Financial Independence/Retire Early -- Learn How!
JWR1945
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Peteyperson was introducing his ideas about how to use a TIPS Ladder right up through the final minutes of the Safe Withdrawal Rate Research Group. Here is an introduction that I have posted at my new site.
http://www.early-retirement-planning-in ... posts.html

This should help you take advantage of a TIPS ladder in your retirement planning. I have extracted several elements of Peteyperson's concept. I have added a few of my own. I have not come close to matching Peteyperson's level of detail.

A TIPS Ladder allows you to avoid selling stocks at distressed prices, which is what causes retirement portfolios to fail. You can avoid selling any shares for an entire decade, if necessary. When stocks are doing well, you treat your TIPS Ladder as the normal bond allocation in your portfolio. You continue to sell shares of stock when needed and when prices are especially attractive. You replenish the TIPS Ladder when necessary. When stocks are doing poorly, you draw principal from your TIPS Ladder.

Initial Steps

For purposes of discussion, I am setting the required lifetime of your retirement portfolio at 40 years. I am setting the withdrawal rate at 4.0% of your initial balance plus inflation.

First, we determine the withdrawal rate of an all-TIPS portfolio that lasts exactly 40 years. If the interest rate is 1.0%, the 40-year withdrawal rate is 3.05% (plus inflation). If the interest rate is 1.5%, the 40-year withdrawal rate is 3.34% (plus inflation). If the interest rate is 2.0%, the 40-year withdrawal rate is 3.66% (plus inflation). These rates are high because they include 2.50% (plus inflation) from principal.

For purposes of this discussion, I will assume that we can get an interest rate of 1.5% with 10-year TIPS. This corresponds to a 40-year withdrawal rate of 3.34% (plus inflation).

Next, we set a target allocation for the TIPS ladder. For purposes of illustration, I will set this allocation equal to 20%.

Under normal circumstances, the TIPS portion of the portfolio would contribute 20%*(the normal withdrawal rate for the TIPS) = 0.20*(3.34%) = 0.668% of the 4.0% that we are seeking.

This means that the equity portion of our portfolio must provide the remaining 3.332% (since 4.000% - 0.668% = 3.332%). Since we have allocated 80% of our portfolio to stocks, we are seeking a (real, annualized, total) return from stocks of 4.165% (since 3.332 % / 0.80 = 4.165%).

John Bogle's modified version of the Gordon Equation (or the Dividend Discount Model) is that the total return from stocks equals the investment return plus the speculative return, where
Investment Return = Dividend Yield + Earnings Growth Rate
and
Speculative Return = the change in the price to earnings ratio over the period examined.

Historically, real earnings (i.e., after adjusting for inflation) have consistently grown 1.5% to 2.0% per year when taken over a decade. [Year-to-year earnings are vary wildly. But the cumulative earnings over a decade are remarkably consistent.]

To get an investment return of 4.165% (real, annualized, total return), we need a dividend yield of 2.165% to 2.665% (assuming that the real, annualized earnings growth remains between 1.5% and 2.0%).

We conclude that withdrawing 4% (plus inflation) is doable just so long as we can avoid being hurt by an unfavorable speculative return.

It is highly likely that the stock market's multiples will contract over the next decade. They are likely to contract by a factor between 2 and 4.

The TIPS Ladder to the Rescue

This is the beauty of the TIPS Ladder.

When prices fall, you use the principal of the TIPS that mature in that year in your withdrawal. Since your TIPS allocation is 20% and since your ladder is 10 years long, you receive 2% (plus inflation) of your desired 4% (plus inflation) withdrawal amount. That is, one-half of your withdrawal amount will come from cashing in TIPS as they mature at par. The rest comes from stock dividends.

Stock dividends generally keep up with inflation although not from one year to the next. Since dividends only have to supply 2.0% (plus inflation) of your portfolio's initial balance, any dividend yield above 2.0% and any interest payment from TIPS gives you extra time before dividends have to catch up.

It makes sense to allocate more to your TIPS Ladder if you expect stocks to do poorly for more than a decade. Outside of the United States, there have been bad periods that have lasted for twice that long. If you were to make a 20-year TIPS Ladder, your TIPS allocation could still be as small as 40%.

In the example, doubling the TIPS allocation would result in their providing 1.336% (2*0.668%) of the 4.0% that we are seeking. Stocks would have to provide 2.664% (since 4.000% - 1.336% = 2.664%). The stock allocation would now be reduced to 60% (instead of 80%). Stocks would have to deliver a 4.44% (real, annualized, total) return. Subtracting 1.5% to 2.0%, the required dividend yield would be between 2.44% and 2.94%.

Once again, this is doable.

Have fun.

John Walter Russell

beachbumz
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Hi John!
That's a great example. I'm going to have to spend some time reviewing it. One question, though, how would this example change (or could you do another one) for a 50 year payout. Since I'm only 38, I hopefully have at least that long .

Beachbumz
Life is Good.

unclemick
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Great example John.

Goes a long way toward explaning why Vanguard Target Retirement Income is holding 25% Inflation protected securities.

And being dividend oriented - I like the way the numbers fall. In the past - too often people pushed the current yield too hard at the expense of dividend growth(the inflation fighter).

A roll your own cat - has a lot of good workable stuff to chew on in your example.

P.S. Thanks to Petey also!

ElSupremo
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Location: Cincinnati, Ohio
Greetings John :)

I'd like to thank you as well for the great post! I will also need some time to digest all of your information. Very interesting stuff!
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JWR1945
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beachbumz wrote: Hi John!
That's a great example. I'm going to have to spend some time reviewing it. One question, though, how would this example change (or could you do another one) for a 50 year payout. Since I'm only 38, I hopefully have at least that long .

Beachbumz

I use real returns and real rates in the following. That is, all of my numbers are what remains after adjusting for inflation.

Just going through the motions mechanically, this is what I find.
1) The 50-year withdrawal rates are 2.55% when the interest rate is 1.0%, 2.86% when the interest rate is 1.5% and 3.18% when the interest rate is 2.0%. Drawing down principal over 50 years accounts for 2.0% in these withdrawal rates.
2) Next, we replace the original 3.34% rate from TIPS (for 40 years of withdrawals with 1.5% TIPS) with 2.86% (for 50 years of withdrawals with 1.5% TIPS).
3) When the TIPS allocation is 20%, TIPS now provide withdrawals of 0.20*2.86% = 0.572% times your portfolio's initial balance. Previously, TIPS were providing 0.20*(3.34%) = 0.668% of your portfolio's initial balance.
4) This leaves a deficit of 4.000% - 0.572% = 3.428% that needs to come out of stocks.
5) Since your stock allocation is 80%, stocks must return 3.428% / 0.80 = 4.285%.
6) Your investment return must meet this requirement. Assuming that the earnings growth is 1.5% to 2.0% (as has been the case historically), your stocks must produce a dividend yields of 2.285% to 2.785%. This is doable.
7) In times of stress, the principal from your 10-year TIPS Ladder will provide 2% of your portfolio's initial balance (plus inflation). Stock dividends must provide the remaining 2%.
8 ) I will assume that your stock dividends have kept up with inflation. (Typically, you can do better, but not always from one year to the next.) Your stocks are 80% of your portfolio and they must throw off 2% of your portfolio's initial balance during times of stress. Your stock dividends must equal or exceed 2.0% / 0.80 = 2.5%.
9) Your dividend yield must be between 2.285% and 2.785% to meet the requirement to match the investment return. Your dividend yield needs to be 2.50% or more for your withdrawals to equal 4% of your initial portfolio's balance (plus inflation). Actually, it can be a little bit less since you also receive interest income from your TIPS Ladder.

Continuing, looking at a 40% stock allocation, this is what else I find.
1) With a 40% TIPS allocation, a 50 year lifetime and a 1.5% interest rate, TIPS will be providing of 0.40*2.86% = 1.144% times your portfolio's initial balance.
2) You must get the remaining 4.000% - 1.144% = 2.856% from your stock holdings.
3) Since your stock allocation is 60%, your stocks must return 2.856% / 0.6 = 4.76%.
4) For your stocks to have an investment return of 4.76%, they must have a dividend yield between 2.76% and 3.26% provided that earnings continue to grow between 1.5% and 2.0%.
5) These numbers are still doable even with today's low yields. You must select stocks with higher than average dividend yields. Fortunately, you can still buy quality stocks at these yields.

Now lets pay a little more attention to cause-and-effect and understanding what is going on and away from the numbers themselves.

The reason for the TIPS Ladder is to weather long periods of declining stock prices. If your portfolio can make it to year 40, it is highly likely that your stock portfolio has become very large. In fact, it is highly likely that you will have been able to increase your withdrawal amount safely. There should be some excellent stock buying opportunities in the next 50 years. After all, the long-term (real, annualized) return of stocks has been 6% to 7%, which is much higher than the 4% to 5% returns that we are seeking.

Behind this assertion is my early observation that portfolio failures can usually be spotted within the first 11 years of retirement. Either the portfolio will have grown enough to be completely safe by that time or it is likely to be in trouble. Historically, we have found that very few cases remain uncertain by year 11.

This leads me to believe that, if you can reach 40 years safely while withdrawing 4% of your portfolio's initial value (plus inflation), your can reach 50 years as well. The difference is when you can comfortably increase your withdrawals above 4% (plus inflation).

Let me add a couple more factors. If you really believe that holding stocks right now is hazardous because of valuations and if you are right, you are better off to reduce your stock allocation and wait until valuations improve. This is where my analysis of switching (i.e., varying stock allocations according to P/E10) comes in. Alternatively, you might prefer to adopt a dividend-based strategy since it reduces your need to sell shares.

We do not know exactly what will happen. History helps us make preparations.

Have fun.

John Russell

JWR1945
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unclemick wrote: Great example John.

Goes a long way toward explaning why Vanguard Target Retirement Income is holding 25% Inflation protected securities.

And being dividend oriented - I like the way the numbers fall. In the past - too often people pushed the current yield too hard at the expense of dividend growth(the inflation fighter).

A roll your own cat - has a lot of good workable stuff to chew on in your example.

P.S. Thanks to Petey also!

Unclemick has the right attitude about SWR Research. We provide background information, but he makes his own decisions.

I will claim credit in helping unclemick keep his hobby stock allocation at 15% instead of being talked into cutting it to 10%. I have looked at the numbers. They are on unclemick's side.

Peteyperson's research went deeper. He looked closely into taxes. Since he lives in the United Kingdom, he looked carefully into the details of inflation-indexed securities from several nations. He included a complete set of asset classes.

Regarding taxes, a TIPS ladder is not taxed for inflation in the UK. In the US and inside a taxable account, individuals must pay taxes on adjustments to principal to match inflation. (With TIPS, this is as it occurs. With ibonds, it is when you cash them in.) This makes sheltered accounts (especially Roth IRAs) and ibonds more attractive for US taxpayers. Of general interest, is Peteyperson's observation that the return of principal is not taxed anywhere. This shelters the 2% that your TIPS Ladder supplies from principal during times of stress. Only a small fraction of your withdrawal amounts come from interest.

Have fun.

John Russell

JWR1945
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ES wrote: Greetings John :)

I'd like to thank you as well for the great post! I will also need some time to digest all of your information. Very interesting stuff!

Fortunately, I have now been able to recover Peteyperson's posts from the SWR Research Group board. In addition, I expect Peteyperson to continue his research. It has been highly productive.

What was missing, largely because of the limited time frame, were some simple overviews to clarify everyone's thinking. Peteyperson's posts assumed a high degree of sophistication among his readers. I think that we provided that here at the NFB. I know that readers at some other sites have no idea of how valuable Peteyperson's latest insights really are.

I expect to build a calculator to investigate Peteyperson's approach. At this moment, I don't think that I will be replenishing his TIPS Ladder because it would be too difficult.

[In addition, my recent findings have brought the advantage of rebalancing into question. My guess is that replenishing a TIPS Ladder would be similar. It seems to provide only a small protection on the downside at the cost of almost all of your upside potential. The key issue seems to be whether it is ever possible to discern when prices are favorable or unfavorable. Year-to-year, you would have a lot of difficulty. But over a decade or two? I think that you can get a pretty good idea. With rebalancing, there is an assumption that you never have any idea. None whatsoever.]

Have fun.

John Russell

Norbert Schlenker
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### Re: A TIPS Ladder Example

JWR1945 wrote: Historically, real earnings (i.e., after adjusting for inflation) have consistently grown 1.5% to 2.0% per year when taken over a decade. [Year-to-year earnings are vary wildly. But the cumulative earnings over a decade are remarkably consistent.]

To get an investment return of 4.165% (real, annualized, total return), we need a dividend yield of 2.165% to 2.665% (assuming that the real, annualized earnings growth remains between 1.5% and 2.0%).

We conclude that withdrawing 4% (plus inflation) is doable just so long as we can avoid being hurt by an unfavorable speculative return.

It is highly likely that the stock market's multiples will contract over the next decade. They are likely to contract by a factor between 2 and 4.

Lots of arithmetic and lots of assumptions. Let's see where a little more arithmetic leads.

You say you're going to spend all the dividends. Real earnings grow at 2% per year (your figures) and multiples contract by a factor of 2-4 (your figures). Arithmetic says you're projecting real losses of 40-70% on equities over the next decade. That's on a price basis, but we can't use total return because you're spending the dividends every year.

Is it a good idea to put 80% of a portfolio into an asset class when you expect to lose 40-70% in real terms over the next decade?
Great minds think alike. Fools seldom differ.

beachbumz
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Hi John!
Thanks for the 50 year numbers and so quick too! I feel a little guilty about hangin' out on the beach, while you were doing all the work. 8)I guess I'll have to buy you a beer some time.

I also liked the 40%/60% scenario. It makes me wonder about a 20% TIPS ladder, 60% equities and 20% other bonds (maybe some unhedged international exposure to protect a little against a sliding dollar). Any thoughts on that one?

Being a TIPS virgin , I assume that one can purchase TIPS maturing in each of the next 10 years without much problem???

Beachbumz
Life is Good.

JWR1945
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Being a TIPS virgin , I assume that one can purchase TIPS maturing in each of the next 10 years without much problem???

Yes, you can. Here is a link to the Government's site. It tells you everything, including how to purchase without paying any commissions.
http://www.publicdebt.treas.gov/sec/sec.htm

Peteyperson is the guy to see about foreign TIPS and ibond equivalents. Oliver is an expert on everything related to international bonds.

I am not familiar with international currencies, but Peteyperson is well versed since he lives in the UK. Here are some of his comments on bonds that you might find interesting. It is from one of the last posts on the SWR Research Group. It has some internet links.
peteyperson Sat Mar 26, 2005 7:33 pm Post subject: Re: TIPS drawdown at staggered coupon rates

You could call them I-Certs but that would be a bit of a mouthful! It is a bit like how TIPS are actually Treasury Inflation-linked Securities in the US but the TIPS name caught on all the same!

I think they are only open to people from the UK, but I not certain. The FAQ will have such information I think.

I-Bonds guaranteed by the Treasury in much the same way TIPS are. Only difference is that the principal is guaranteed (even from deflation) and the price doesn't move. There is a tiered progression of how the inflation is applied to the balance but it seems to work out fine.

Bond returns have been better in the US, you are correct, but it is a mixed case globally. Some countries did 2-3% real pre-tax, pre-costs, some did not. Prof. Dimson of London Business School has published data for US Bonds from 1900-2000. 4.8% nominal, 1.6% real. Inflation 3.2%. Over most recent 75 years were 2.2% real; 50 years 1.9% real, and 25 years 4.9%. The latter being due to the high rates at the start of the period being analysed. So with US bonds it does depend largely on what period you consider, what the taxes would have been and the costs, as to whether they were positive real returns of any measure.

In terms of the UK I-Bonds, the return over 40 years is closer to 3% because of the lower return but is not much different due to lack of taxation. The product is not new. It has been offered for 37 years I believe.

http://www.nsandi.com/products/ilsc/ind ... n=overview

Tiered rates per year:
http://www.nsandi.com/products/ilsc/rates.jsp

Backed by H.M. Treasury (National Savings handle 17% of national debt):
http://www.nsandi.com/privacy/backedbytreasury.jsp

Welcome your observations on the product.

Petey

You don't have to feel guilty:
Thanks for the 50 year numbers and so quick too! I feel a little guilty about hangin' out on the beach, while you were doing all the work.

I posted my response at my web site. Everything evens out.

Have fun.

John Russell

peteyperson
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beachbumz wrote: Hi John!
Thanks for the 50 year numbers and so quick too! I feel a little guilty about hangin' out on the beach, while you were doing all the work. 8)I guess I'll have to buy you a beer some time.

I also liked the 40%/60% scenario. It makes me wonder about a 20% TIPS ladder, 60% equities and 20% other bonds (maybe some unhedged international exposure to protect a little against a sliding dollar). Any thoughts on that one?

Being a TIPS virgin , I assume that one can purchase TIPS maturing in each of the next 10 years without much problem???

Beachbumz

Hi beach,

That depends on where you live, Beach. I do not know what the US currently offers.

As TIPS are a fairly new things in US, you may be more restricted initially. This is something someone can work around until there are 10-year TIPS available on all maturities desired.

Petey

hix9
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anyone know what book the reader is referencing here?

http://www.dallasnews.com/sharedcontent ... ffdc8.html

otherwise seems similar to tips approach.

hi norbert
Is it a good idea to put 80% of a portfolio into an asset class when you expect to lose 40-70% in real terms over the next decade?

i didn't want you to feel ignored so i researched this and according to my source the answer is no:

"Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it." WR

but i expect your question should generate a more useful discussion from smarter folks here.

hix9

JWR1945
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hix9 wrote: anyone know what book the reader is referencing here?

http://www.dallasnews.com/sharedcontent ... ffdc8.html

otherwise seems similar to tips approach.
hix9

Scott Burns is merely describing a TIPS ladder. Scott Burns differentiates between drawing down some (or all) of the principal versus reinvesting all of the principal.

What Peteyperson has come up with is much different. He uses a TIPS ladder in an innovative way to avoid selling stocks when prices are down. Having to sell stock at unfavorable prices is what kills retirement portfolios.

Have fun.

John R.

ElSupremo
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Greetings Norbert :)

I didn't realize there was an impression you were being ignored. I sure didn't mean to ignore your post but I'm having a little difficulty getting all these numbers to add up. I was messing around with this today and my main problem seems to be tying this all in with the ups and downs possible in the market. I don't think I have anything against a straight forward TIPS ladder as part of ones retirement portfolio. But when we go beyond that things get fuzzy. I'll step aside in this thread and let those that are a little better at math debate this one. But I will be watching with interest.
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ataloss
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I'm having a little difficulty getting all these numbers to add up

lol,
Have fun.

Ataloss

Norbert Schlenker
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ES wrote: I didn't realize there was an impression you were being ignored.

It's not you, ES. It's JWR.

If he can write 22 paragraphs containing countless numbers and many conclusions about what is "doable" given certain conditions, then it seems to me that he should also be able to answer a simple question about a much simpler conclusion that can be drawn from the same assumptions.

I didn't want to embarrass the guy so I've waited quietly. I suggested to a friend of JWR's, who has quite a high opinion of his work and who thinks JWR's contributions in this thread and others are constructive wrt FIRE issues, that I hoped John would consider my question and answer constructively.

At this point, I can only conclude that JWR isn't going to answer. More than 24 hours have gone by. Two other lengthy posts have been composed. Yet JWR hasn't bothered to answer my very simple question.

Let me propose a theory to explain this behavior. It fits the observed facts to the letter. The remainder of this may strike you as an attack on JWR's person rather than JWR's ideas. Because he won't actually defend his assumptions, logic, or ideas, I can see no alternative.

JWR is a mathematical novice who puts numbers into a calculator and reports what comes out. He appears not to know what goes on with the calculator. To hide his own confusion, he lards almost every post with numbers, adding unwarranted decimal places, knowing that most readers will think that anything with so many so precise numbers must be correct. He makes unfounded assumptions and pretends that he's not doing it. The result is GIGO. JWR's lengthy tables and numerical recitations are about as useful for understanding retirement withdrawal strategy as the Knott's Tables of trigonometric values I was handed in 1972 was in understanding trigonometry.

For the most part, JWR has retreated to his own website, where he can pretend that criticism of his methodology doesn't even exist. On this forum, he will not respond to even the simplest substantive question. He's out of his depth and he knows it. He is too scared - yes, SCARED - to respond to any question that even skirt his conclusions because it will reveal to every reader - even those who are innumerate - that he has no abilities in this area whatsoever.
But I will be watching with interest.

For the reasons stated above, I expect there won't be much to watch.
Great minds think alike. Fools seldom differ.

ataloss
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nfs, he can wait you out. asking relevant questions is considered "ataloss type posting" and is highly discouraged in some circles

But I will be watching with intercst
Have fun.

Ataloss

Norbert Schlenker
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ataloss wrote: nfs, he can wait you out.

I am sure that he can. I'm going to be charitable, as it's the weekend, he probably has things to do, etc. But if he starts posting again without addressing the question I posed, that's a conclusive demontration of lameness.

Of course, he can slink off to his own site, where he can screen or ignore questions as long as he likes. Ain't the web great? Anyone can spout unfounded opinions. As long as he stops doing it where innocent parties might be misled, it's cool.
"ataloss type posting"

I always thought the technique of considering the facts on display and applying reason to be a form of the scientific method. It's quite a coup to have the technique named after you. Congratulations.
Great minds think alike. Fools seldom differ.

unclemick
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Hmmm

I have no problem understanding JWR's stuff. Dividends were 40% of my taxable income for a long period of ER.

1966 - 1982 (albiet work years), became quite familar with periods of rising earnings combined with falling multiples.

Now in my second decade of ER have to look at things like spending IRA and when to take SS, and perhaps some mini Roth consversions in case I don't croak on time.

JWR's stuff - to repeat - fits in with my sense of common sense - handgenadewise.

De Gaul and the Norewgian widow ride on!

Heh, heh, heh

ataloss
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hi unclemick

dividends are good- is that jwr's point?
better to buy (stocks) low and sell high- another of his unique insights?

jwr isn't always wrong but he seems to have a great deal of unjustified confidence (e.g predicting the future)

jwr generates all sorts of relatively meaningless numbers to back up his truisms but to find value in jwr reminds me of reed talking about kiyosaki

"˜Missing the point'
Since I posted this analysis, a number of Kiyosaki "cult members"￾ have contacted me to denounce me for "missing the point"￾ of Kiyosaki's book. "OK,"￾ I responded, "Please tell me the point."￾ The odd thing is that each person has a different version of what the point of Kiyosaki's book is - and it is never something I recall reading in the book. In fact, if a book has a point, multiple readers ought to come up with the same answer when asked what that point is. If they come up with different answers, it is either because the author was incompetent at communicating his point, or because the book has no point, or because the author deliberately obfuscated the point.

http://www.johntreed.com/Kiyosaki.html

Anyway I am glad that his "research" is no longer featured here