Monday, January 07, 2008

Value Proposition

Value is a funny word. Not amusing, but odd; it has many different meanings and applications, in different situations; and it can be among the most difficult things in life to know, evaluate, and understand.

A few years ago, a man named Robert Kiyosaki made an awful lot of money, by telling people the rich had "secret" knowledge they passed down from father to son; and the poor did not. In reality what he was saying was that the poor didn't understand money, the rich did, and they taught their children. He then proceeded to "reveal" these secrets to the rest of us.

Playing on class envy and conspiracy theories is a very effective tactic; and it's made Mr. Kiyosaki a lot of money.

The rest of his book(s) were taken up with either correct, but basic and well known financial advice; or incorrect, dangerous, and stupid financial advice; whatever made Kiyosaki look more like a genius to those who had never been taught about money. He became a bestselling author many times over; and in fact his primary book on the subject is still among the best selling financial books in America, especially on amazon.

He's also declared bankruptcy twice since becoming rich (he is not wealthy by any means), has been sued countless times, has been investigated for fraud, fined, etc... etc...

He did have a valid point though; there are things that the rich... or perhaps a better term would be the wealthy, but let's stay with rich for now... know about money, that the poor and middle class don't.

Of course this is no great conspiracy theory; it's just that relieved of the burden of struggling just for survival; and having the budget necessary to try and fail; the rich either learn what REALLY works, or they end up rich no longer (or they at least hand their money over to someone who DOES understand anyway).

So, what are those things the rich know that the rest of us don't?
  1. Cheap is expensive; value is a bargain.

  2. Time is expensive; anything reasonable you can do to save it, is good value.

  3. Hard work won't make you rich, but lack of it will probably make sure you get and stay poor; unless you have real wealth (and know how not to lose it).

  4. Income is not wealth.
Pretty simple concepts to write down, a bit more difficult to full explain, and a lot more difficult to execute... but I'll give the explaining part a shot.

If I buy a $500 couch (which isn’t cheap in terms of an average persons paycheck, but is in terms of couches), I can expect to replace it every two to three years. If I buy a $3000 couch (what you’ll pay for quality; anything more and you’re just paying for style), then I should never have to replace it at all. If the fabric gets worn or I want to change it, it’s worth re-upholstering. In the mean time, I’ll be much happier with the more expensive couch.

You need to look at it from a perspective of total satisfaction of couch experience over your lifetime; and the total couch costs over your lifetime. If you have to replace a $500 couch 12 times, that’s $6000; vs the $3000 couch that you never have to replace (maybe you have a $1500 re-upholster at one point), and which gives you an overall better couch experience; in the long run, it is the better value by far.

The problem is understanding what is value and what isn’t; that’s where experience, and the ability to work with the numbers comes in. For example, if I know I have small children and dogs and cats, and I’m going to be moving in three years anyway, then there is little value in the more expensive couch right now; but when I buy it later, my real “couch cost” goes up to $3500 rather than $3000; because of the $500 I’ve already spent.

Let's look at a much more practical example; because let's face it, not everybody has a $3000 couch, but most of us have cars.

The absolute worst "reasonable" seeming thing someone with a very limited income can do financially, is buy a $500 car (the second worst is going into massive debt to buy a new car, but that's another story entirely).

Why's that? After all, if a $500 car works, it helps me earn more money, get more done in my life etc... Right?

Sure... until it inevitably breaks down in expensive and difficult to fix ways.

There has rarely been a $500 car that didn't end up costing $2500 in maintenance, repair, and upkeep costs over it's "useful" life. Meanwhile, every time it breaks down, it costs you time, money, stress... and often your job.

Reliable transportation is a money earner; unreliable transportation is a BIG money loser. Even if it's more expensive, it's always better value to pay for reliable transportation.

Most often, you are better off going without a car for the amount of time it takes you to save for a $2500 car, than you are buying a $500 car, or even five $500 cars.

You might think that you can get around the problem by simply buying another $500 car every time it breaks down, rather than repairing the old one; but it never works out that way. The $500 cars kill you $50 or $100 or $200 at a time, until all of a sudden you've spent just as much as the $2500 car; but all you have in hand is still an unreliable $500 car.

Even if you DO manage to buy another $500 car every time one breaks down, how much time has that cost you? How many times have you lost your job because of it? ...and again, at the end of it, you've spent $2500 and all you have is another unreliable $500 car.

It's called throwing good money after bad, and it's a sure way to ruin yourself financially.

The exception, is when you have no other option but have a car, in order to be able to work. If that's the case you need to find the most reliable car you can stretch to buy, with the lowest maintenance costs; and replace it with a more reliable car as soon as you possibly can (ahead of all other spending). The value here is in ensuring steady income, not in the false economies of cheap cars.

The poor spend their lives rarely getting ahead not because they don’t have any money (you can deprive yourself and save a surprising amount); but because whenever they do have money, their savings get wiped out by having to rebuild over and over again. Cars, furniture, moving from apartment to apartment, losing deposits, losing furniture, having to pay moving costs… It’s all wasted money, and tremendously draining.

The only way to get ahead, is to get off the treadmill. When you want to buy something, do one of two things:
  1. Wait until you have enough money that you can buy value.

  2. If you absolutely cannot wait; buy the cheapest possible thing that will get you by until you CAN buy value.
The second choice is only an option, if it will last until you can afford better. You never want to sink a cost more than once… “Get you by until you can afford value” is important; don’t buy something that will need to be replaced or repaired before you can afford quality, or you are going to end up worse off.

...well, excepting in those rare cases where value is actually in replacing the cheap product.

Certain tools for example do the job just as well, and wear out just as fast whether they cost $20 or $200; so buying the $200 doesn’t provide value.

.. except of course, when you’re dealing with TIME.

If the $20 drill and the $200 drill do the job just as well, and the $200 drill bit only lasts 5 times as long as the $20 drill; then there’s no value in the $200 drill.

But, if replacing the $20 drill five times, means doing a lot of work over; or interrupting critical work often to change out drills, well, the time you avoid wasting is worth a lot.

This seems to be one area where tradesmen, and the rich have the same understanding. It makes sense to pay for quality, when it saves you time; because time is ultimately what value is all about.

No professional mechanic will buy tools that are likely break in the middle of a job; even if the alternative is a FAR more expensive tool; because that tool breaking costs them time, and rework, and aggravation, and lost business; all of which are more valuable than cash.

The rich pay people to do things for them, the poor often try to get by without, or do it themselves. I fully believe in doing things for yourself when it makes sense, but there are many times when what you are “saving” in direct cost, is actually costing you more in time.

For example, packing up and moving for yourself; something I’ve done many times.

If you've only got a small apartment, a friend with a truck, and you're moving across town; it usually makes sense to move yourself. After all, it's just a few (hah!) hours of time and effort, vs. $500 for movers.

When I had to move cross country though it didn't make sense at all. Packing and moving myself would have meant taking two weeks off work (or at least a week and a half), buying all the boxes and materials, packing everything, renting a truck, loading it, driving for 5 days (you can do it in less in your own car; not so much in a rental moving truck), paying for the fuel food and lodging necessary to do so, and then unloading it all on the other end.

That was two weeks, where I was earning far more money than the difference in cost between doing it myself, and hiring professionals (about $1000 difference). Meanwhile, I was experiencing far less stress and physical injury by having professionals move me.

Oh and I should note, one of my jobs as a teenager was as a professional mover; I know what I'm doing, and I know that I don't want to be doing it. I love driving across country, but doing it for recreation, without a fully loaded vehicle; is very different than doing it with a 24 foot box van, and a hard time limit.

Then there would have been the complication of moving the car across country with me. If I moved myself, it would have meant renting a different (larger and more expensive) truck, and a trailer for the car, paying more insurance, more fuel, and taking an additional day on the trip which means more food and lodging cost. I'd guess another $500 onto my costs.

If I paid for movers; but then decided to drive the car myself, it would have been 4-5 days of driving, and $300 worth of gas, plus another $300 in hotels and food.

Instead, I paid $400 total, to have the car picked up and shipped, door to door. (this was almost 10 years ago now, it's a bit more expensive today), and $200 for a plane ticket.

That's a break even proposition in cash; but a huge difference in stress, and wasted time. If I drove, I would've been out of commission for a week; as it was, I was unavailable for a day.

In either case, my time was far more valuable to me than the few hundred dollars I might have saved. I used that time to earn more than the cash I spent; and I avoided a great deal of unpleasant work.

The value there is the time; not the cash.

Sometimes the choice to do something yourself, vs. hiring a professional is a question of having the right tools; tools which professionals have and you probably don’t. Sometimes, if you have the skill to use them; there is value in buying those tools, rather than paying someone else to do it; but again, it ultimately comes down to time, and how you value it.

For example, I enjoy building things with wood; and I learned how to do so in my uncles furniture restoration shop when I was a teenager (one of my first real jobs). When the time came to build some bookshelves, we had the option of building or buying. Based on the number of shelves we wanted, we would have needed to buy seven six foot high, 5 shelf, 42" wide book shelves. If we wanted them in oak (or any other hardwood), they would have been a minimum of $750 a piece.

Sorry, but I'm not spending $5500 on bookshelves.

...but, I can get the wood for about $1500; and I've got the tools I need to do it... though I'd prefer to upgrade my table saw and router, and maybe grab a radial arm saw; about $1500 total.

$3000 is still a fair bit of money for shelves, but I have the skill necessary; and at the end of it we'll have beautiful oak bookshelves fit to our needs (and our rooms) exactly; a few new tools, with which I can build other things; and the pride of having built them myself.

I could even do it for $1500, without upgrading my tools; but by upgrading I'm going to save myself at least 8 hours worth of time and aggravation (I'm going to have to do over a dozen 6' straight rips in hardwood; and all I have is a contractors saw)... I'm guessing more like 16; and that's just on this one project. By upgrading my tools now, not only do I save that time (and get the value back from it), but again, I now have better tools to help me save time later.

I'd say that's excellent value personally. The only reason I haven't done it yet, is because there have been other, higher priorities for our spending.

Like I said above, knowing value is the hardest part; and one of the most important skills you can develop in this world. Knowing value, and acting on it, is how you become wealthy.

So... if I'm so smart, why aren't I rich... or more importantly, why aren't I wealthy?

Well, for one thing, I haven't really followed my own advice.

Actually that's not totally true; I did to an extent, in that I have alway bought for value not for price; and I have generally valued my time highly (though I am by nature a workaholic, and my chosen profession often demands extreme hours).

The advice I never took, was the second half; number three and four.

You see, I've always owned my own businesses, or been involved in direct entrepreneurship. I started my first business when I was in high school; and other than my time in the Air Force, I have generally worked for myself, or as a founder of a business.

That's a high risk, high reward path. 80% of all businesses fail in the first two years.

I've been rich. I've been a multi-millionaire three times.

All three times I ended up with not much to show for it; because I started the process by getting rich, but I didn't secure it by becoming wealthy. I worked hard, but hard work doesn't do it.

Having 12 million dollars in cash and stocks makes you rich; it doesn't make you wealthy. Wealth can't simply evaporate overnight.

Rich is cash in hand, wealth is something else entirely. Wealth is long term security.

Let's define wealth here, just for clarities sake.

To be wealthy, you must hold enough assets of persistent and appreciating value, in excess of your liabilities; that should you be unable to earn any income, you could still maintain your standard of living indefinitely.

Additionally, you must also have enough cash and convertible assets to cope with an unexpected expense equal to your cost of living, for one year, without eating into your principal or foundation assets.

Anything less than that isn't wealth. You may be rich, but you aren't wealthy.

It's a fairly simple to define, a bit more difficult to put into practice.

I spent most of the last 10 years working at jobs that paid me substantial though not "rich" incomes. I haven't earned less than $100,000 per full work year, since 1999. I make a fair bit more than that right now...

...and I'm mostly broke.

There's a lot of reasons for that.

The first reason has to do with my philosophy of money, which up until recently has been "I'm going to go for what I want, and not worry about the money". I risked big, I won big, and I lost big.

I could do that, when I was 26 and flying around the world every week, and it was just me to take care of. I would take a six month contract for $200,000; and I'd not "officially work" for six months, plowing that money back into pursuing my interests.

I wasn't on vacation, I was pursing business interests, which sometimes worked out, and sometimes didn't. It's not in my nature to not work; but I enjoyed having the freedom to work on what I wanted, when I wanted. I did it because I enjoyed it, and because I could.

In the process however, I gained and lost three businesses, several million dollars, and a first wife. I also lost a lot of money by buying and selling real estate at the wrong time; and a lot of money in rent, and expenses... and never really acquired any persistent assets.

Funny enough, I've never lived extravagantly in that time. Sure, I've lived in nice houses, but not hollywood nice. 2000sq feet in a nice but not fancy neighborhood, with a nice view. The most expensive car I've ever owned was an Alfa Romeo 156 (I did have a Porsche at one point, but it was 20 years old); nice, but again, not extravagant. I don't buy expensive and flashy jewelry, boats etc...

...But I've still got nothing to show for having earned all that money.

That's the problem with being rich, without being wealthy; cash goes away very quickly.

The last two years, since I came into a readymade family; have been the happiest, and most fulfilling of my life. They've also been by far the most expensive.

I moved back from Ireland in 2003, with nothing but two hockey bags of stuff; and the $20,000 cash I had left over after I was screwed on selling my house quickly (I gave an agent authority to make a good deal, and they made a very bad one; I believe pocketing part of the difference, but I didn't have time to pursue it). I came back because I thought my mother was going to die, and I lived on that cash for six months, helping to take care of her, before I finally went looking for (and found) a job.

A few months after that, she and her second husband split, and I ended up using all my cash and convertible assets to help her buy a house; whose mortgage was supposed to be paid for by her divorce settlement. Unfortunately that didn't happen... Let's skip all the details and just say that I've bailed her out a couple times since then, on her mortgage and her medical bills (which are truly astronomical. Far more than the mortgage... or for that matter, the cost of the house outright). Finally, in the middle of last year I had to say no more.

Then a few months after we got her into her house, I lost my gig, found another one for 90 days, and then lost that one too; before finally settling into my current streak at two and a half years of solid gigs (though there was still a couple of months in between my current and previous contracts).

That's the nature of my business, it's streaky. You make great money for few months, up to maybe two years; then you don't work for anywhere from a couple weeks to a couple months; then you get back to good money again.

Remember what I said earlier, about having to start over, over and over again? How it drains you and keeps you from ever getting ahead?

Well, you don't have to be poor for that to be true. You can make $200,000 a year and have it happen just as easily.

Of course I know there are people out there reading this who support a family on $25,000 a year, who have to be offended by that concept; but it's true, and it isn't bad decisions and sloppy money handling.

The thing is, the more money you have, the more everything else takes; simply because it becomes possible. When your mother needs a $50,000 bailout and you make $25,000 a year, it isn't even a consideration; she goes bankrupt, and she comes to live with you. But when you make $150,000 a year, even though it ruins you financially, you bail her out.

Of course you could decide to live as if you didn't make the money; and that can be good advice; but it's also not how I've wanted to live.

For the last two and a half years, I have been stepfather to two beautiful girls, and husband to a wonderful wife. My income has enabled us to send the girls to a great private school (thankfully subsidized by the parish, or we wouldn't be able to afford it). It has let my wife stay at home to take care of the girls, and the house. It has let me set up our household with the furnishings necessary for four people to live reasonably comfortably (again, nothing extravagant, the most expensive thing was the $1250 TV... I haven't bought the $3000 couch yet).

Unfortunately, it has also come with a few setbacks.

Just after we moved into our current house, two years ago, my then current contract was cancelled; though it was expected to be renewed (budget cuts). I was recruited for my new contract right away, but because of the excessive bureaucracy at my new gig, it took 60 days between the phone call saying they wanted me onboard, and my first paycheck.

Then, in July of 2006, my car burned (electrical fire), and the insurance wouldn't cover it. That was a total loss; and we had to go out and buy another car; eating up another chunk of savings.

All of that would have been ok, but for another huge expense, that has eliminated all our savings, and kept us from accumulating any real cash.

We've been fighting a custody battle with her ex the entire time; and he has deliberately made the fight as expensive as possible. He lost the case... essentially the moment we filed; but he has filed pointless motions and appeals over and over again. We had over $10,000 in legal expenses in 2006, and over $30,000 in 2007.

As a result, we have good income, reasonably good credit (I'm still having problems clearing up previous identity theft issues), and almost no debt; but we also have no savings. In fact because of recent major payments that had to be made to the lawyer; at this point we don't even have emergency savings.

Again I say, this is what happens when you have income, but not assets. Income does not equal wealth. Cash can disappear fast as smoke when things turn south.

Wealth endures.

The way to build wealth is again simple in concept, difficult in execution:

  1. Use your income to purchase assets which retain or increase their value; while at the same time, hedging your cash to cover emergencies, so that when they happen you don't have to sell assets on unfavorable terms.

  2. Do not sell major assets, unless you can do so on extremely favorable terms; and immediately use the proceeds to fund the acquisition of an asset that will provide either a greater return, or greater security at the same return; as the asset being sold (this is called bootstrapping).

  3. Once acquired, never reduce your principal, your reserve capital, or your assets. Converting an asset to cash is as good as a loss, unless that cash is immediately converted back into an appreciating asset.

  4. Always maintain enough liquidity and flexibility to bail yourself out. The more invested or extended you are, the more you need to keep to bail yourself out.
Those four steps are what you need to be wealthy. Following them won't guarantee you'll achieve wealth; but not following them will guarantee you wont, short of a windfall.

Unfortunately, I haven't followed them; and look where I am today. Sure I'm not in an awful financial situation; in fact I'm OK (and a lot beter off than 99% of the planet); but how much better off could I be, if I HAD taken my own advice?

UPDATE: I wrote this post before I knew about this. I'd say, "how about the irony", if we weren't busy trying to keep our kids from being taken away from us.