FoC (8) - Rich Dad Poor Dad

Another example of the fallacy of composition that is ignored, because it applies during good times is the book called read Rich Dad Poor Dad by Robert Tiyosaki. I read this book several years ago. He explained how a person can build sufficient wealth to live without working by investing in real estate. I understood his approach, but I was never willing to commit sufficient energy to following his plan, so I have not followed his advice.

A key part of the Rich Dad Poor Dad approach is that well-chosen properties will increase in value over time. The value of the investment will grow even faster, if the purchase is highly leveraged (most of the purchase price is borrowed). This teaching is true during a time of inflation. It has been true for the last thirty years, because governments have inflated their currencies almost continually.

The fallacy of composition applies to this practice. Leveraged investing in property may be good for the individuals concerned, but it is bad for the economy as the whole. Residential property is unproductive, so speculative investment in property squeezes out investment in productive activities that would benefit the entire economy. Rich Dad activities produce Poor Bad economies.

People who have been successful in property investment should understand that the benefits of leverage (or borrowing) come through government-made inflation. Their wealth is the direct result of government policies that have harmed the economy.
They should also understand that when inflation of the currency stops and property prices begin to fall, the value of the outstanding mortgage is unchanged, so the owner’s equity takes the full hit. In a collapsing property market, leverage amplifies the losses, just as it amplifies the profits during the previous period of inflation.

If governments ever give up inflating their currencies, (there is not much sign of this happening yet), the Rich Dad Poor Dad method will stop working. Everyone who follows his advice should understand the consequences.

The complete series on the Fallacy of Composition is here.