Advanced Money School Lesson 1: Introducing You, Inc.
Written by: David Weliver
Give yourself a pat on the back for signing up for Advanced Money School!
No, seriously. In nearly 15 years as a personal finance journalist, I have learned that there are only two types of people in the world:
- Those who are interested in learning how to grow and protect their money and use it prudently.
- Everyone else.
You’ve already demonstrated that you’re in the first group. You might, however, be surprised to learn just how exclusive that group is.
Why Advanced Money School
A 2016 study of global financial literacy by The Standard & Poor’s Rating Services Corporation and George Washington University finds that only one in three adults worldwide can correctly answer at least three out of four very simple personal finance questions about risk and diversification, inflation, interest, and compound interest.
If only a third of adults have a basic understanding of personal finance, I think we can infer that the club of people actively pursuing more financial knowledge is appreciably smaller.
Today, you’ve indicated you already have a grasp of basic financial topics like budgeting, interest, and credit. That’s great because we’re going to go beyond all that here.
Over the next 10 days, we’re going to dive deeper into the principles that allow a small percentage of people to become financially independent.
Obviously, mastering these principles is a lifelong journey. The lessons to follow will provide a roadmap to follow if you want to build and preserve wealth. It’s up to you to put this knowledge into action in your own life.
I can assure you, however, that the principles are proven. This stuff works.
And the great thing is, there’s no rocket science here. Although you can spend years chasing better investment results by studying business and economics, it’s completely unnecessary.
You can create a wealth plan that’s dead simple. All you need to do is follow it.
Sound good? Then let’s dive in.
Shift your mindset and think like a business
Our first lesson is about mindset.
Now, if you’re left-brained “numbers and facts” type of person, bear with me here.
As I hope to demonstrate over the next 10 days, behavior is by far the most important part of successful money management and wealth building. The math is secondary.
For this course, I’m going to ask you to think of yourself as a business of one: “You, Incorporated.”
It doesn’t matter if you’re not actually a business owner or freelancer. It doesn’t matter if you draw a regular paycheck, if you’re a student, or if you’re already financially independent and living on your savings.
What we want to do is to transform how you approach earning, spending, and saving money by thinking of yourself as a business of one.
It’s as if you are a for-profit company whose purpose is to earn profits for its shareholders. (In this example, you also happen to be the sole shareholder, but let’s ignore that point for the moment.)
With this mindset in place, we’re going to talk about six key ways you will approach money differently than perhaps you have in the past. Some of the ways are simply reframing ideas with which you are already familiar, while others may seem completely new.
Six ways to approach money differently:
Let’s start by unpacking the six ways we can approach our relationship to money differently.
- Be profitable.
- Spend money to make money.
- Be accountable.
- Employ leverage.
- Take calculated risks.
- Protect your assets.
1. Be profitable
As CEO of You, Inc., you must deliver profits. Ideally, you’ll be profitable every month, every quarter, and every year.
In other words, your revenue – or income – must be greater than your expenses.
It’s the Golden Rule of personal finance – spend less than you earn – through the lens of your “business.”
If you can’t turn a profit, nothing else is going to matter. Eventually, you’ll be out of business.
Sure, we’ve all heard the stories of tech start-ups that run multi-million-dollar losses for years (Facebook, Uber, Tesla). You, Inc., probably won’t get venture capital. Sorry.
In limited cases, you might be running You, Inc. at a loss for a certain period of time. For example, if you’re in school. Let’s say you’re going to graduate school and using student loan distributions not only to pay tuition but also to supplement your living expenses. In this case, you’re running the business at a loss.
That can be OK because you’re investing in yourself to increase your earning potential in the future. In your situation, the key is to keep your losses (and the amount of capital you need to borrow) to a minimum.
Assuming you’re working for a living, however, your business should be profitable.
Ideally, very profitable.
Profit margins are one measure of a business’s health. The slimmer the margins, the more critical it becomes that everything runs perfectly. With fatter margins, however, you can afford to weather setbacks or even unprofitable months or quarters.
To be explicit, the profit margin of You, Inc. is the same as your personal savings rate.
The higher your profit margins, the faster you accumulate wealth, and the more resilient you’ll be when life throws you a curveball.
For example, let’s say you earn $5,000 a month and have a profit margin of 20%. Every month, you deposit $1,000 into savings. Not only is your savings account growing at a good clip, but you also have a $1,000 cushion in your budget in the event of a surprise. If you get stuck with a medical bill or your car breaks down, it’s not the end of the world.
What’s the ideal profit margin?
Honestly, it’s impossible to say. Every business is different. Some super lean businesses doing good revenue might have profit margins north of 50%, while businesses in certain industries might be happy to eke out 5%. The right level for you probably lies somewhere in between those numbers and depends on how much income you bring in, your costs of doing business (fixed living expenses), and how lean you want to run (in other words, how much you choose to spend on luxuries).
2. Spend money to make money
As individuals in a highly consumer-driven culture, we spend a lot of our money on stuff “just because.” Because it made us feel better. Because we fell victim to another targeted ad on social media. Because we wanted it.
Even when we “need” something like a pair of jeans or a car, we frequently don’t just look at the utility of the thing we’re buying; we look at the prestige. We buy the brand-name jeans. We buy the luxury trim instead of the base model, or maybe even the Audi instead of the Honda.
In business, however, every dollar has a job.
If spending the dollar doesn’t move the business forward, it shouldn’t be spent. That’s the golden rule here.
A good example of this is to compare B2C and B2B advertising for either clothing or vehicles.
In the consumer-facing ads, the messaging is all about how you’ll look and feel – the image you’ll project to the world. In the business-facing ads, the messaging will almost certainly talk about function and value – how much utility you get for the money.
Also, have you ever noticed how it costs businesses a lot more to buy practically identical products and services than it costs consumers?
Up close with a few examples
When I rented office space three miles from my home, the cost to connect the internet to my office was double what I paid for nearly the same level of bandwidth at my home – with the same company. The only difference was that one was a commercial address and one residential.
The same thing happens with software. If you want to use Microsoft Office or Adobe Creative Suite for a business, it’ll cost you a lot more than if you’re buying a license for personal use.
The reason for this is simple: businesses will pay more for these things because they need them to make money. If you’re a graphic designer, you’re probably not going to do much business without an internet connection and Adobe Illustrator. Indeed, businesses are willing to spend freely when the product they’re buying will earn them money.
Let’s say you’re running a lemonade stand and selling 50 cups of lemonade at $1 per day. The thing is, you’re squeezing the lemons by hand and sometimes lose customers who won’t wait very long. Along comes a salesman offering you the best-ever lemon juicer for $2,500. That’s a lot of money! Earning $50 a day, you’d need to work 50 days just to afford it.
However, let’s do some math here. You figure that if you buy the machine, you’ll actually be able to increase sales 50% and sell 75 cups a day. Now, you only have to work 25 days to pay for the machine.
But, that’s still a lot of money.
Then, however, you think longer-term– about the entire year.
If your stand is open 300 days a year, you plan on earning $15,000 at your current level of sales. If you buy the juicer, however, you’ll earn $22,500 this year thanks to the increased sales. Subtracting $2,500 for the cost of the juicer, you’ll earn a net of $5,000 more. Even better, the juicer has a 10-year warranty, meaning you’ll continue to earn an ROI on the juicer purchase for a long time.
This is an important point, so let’s pause for a moment and think about this: when’s the last time you spent money on something that will pay for itself many times over?
Return on investment (ROI)
For all the talk about the increasing cost of higher education and burdensome student loan debt, I think we sometimes forget that, more often than not, that college is a good investment because it provides ROI: You’ll earn more over your lifetime because you went to college than the cost of tuition.
Beware, however, what I will call “false ROI opportunities.” Buying the home that you’ll live in is a good example. Now, I’m a homeowner, and understand that I have nothing against homeownership. But it’s not the investment you’re well-meaning but misguided uncle would lead you to believe.
Other things to watch out for are rare or collectible consumer goods – everything from whiskey to watches and guitars. If you want to dabble in collecting, do so on a small scale and expect nothing to appreciate. If you want to “invest” in rare or vintage consumer items, wait until you’re already rich and can afford it if things don’t work out.
Now, at the end of the day, you are not, in fact, a business; you are an individual person. And as an individual, you can go ahead and spend some money on “nice things” that bring you joy or project a certain image.
As you do, however, learn to question every purchase as CEO of “You, Inc.” Does this purchase provide a good return on investment? Will you get the most utility for the least amount of money?
In asking these questions, it’s important to note that you’re not looking solely for the least expensive option. In fact, as a business owner, you may soon realize that always buying the cheapest item is a fast way to waste money when you need to repair or replace things rapidly.
Instead, look at every purchase for quality, value, and return on investment.
3. Be accountable
Have you ever been an employee without a boss?
In business, everybody has a boss. Everybody is accountable. Even the CEO is accountable to their board of directors, and the board is accountable to shareholders.
If your job involves making spending decisions and you frequently squander money, how long do you think you’ll keep your job?
As CEO of You, Inc., you need to find ways to be accountable for your financial decisions.
At a minimum, you need to become your own board of directors and review your own finances at least quarterly, if not monthly.
To me, this is the most important reason for tracking your spending.
We’ll take a closer look at Advanced Budgeting in the next lesson. But I’ll say this now: it can be difficult to stay in the habit of budgeting. In addition, you may very well be past the point where you need to keep a close eye on your monthly cash flow – your emergency fund and profit margins are healthy enough that you don’t sweat small fluctuations in spending.
As a result, budgeting may no longer need to be part of your daily, weekly, or even monthly routine. But you still want to track where your money goes and then force yourself to look at it straight on.
The numbers don’t lie. Looking at them forces you to reckon with where your money is going, and then in turn identifying leaks and question your expenses over time.
I know, not easy.
But the key is not to stop at being accountable to just yourself. Consider pulling in somebody else. If you’re in a relationship, your partner is an obvious choice. Although I had my finances in pretty good shape by the time I married my wife, my financial discipline improved after we began combining money and making joint spending decisions.
What I’d say is that even if you don’t share all of your accounts, frequent, honest communication about money is good for both your wealth and your relationship.
If you’re single or – for whatever reason don’t want to discuss money with your partner – consider hiring an accountant or bookkeeper. Again, almost every company has an accountant. You, Inc., should consider one too.
Even if the only thing your bookkeeper does is tally up your spending every month, the sheer fact that you have to share your transaction history with someone else will have a positive psychological effect on your decision making. Because the truth of the matter is that from time to time, we all buy things we know we probably shouldn’t. Knowing in the back of your head that your bookkeeper will see how much you spent might just be enough to make you think better of making a questionable purchase.
4. Employ leverage
If you want to get serious about building wealth, you must learn to harness the powerful force of leverage.
Leverage is the exertion of force using something (a lever) that allows you to greatly magnify the force exerted.
Just as you can use a pry bar to amplify how much weight you can lift, you can employ a variety of tactics to amplify your ability to earn money.
The most common example of a business using leverage is capital. Simply put, capital is money the business borrows with the expectation that its profits will be greater than the interest payments on that loan.
But this is a narrow definition of leverage, and I’m not suggesting you go out and take on debt. Here are a few more ways to think about leverage:
- Leverage is hiring professionals to free up your time for high-value activities: a housekeeper, a dog walker, or a virtual assistant.
- Leverage is turning your commute or daily run into learning sessions to develop new job skills or become a better investor.
- Leverage is getting paid to do two things at once, like babysitting when you can work on a business idea after the kids have gone to sleep.
And, yes, sometimes leverage is borrowing money when you expect a positive rate of return after making interest payments.
While there are limited scenarios in which I would recommend you employ financial leverage in your personal life, I can think of a few examples:
- Taking out a mortgage to buy an investment property.
- Investing money rather than paying down a low-interest mortgage or student loan with the expectation that your investments will earn a greater ROI over the long run than the interest rate on your loan.
- Taking out a low-interest auto loan instead of paying cash for the same reason.
- Using a 0% APR credit card to make a purchase and paying it off over 18 months while your cash continues to earn interest in a high-yield savings account.
In each of these scenarios, you can reasonably expect to come out ahead by using borrowed money.
Of course, only use financial leverage if you’re comfortable with the risk. Some people prefer to live without debt, and that’s fine.
That said, the next thing to know about running You, Inc. is that risk begets returns. Which brings us to our next section…
5. Take calculated risks
Modern capitalism is far from perfect, but it’s the world we live in.
We can argue whether people like Mark Zuckerberg, Jeff Bezos, and Bill Gates deserve to be billionaires. But they are clear examples of how big risks lead to outsized rewards.
Zuckerberg and Gates are Harvard drop-outs. Jeff Bezos traded a cushy job at a hedge fund to start an online bookstore out of his garage with $300,000 he borrowed from his parents. Yes, an online bookstore in 1994! For reference, the World Wide Web was only three years old. Netscape, the first dominant Web browser, was founded the same year.
When it comes to money, slow and steady doesn’t win the race. In fact, if you go too slow and steady, you might not even cross the finish line.
What we all know is that there are few certainties in life other than death and taxes. But I’d say that we add inflation to the list.
Inflation in the United States averaged has 3.25% between 1914 and 2019. At that rate, the purchasing power of a single dollar is roughly cut in half every 20 years.
As I’m writing this, the best savings accounts in the country pay about 2%. While that’s more than the present inflation rate of 1.7%, it’s significantly lower than the average inflation rate over the last 100 years.
What this means is, even if you are earning interest in a savings account, the value of your money is declining over time. While a savings account is insured, it is not safe.
The only way to ensure your money grows on pace with or faster than inflation is to earn a higher return than a savings account offers. And, almost always, the only way to earn a higher return on your money is to invest in something that may lose value. In other words, you must take a risk.
If you want to build wealth, you simply must become comfortable with risk.
Risks are not the same as gambling
It’s important to point out here that taking risks is not the same as gambling. Don’t go put your life’s saving on the roulette table.
What we’re talking about is taking risks where there is a positive expectation.
In a casino, unless you know how to count cards, every game has a negative expectation. In a game where the player wins even money, 45% of the time and the house wins even money 55% of the time, the player can never ever win in the long run.
If, however, there were a game in which the odds were exactly 50/50, but when you win, you win 110% of your initial bet, suddenly the tables are turned. If you bet $10, you have a 50% chance of losing that $10. But you have a 50% chance of winning $11. Let’s say you play 100 hands – long enough that the variance of your wins and losses approach 50/50 exactly. You’ll have lost $10,000 but won $11,000 – a $1,000 profit.
This is an example of a positive expectation. Even if you could only make the bet once, it would be in your favor to do so (assuming you can afford to lose $10). You might still decline this bet based upon the fact that the pain of losing $10 is certainly greater than the joy of winning $1. But what if you didn’t win $11 but $100 on a 50/50 bet.
Tempted now? What if the payout was $500?
I give you this example because it’s a different way of looking at the risk of investing in the stock market. When you invest for a long-time in a diversified portfolio of stocks, there will be years in which you will lose money. In particularly bad times, it could a lot of it (though hopefully not 50%). Still, the money you invest will grow significantly over time – possibly doubling every 10 or 12 years.
Investing is the one calculated risk that nearly everyone must take. But there are countless examples of how you can employ calculated risk-taking in other areas of your life.
Although entrepreneurship is an obvious example, it’s not for everyone, and that’s OK. Other examples might be moving to a new city with better employment prospects even before you land a job, going back to school, or employing leverage in one of the examples in the previous section.
My first mantra of the course: no risk, no reward!
6. Protect your assets
Risk is an unavoidable part of business and successful personal finance. However, just as you want to manage the risks you intentionally take, you also want to manage the risks you can’t avoid.
Any given business faces countless types of risks, from fire and natural disasters to lawsuits from customers, employees, or other businesses.
They manage these risks in myriad ways: with insurance, with lawyers, and, most importantly, with safe, ethical, and conscientious business practices.
As CEO of You, Inc., you need to give serious thought to managing your own risks. Granted, this was probably the last thing on your mind when you were just starting to learn about money. Why waste time and money protecting assets you don’t have?
Well, it’s true, the more wealth you accumulate, the more important risk management becomes. However, certain types of protection cannot be ignored even if you’re starting from zero or negative net worth.
Risk management comes in many forms:
- It’s ensuring your investments are properly diversified and doing due diligence on any new investment you make
- It’s having adequate insurance – auto, home, renter’s, health, life, disability, and, in some cases, excess liability.
- It’s having back-up plans in the event you lose your job or become ill or disabled.
- It’s taking appropriate measures to keep your finances secure and protect your privacy.
- And, in unique cases, it’s having business entities, trusts, or other legal protections in place to protect your assets in the event of a lawsuit.
You can work your entire life and do everything right to amass a fortune large or small. And yet, in the blink of an eye, an illness, fraud, or lawsuit can wipe it all away.
Take a second to imagine:
- You don’t have health insurance and discover you have cancer requiring $150,000 a year in treatments.
- You’re at fault in a car crash; the other driver sues you for $1 million and wins, but your auto insurance only covers $250,000.
- You get to know a brilliant, charming financial advisor who promises to earn you twice your current rate of return. You invest and lose it all in a Ponzi scheme. (Remember how many smart, successful people Bernie Madoff duped?)
You, Inc. wouldn’t operate without the right insurance, advice from lawyers, and the appropriate policies in place to minimize risks.
Neither should you.
Lesson 1 wrap up
Now that you’ve spent a few minutes thinking about yourself as CEO of You, Inc., it’s time to do a brief exercise, Your Money’s Mission Statement, to cement the ideas in this lesson.
In the next lesson, I’ll explain the importance of creating a wealth map (or plan) and how to start doing so. Going forward, I will mostly go back to referring to you as an individual rather than as the business “You, Inc.”
But I will remind you here and there to once again examine something as if you were the CEO of your own enterprise. I encourage you to do the same with any financial decision you face. You just might decide differently as CEO than you would as an individual.