the money pillar

EVERYTHING YOU KNOW ABOUT MONEY IS WRONG

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This is a bold and arrogant statement. The sad reality is that it is true. School does not teach you essential life skills. It doesn’t teach you how to work with money. This creates a money vacuum. Aristotle spoke of the “horror vacui”- "nature abhors a vacuum". By implication, nature makes sure that vacuums are filled. In the case of money and finance, this vacuum has been filled with misinformation from the financial industry.

 

The financial industry has no interest in educating you – they only want to sell you stuff. They will give you just enough information to buy the product or service, but not enough information to truly ascertain whether the product or service is suitable. Regulators have tried to force financial institutions to pay attention to “suitability”. The problem is that these suitability tests are so broad and general that it is almost impossible to avoid misselling.

 

Alvin Toffler says that “the illiterate of the 21st century will not be those that cannot read or write, but those who cannot learn, unlearn and relearn”. In this blog, we look at THREE money lies you need to unlearn.

 

Lie #1: It is Easy to Tell the Difference Between Assets and Liabilities

Accounting is taught in many schools – and is useful in finance. Your accounting teacher, however, failed to mention the huge difference between accounting and finance.

Accounting teaches you that a house and car are both important assets. Banks have jumped all over this and throw money at prospective home and car owners. The problem is that both these “assets” are predominantly “liabilities”.

 

In finance, the value of a financial asset is the present value of its positive future cash flows. When you buy a house, and you live in that house, are your monthly cash flows positive or negative? You need to pay rates, taxes, lights, water, insurance, mortgage (if you financed the house). All these items are money outflows, indicating that this house is not a financial asset. The same is true for a car. You need to pay for petrol, insurance, maintenance, fines, parking, and monthly financing (if you are leasing the car or bought it on an installment sale agreement).

 

What determines whether something is an asset or liability is not its inherent nature, but what it is used for. Robert Kiyosaki, the author of "Rich Dad, Poor Dad", expressed it best. An asset puts money in your pocket while a liability takes money out of your pocket. A house is only an asset when it generates positive cash flow (i.e. when you rent it out). A car is only an asset when it makes you money (i.e. when you hire a driver and put it into Uber). Financial freedom comes from understanding the difference between an asset and a liability and building up a portfolio of assets that generate a stream of high-quality and predictable positive cash flows.

 

Lie #2: Risk is Bad

Banks want you to put your money into a low-risk savings account. This is one of the best products – for them! What do you get in return? You will receive a very low-interest rate. The bank, on the other hand, will lend your money out at a far higher interest rate to another customer. This is how traditional banking works.

 

So why do people deposit money into savings account? Our faulty brains tell us that risk is bad. Studies have shown that the fear of losing 100 is far greater than the joy of making 100. We are hardwired for self-preservation and risk avoidance. The problem is that without risk, there can be no meaningful return. If you want more returns, you need more risk.

 

Jeff Bezos of Amazon became the world's wealthiest person in 2018 by taking risks. He put all his eggs in one basket. He went all-in on a little company that sold books over the internet. As of September 2021, Amazon boasted a $2.5 trillion (that is almost the size of the United Kingdom’s GDP) market capitalization. Risk is good as long as it is managed.

 

If you start a business, and you believe in the business with all your heart, mind, and soul, go all in. Commit to it and believe you will succeed. This belief, commitment, and drive will act as a risk management tool. The same is true with stock market investing. You need to do your homework on the stocks you buy. The more you know about the company, the better you will manage the risk associated with that company. If y0u want your money to truly work for you, you need to take calculated risks.

 

Lie #3: Debt is Evil

This lie does not come from the banks – it comes from financial advisers. The first thing financial advisers tell clients is that they need to pay off ALL their debt. Why do they say this? Because they are financially illiterate! Credit cycles drive economic cycles and without credit, economic growth would be anemic.

 

You need to differentiate between good and bad debt. The determinant of whether debt is good or bad is not only the interest rate, it is also how the debt is used. If you use debt to acquire high-quality assets, it can be a very powerful generator of financial freedom.

 

For example, interest rates in most countries are at historically low levels. If you buy a car on credit, paying a 10% interest rate, and get it working in Uber generating a net yield before tax and interest of 20%, you are generating a return of 10% out of fresh air (assuming you did not have to put a deposit down on the car). Even if you put a deposit down, your return on investment would be through the roof! This is good debt.

 

Bad debt is used to finance activities that do not generate any cash flow. For example, taking out a loan to go on holiday, or remodel your home, or increase/decrease the size of a body part. The poster child for bad debt is the credit card on account of its high-interest rates and them often being used to acquire non-cash generating assets.

 

Allow me a few words in defense of the often-maligned credit card. These are the most commonly sited reasons for credit card evilness: credit card companies make money out of you, you are setting a bad example for your kids, credit cards are like the apple in the Garden of Eden, and you do not need a credit card.

 

Firstly, credit card companies do not always make money from you. There are two payment options on your monthly statement. The first is the minimum payment. Credit card companies pray you choose this. It allows them to charge usurious interest rates disclosed in small print on page 89 of your contract. There is another option which is the payment to avoid interest. This is a thing of beauty. It will settle the balance at the cutoff date of the card. The cutoff date is normally ten days before the payment date. If your cut of date is the 20th, your payment date will most likely be the 30th. If you buy a Louis Vuitton bag on the 21st, you will only need to pay for that necessity on the 30th of the following month. You are the recipient of 39 days of FREE MONEY. I don't care where you are from, but that is a great deal. The banks make no money out of you in terms of interest. They may charge an annual membership fee but this is all the blood they will be sucking from your veins. The second argument is you are setting a bad example for your kids. Teach them about the 39 days of free money and that bad example turns into a good example. It is your job as a parent to educate your kids financially because they will not get this at school. Buy them a copy of this book. Every member of every family should have their own copy – books are like swimming trunks; they should not be shared. The third point is one of temptation. Credit cards present too much of a temptation. Whatever happened to self-control? At what point did self-control stop differentiating us from wild animals? If your credit card is your biggest source of temptation, then you may have bigger problems. The final point is that you do not need a credit card. This is just stark raving mad – you do not need two lungs, but you were born with two. You do not need wisdom teeth – they serve no real purpose – but most people are born with them and are a bloody nuisance to remove. I hate going to the shopping mall. My wife could spend an entire day there. After half an hour, I want to rip my eyes out of their sockets. Amazon, on the other hand, is god's gift to men like me and is best done with a credit card – add to this list Netflix, Spotify, and Uber.