Build a profitable business- the baby steps part 11

3. Penny-pinchers. We could just as well called this group the “Pay yourself first”-group, or perhaps “Get rich slow”-group. Perhaps penny-pinching sounds a bit more negative than we intended it to. We actually subscribe to some of the theories that this group tends to have memorized by heart. We have emploeyd most of them during our lives. We also like to pay ourselves first. We also like to put that capital to extra use, always looking for ways to make the money work for us. We also believe in the power of compounding. If you are looking for serious wealth there is definitively words of wisdom to be found in the libraries of the penny-pinchers. We have read all of the books. Some of them we loved. And some of them we didn´t like as much. But there is definitively value there.

While the “trying to get by-group” and “middle-class group” are basically financially illiterate the “penny pinchers” appear quite astute in contrast. Most of them are quite intelligent. Most of them have some serious interest in taking control of their financial lives. It is not unusual to start out in the “middle-class group”, graduate to the “penny pinchers” and ultimately end up in one of the groups later on in this list. That has to do with the fact that a solid “penny pinching”-education makes a lot of sense to most people, can be easily aquired by anyone, and is an excellent building block for further advancement towards financial independence.

If you hve been interested in taking control of you financial destiny, chances are you have met some “penny pinchers” along the way. They are easily recognizable as they have a smug grin on their face as they penny-pinch the living daylights out of yet another 8-buck latte in order to max out their 401 k. They preach with passion about concepts such as ”passive income”, “pay yourself first”, and “the power of compound interest”. In short, these folks are organized. What´s more these folks have a plan. Where the “trying to get by-group” and “middle-class group” rely on either destiny or the good-will of global corporations to bless their financial destiny, “penny pinchers” rely on battle-tested historical techniques that might not make them super-rich, but will probably make them quite affluent by the time they retire. But all that glitters ain´t gold.

There are some weaknesses in the armour of the line of thinking advocated by the “penny-pinchers”. First of all, this is going to take time. The “penny-pinchers” do offer sound advice but their goal is just too far down the road to get us excited. Basically, you penny pinch for 4 or 5 decades, and if everything goes according to plan, you will probably live the last decades of your financial life in affluency. We think you are much better of being rich at a younger age. That way you get the maximum amount of time to enjoy the fruits of your wealth. Second of all, the ”penny pinchers”, have a somewhat naive outlook on compound interest. Compound interest is powerful indeed. Itis their theories regarding yearly ROI:s that makes us sceptical. We have read books by “penny pinching” authors where one of the punchlines seems to be “get 10-15% return on your investment each year and let compounding work its magic”.

We find this line of reasoning to be slightly amusing, but it also provides us with useful information. The information, of course, is that the authors have little investment experience. In most cases, they claim to be expert investors. We beg to disagree. Among our ranks here at Richopedia.com we have a hedge fund manager and a daytrader making a living trading the market. An investment return of 10-15% each year is no small feat. Bernie Madoff, the brain behind the biggest financial fraud the world has ever seen, made 10% each year and had an inflow of investors right up until the very end. Bernie Madoff had some $ 36 billion AuM (assets under management) and yet here we here about authors of wealth books telling us that it´s fairly easy to bank 10-15% a year if you just learn a trick or two. That´s simply not true.

The third weakness in the argumentation of the “penny pinchers” is that they generally do not account for taxes and inflation. And in those cases they do, they only account for the “official inflation”. Of course if you´ve been around the (Wall Street) block, you know by now that the official inflation is pretty misleading (or should we say manipulated). Depending on where you live, the taxes and inflation aspects will differ. But for most western countries the official theoretical inflation is almost always lower than the inflation you will encounter in your daily life. If the “unbiased” government statistics bureau of your country claims that ytou have an annual inflation of 2 %, you can almost be cartain that inflation in reality is 3% or higher. Why they are providing misleading statistics? Long story. In short, inflation is the easiest way to take a part of your citizen´s wealth without anybody noticing (anybody but those who are financially literate that is, but they are so few anyway)- To put it another way, inflation is a secret tax. When countries are running deficits, like most western countries are, they can either raise taxes, cut costs or print (which means infflation). Since no government to this day has won an election raising taxes and cutting down on welfare and other spending politicians choose the line of least resistance; they print the missing money and can thus unobserved get a hold of their citizen´s money. It´s easy, it´s effective. And best of all, your average voter has no clue about the hand reaching discreetly into their pockets.

If you follow the penny pincher strategy for 4 to 5 decades you are likely to become affluent. Hell, it´s even likely that you will become a millionaire. The only problem is that, in the future, most of us will be millionaires. The rapid western inflation will need to be upgraded even further in the future since it´s the only way the western world can handle their debt-swamped and deficit-burdened balance sheets. If you are making, say 5 % in interest each year in many western countries you are just barely managing to defend the purchasing power of your holdings. We are assuming many of you who read this yoare living in a country with a tax rate of say 30%. That means out of the 5% interest 3,5% remain after taxes. With an unofficial inflation running above 3% you are just about keeping status quo. It´s easy to let yourself get carried away when you look at fancy “compound interest spreadsheets”. The truth is that they are to a large degree misleading, since taxes and proper inflation numbers have not been accounted for. There is a risk many commited “penny pinchers” will be a bit dissappointed regarding the real value of the savings they have accumulated over their lifetimes. The inflation/tax dilemma means you need to make an even better return on you capital than you initially expected. Suddenly the “penny pincher” strategy is losing some of its appeal. After all real purchasing power, not nominal, is the name of the game. And by the way, if you happen to stumble upon someone who can consistently make 10-15% per annum give us a call. We would be happy to give him all our capital.

The fourth weakness in the argumentation of the “penny pincher” strategy is the assumption by the “penny pinchers” that the market is always going to go up. Those unfortunate speculators who bought some stocks in 1929 had to wait until 1954 until they were even. 25 years is a long time to wait. Especially if you are simply waiting to get a dollar in return for every dollar invested. The “penny pinchers” argue that the market is always going to go up over the long run. We just gave you an example that proves this is not the case. We´ve had a long period of time with easy money providing fuel for the global indices. While most companies at the time of this writing are in good shape, the government finances of the western world respresent an accident waiting to happen. We would not be surprised to see a major crisis materialize sometime during the coming decades. Naturually, should such a major crisis materialize, the wisdom of the buy and hold strategy and the conventional wisdom of an ever-rising stockmarket would be put to shame. That´s just the thing with conventional wisdom. It pretty much stays conventional. But there are times where the wisdom goes out the window.

The fifth, and last, weakness of the “penny pincher” strategy is that you have to forsake stuff over a long period of time in order to reach your goal. Wouldn´t you prefer to work your butt of for a couple of years and reach the goal of the “penny pinchers” in a much shorter time span, perhaps 4-7 years. And wouldn´t you enjoy being able to drink a latte, take a cab or go to the restaurant without being worried about the expense? We know we would. Why not be rich now instead of penny pinching away for 40 or 50 years, and possibly become rich later. The flaws of the traditional “penny pinching” method doesn´t mean it´s a flawed strategy. It´s just flawed if you use it the traditional way. Instead let us show you how many of us have adopted our own variation of the “penny pinching” method. If you find our version to not be to you liking you can always go back to the ordinary “get rich slow”-theory. It isn´t bad. More than likely you´ll end up with solid economy, but chances are you will be too old to enjoy it if and when you get rich.

So let´s take  look at our version. Not much difference really. Most uf us have read the wealth books. Pretty much all of them. Even the really dumb ones. We agree about the importance about paying yourself first. We all do. And more importantly we all payed ourselves first when we were just starting out. The only difference is that we didn´t pay ourselves the usual 10-20% that most wealth books are recommending. No sir. Most of us payed ourselves between 50% and 95% of our disposable incomes during intense periods of time. How is that possible you ask? Well, when you have a burning desire and can think of little else you start to get pretty creative. Some of us lived on noodles or cheap pasta. Some of us slept at the office, in order to avoid paying rent. Some of us bartered. A snazzy web site in exchange for a daily lunch during  a month at the neighbourhood restaurant. You give me this. I give you that. It´s win-win.

In the end we stayed true to the “pay yourself first”-principle. Only we took 50%-90% to the bank, instead of the usual 10%-20%. And that made a world of difference. Anyway, so far our version seems pretty much in line with the traditional one. A slightly tweaked version perhaps, but still the same principles. Not really. The next step of the traditional “get rich slow”-methodology is to use the money you´ve just earned and put it to use. Make your money work for you. Put it in 401k. Put t in mutual funds and don´t touch it for the next couple of decades. Think long-terms. See market crashes as wonderful buying opporunities. Just keep that going for a while and if you are lucky you will wake up one day with a fortune to your name. That´s the theory of it at least. Well, most uf us went about it differently. Instead of saving 10%-20 and putting them to work over the nex 40-50 years, we saved as much as 95% and risked everything in one big swoop. That´s the difference you see. We never used the “get rich slow”-method  to get rich slow. We used it to get our hands on enough capital to be able to start an enterprise and get rich quick (er). We were simply waiting for the idea about the next best thing since sliced bread to come along. It´s not really a quick way to get rich. In most cases it´s going to take at least  a couple of years to get rich as an entrepreneur. But that´s a hell of a lot faster than having to wait 40 to 50 years to hear the cash register ring.

Also it is important to make a distinction here. While we saved the bigger portion of our earnings each month there were stuff we were happy to pay for. We would save up to 95% of everything we earned, but at the same time we could go on serious shopping sprees at times. What´s the logic behind that? First of all, we never, ever, went shopping for things merely because we craved them. We only parted with our hard-earned cash for stuff we felt could help our long-term balance sheet. Another way to put it is; we only spent money on things that would perobably lead to more earnings further down the road. The way we are seeing it, that´s not really spending, that´s more like investing. A perfect example of this is education. If we wanted to enter a certain business area we tried to learn as much as possible about it. Some of the things we did cost money. Not a lot of money, but still, the costs were there, and despite the fact that we were saving like maniacs, we di´dn´t hesitate about forking over the cash for the tuition fees.

At times that meant buying books about the subject. Sometimes it meant going to a trade convention to size up the competition. There were other times when we took a seasoned industry veteran for lunch and pumped him/her for information about their experiences. For the price of a lunch, we would often walk away with invaluable information and insight. On top of that we very often gained a valuable contact into the business we were interested in. Most of us work out several times a week. Some of us worj out each day. Why? Because we have learned that it enhances our ability to do business. It will cost some money. And it will cost you some time- of going to and from training- and doing the actual exercises. But again, we think you shouldn´t be penny pinching with regards to stuff that we see as investments. Stuff that will enable you to make even more money down the road. Save on those silly expenses that really don´t matter in the grander scheme on things but be ready to pay up for things that will bring experience, knowledge, education or a positive footprint on your balance sheet sometime in the future. We also like small costs today that can bring bigger payoffs down the road, and some business opportunities that bear the form of options can also be considered a cost that is acceptable.

Before you pay up, ask yourself this question: will paying for this help me build up longer-term balance sheet value, personal development or knowledge. If the answer is yes, you are allowed to chip in. There are times when it is difficult to determine whether or not an expense is to be considered as value generating for you balance sheet or not. Travelling is an expense that immediately pops into mind. We consider travelling or living abroad to be one of the best experiences an entrepreneur can undertake. Not only is it beneficial for your knowledge about how the world works. You learn a great deal about other people, and even more about yourself. Being part of another culture and living in another country is probably the best move one can make from a personal development point of view. Determining whether or not a trip to another country is allowed when you are saving up for bigger things is really a personal matter. You yourself must ultimately decide whether or not that trip makes sense to you, in relation to the bigger picture. And by the way, we know several entrepreneurs that discovered their “great opportunity” during a trip abroad. Taking a successful existing idea you encounter on a trip and trying to adopt it at home is an excellent way to start a business. You really don´t have to invent the wheel a second time around. You just need to be able to build a good enough replica of the wheel you saw in action.

We will all encounter great opportunities during our lifetime. They will be all around us. Every once in a while a truly outstanding opportunity will come along. Something so good you just have to act on it. That´s when you grab the cash you´ve been saving up and go for the kill.But wait a minute, some of you will say. I can´t forsake so much. Why would I deprive myself of all the grand things in life for the next couple of years? Is it any better to live a limited life for 40 to 50 years depriving yourself of the luxuries in life? We don´t think so. We´d rather suck up the pain short-term, work our butts off, and live the rest of our lifes as financially independent multimillionaires.

Then again that´s just us.