An Inconvenient Truth: Personal Finance Edition: Additional Thoughts

In yesterday’s post, An Inconvenient Truth: Personal Finance Edition, I blogged about the notion that by purely saving you may actually be losing money.

After reading deeper into the article that prompted my thinking, the comments people have about it and talking to a few people I know interested in these topics, I have a few after-thoughts:

• I still don’t understand the hostility most of the commenters have. Of course no one wants to see our economy in trouble. No one wants to see America’s wealth shrink, but isn’t it a possibility at least worth considering? Isn’t it something worth learning about to figure where he may be coming from? You can’t predict the future, nor can you influence the will of the mob. You can prepare yourself for what might happen, whether good or bad, and have contingency plans for those options. Preparation for all likely scenarios is the only way to find consistent returns, in good economic times and bad.
   
• I can expect some people who have a lot of experience in the stock market and have had better returns than market average take particular offense to this kind of thinking. They, most likely, made a lot of money (and value) in the last 5 years. Unfortunately most people are not active investors. They do as the financial planning industry tells them and diversify their assets between market indexes or bonds or cash or REITS or all the above. They hope that “law of averages” works to their benefit. These are the people who concern Mr. Kiyosaki as they think they are getting closer to their goals, yet an argument can be made that the last five years put them further behind. They may not have the ability to live the life they planned for when it comes time to retire due to a reduction of purchasing power.
   
• His view is obviously quite unpopular, yet my studies tell me the motion of the stock market tends to favor the unpopular vote. Technical investors look at the put (a bet the market will go down) to call (a bet the market will go up) ratio as an indicator for market turns. When the sentiment is such that everyone is betting the market will keep going down, it actually tends to reverse, and vice-versa. This is a form of “stepping outside of the mob” and doing the opposite, which takes intestinal fortitude! I can’t say I’ve studied crowd psychology and the economic cycles but my guess is that things aren’t much different. I also know that Warren Buffett has made a lot of money by flanking popular vote.

I’m not entirely sure what all this means for me and my financial freedom strategies. My security blanket plan still revolves around the “put my retirement funds in a safe, secure index fund” strategy. However, the purpose of my experiment is to see if it is possible to reach financial freedom much quicker by building a business using mostly passive thought. I also like to think that there is merit to acting contrary to popular belief, as popular belief is what got most Americans (by definition) deeply in debt with little chance of a safe retirement. This is why my rules were inspired by common excuses for not using a business as a vehicle to reach financial freedom.

If all this works, it is a greatly accelerated alternative to the “buy & hold index funds and bond funds strategy”. If it doesn’t, I learned a heck of a lot for not much time or money.

An Inconvenient Truth: Personal Finance Edition

In a recent post I noted how once you are living beneath your current means its more important to increase your income than decrease your expenses while you are on your journey to financial freedom. Really it’s a combination of living beneath your means while also expanding them that I’m going for. In fact. as a somewhat cryptic article by Robert Kiyosaki for Yahoo! Finance states, when you’re purely saving your money you are probably actually losing value even though the price may be going up. Sound crazy? It’s been happening for the last few years.

It’s funny to me to read the comments following his article. I think people find what he’s saying too hard to swallow. After all, it’s far easier to discredit than to adjust behavior, especially when the entire financial planning industry has been telling people that investing for the long term, diversifying and paying down their mortgage is the right thing to do! I think a lot of people missed the point, which is the stock market may look good now but you have to take a bigger picture approach to your personal finance strategies… Especially if you don’t have a lot of time between now and retirement.

Allow me to illustrate Kiyosaki’s point. Let’s assume you are of the young, aggressive saver type. You had some market timing savvy and placed all of your retirement savings in a 401(k) / NASDAQ index fund January 1, 2002 thinking you found the bottom of the dot-com fallout. January 1 2007 shows a pretty nice gain over the past five years. The problem is that the value of your investment actually decreased when compared to gold and other currency markets. Using some figures for the NASDAQ, gold cost / ounce and the Euro, we see the following:

Year	NASDAQ in $	NASDAQ in EURO	NASDAQ  in Gold Ounces
1/1/2002	$1,979.08	2162.65 EUR	~7.00 Ounces
1/1/2007	$2,434.92	1840.29 EUR	~3.93 Ounces

At face value, the price of the NASDAQ has gone up quite a bit over the 5 year period. In a vacuum you may even be quite happy with your investment choices. On a global scale however, you’ve actually lost quite a bit of wealth in the process. Whether we realize it or not, our purchasing power has gone down even with recent increases in asset prices. With easy access to debt, Americans continue to borrow from a bank. As they make purchases their borrowed money gets deposited in another bank. As that money is deposited, it gets lent out 5-10 time’s over, creating new dollars out of nothing and making existing dollars have less value in the process.

America is an import economy. When our dollar buys us less overseas, eventually that comes back to hurt us. Luckily we’re as willing to go into debt as other countries are willing to finance our over-consumption – to the tune of ~$500,000,000,000 in 2006. This easy access to debt has allowed us to create phantom wealth in our homes and borrow against it to continue buying junk that we couldn’t afford on our actual income.

The complexities of why this happens are far to great for this little blog of mine, the implications are much easier. As the devaluation of the dollar continues to ripple through the US economy, people are going to find that the 401(k)’s that are increasing in price continue to lose purchasing power.

Running to “risk-free investment vehicles with historical returns of 10%” may actually prove to be much riskier than my new business venture. If it works the returns are infinite (no time, no money). I’ve printed money for myself. If it doesn’t work, I may have to pay back some debt which I’ll be sure is manageable. The funny thing is that at this rate I can actually make money by borrowing (a dollar 5 years ago is worth 25-50% of what it was today!)

How can you combat all this? That is the $500 billion question. Some may argue that I am comparing apples to oranges, but the real concern is that historically a country with huge amounts of debt has found themselves with a depression or prolonged recession, which is really worse than poor returns. Another argument can be made that we buy goods and services here with our $US so all that matters is that those dollars are increasing.

Starting a business that will work for you in times of noth recession and expansion is one way of keeping up with the devaluation of our currency. Theoretically as your costs rise, so do the prices people will need to pay for those goods. I’ll do great if the economy continues to expand and I’ll do just fine if the economy tanks. This is why I believe my business will give me a better chance at financial freedom than my retirement accounts alone!

In a Globalized Economy, Ideas Can Set You Free.

I recently read The World Is Flat by Thomas L. Friedman. It’s a fascinating book on many levels as it explored, in-depth, the economical, sociological and political implications of the Internet and technology.  According to Friedman, we’ve now reached ”Globalization 3.0.”

I will save the general book review for others, however the point that I found most fascinating is that efficiencies afforded only recently through technology and the Internet has enabled large companies, who 20 years ago wouldn’t want to service any company short of the Fortune 1000, to now actively search for business amongst the little guys. They want to give people like me the benefit of their billions of dollars of R&D into their area of expertise in a nice little package offered for a ”pay as you need” pricing structure.

If you have a idea for a business you can, in theory, simply outsource the R&D to an engineering firm in India. You can outsource the design of your logo, product packaging, website and sales collateral to a design firm in Argentina. If you are selling a tangible product, and it’s not like you have to these days, then you can outsource your manufacturing to China. You can outsource getting your product here and all the details of distribution and fulfillment to reputable U.S. companies like UPS or DHL. The same goes for Sales, Marketing, Customer Service, accounting, legal, etc.

I aim to see how far I can take this concept of outsourcing everything. It would seem that just about every aspect of your business, except the original business concept – your idea, can be managed cheaply and efficiently by someone else’s employees, trucks, warehouse space and knowledge thanks to Globalization 3.0.