

Today, workers who save money and invest in a 401(k) plan are the highest taxed people in America. Now, I can hear some of you asking, "Isn't saving money and investing in a 401(k) having your money work for you?"

No -- at least not according to the IRS. A worker's pay is taxed at the highest tax rate possible. So are your savings and income from your 401(k). In most cases, money goes into a 401(k) tax-deferred but comes out as highly taxed ordinary income.

One of the reasons the rich are getting richer is because they have more control over our number one expense: Taxes.

For example, my passive income from real estate can be the lowest taxed income of all. On one of our commercial properties, my wife and I receive approximately $30,000 a month in income -- almost tax-free. When we sell the property, we can legally take the capital gains without paying capital gains tax, which in our state would be 20 percent. Try doing that with stocks, bonds, mutual funds, or real estate investment trusts (REITS). In fact, mutual funds can be a tax trap if you do not understand the rules.

Another example, when we invest in oil and gas projects, we receive approximately a 70% tax deduction and a depletion allowance -- another tax break -- for income from oil and gas revenues. That means if I invest $10,000 in oil and gas, I can deduct approximately $7,000 from my income as well as receive a tax break for income from the sale of the oil and gas.

Obviously, I'm not a tax professional and you should not make any tax or investment decisions based on this brief article. My point is this: If I had followed my poor dad's advice and got a job with a 401(k), there would be almost nothing an accountant could do to protect me from higher taxes. The 1943 Current Tax Payment Act saw to that. Today, employees with a 401(k) work hard and earn less.

The federal government provides the biggest tax breaks for business owners and investors in oil and gas and real estate. Why? Business owners provide jobs and jobs mean employees who pay higher taxes. The economy needs oil and gas so anyone who explores for oil and gas are given big tax breaks. And people who invest in real estate are given big tax breaks because the government needs investors to provide housing. If investors didn't provide housing, the government would have to.

After 1943, people who worked for money lost most of their tax breaks. Now, entrepreneurs and investors get the big tax breaks -- and that's another reason the rich get richer.

Why Savers Are Losers

My poor dad believed in saving money. "A dollar saved is a dollar earned," he often said.

The problem was he didn't pay attention to changes in monetary policy. All his life he saved, not realizing that after 1971 his dollar was no longer money.

You see, in 1971 President Richard Nixon changed the rules of money. That year, the U.S. dollar ceased being money and became a currency. This was one of the most important changes in modern history, but few people understand why.

Prior to 1971, the U.S. dollar was real money linked to gold and silver, which is why the U.S. dollar was known as a silver certificate. After 1971, the U.S. dollar became a Federal Reserve Note -- an IOU from the U.S. government. Instead of our dollar being an asset, it was turned into a liability. Today, the U.S. is the largest debtor nation in history due in part to this change.

Taking a brief look back at the history of modern money, it's easy to understand why the 1971 change was so important.

After World War I, Germany's monetary system collapsed. While there were many reasons for this, one was because the German government was allowed to print money at will. The flood of money that resulted caused uncontrolled inflation. There were more marks, but they bought less and less. In 1913, a pair of shoes cost 13 marks. By 1923, that same pair of shoes was 32 trillion marks!

As inflation increased, the savings of the middle class was wiped out. With their savings gone, the middle class demanded new leadership. Adolf Hitler was elected Chancellor of Germany in 1933 and, as we know, World War II and the murder of millions of Jews followed.

A New System of Money

In the closing days of World War II, the Bretton Woods System was put in place to stabilize the world's currencies. This was a quasi-gold standard, which meant currencies were backed by gold. The system worked fine until the 1960s when the U.S. began importing Volkswagens from Germany and Toyotas from Japan. Suddenly the U.S. was importing more than it was exporting and gold was leaving our country.

In order to stop the loss of gold, President Nixon ended the Bretton Woods System in 1971 and the U.S. dollar replaced gold as the world's currency. Never in the history of the world had one nation's fiat currency been the world's money.

To better understand this, my rich dad had me look up the following definitions in the dictionary.

"Fiat money: money (as paper money) not convertible into coin or specie of equivalent value."

The words "not convertible into coin" bothered me. So my rich dad had me look up the word: "fiat."

"Fiat: a command or act of will that creates something without or as if without further effort."

Looking up at my rich dad I asked, "Does this mean money can be created out of thin air?"

Nodding his head, my rich dad said, "Germany did it and now we are doing it."

"That's why savers are losers," he added. "I fought in France during World War II. That's why I never forget that it was after the middle class lost their savings that Hitler came to power. People do irrational things when they lose their money."

Most economists would disagree with my rich dad's correlation between the loss of savings and Hitler. It may not be an accurate lesson, but it's one I never forgot.

Between 2000 and 2005 housing prices went through the roof. Oil went from $10 a barrel in 1997 to over $60 a barrel in 2005. Gold went from $275 an ounce in 1996 to over $475 an ounce in 2005.

In spite of all these increases in prices, the federal government's economists say, "Inflation is low. It's under control." They are allowed to say that because the government is charged with only monitoring inflation in consumer prices -- not asset prices. The consumer price index (CPI) is the pressure gauge the government watches because they want to make sure the consumer is happy finding bargains at Wal-Mart, which is easy because China is forcing consumer prices down.

The problem is our dollars return to the U.S. to buy our assets. In simple terms, we send cash overseas to buy goods, and overseas investors take our cash and use it to buy our assets. That's why the Wal-Mart shopper finds bargains in the store but can't afford to buy a house, gas, gold, or stocks. Those same "consumers" also worry about their jobs going overseas.

In summary, investors shop for asset bargains, and consumers shop for consumer bargains and try hard to save money that is not really money. That is another reason why the rich are getting richer.

For more on this subject I recommend reading "The Dollar Crisis"by Richard Duncan.

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