Month: May 2013

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Entrepreneurship Part II – Observations on ownership vs. working for others

Waiting for a signThis is a continuation of a theme started earlier, in this post On Entrepreneurship, Part I

Founding an investment firm

A friend from college once explained to me that, growing up, he didn’t realize his family was wealthy.  His dad worked at an investment firm, and they had a comfortable lifestyle, but my friend noted no major extravagances about their life.

One day his father told him that he had in fact founded the investment company where he worked, and that while the salary he’d drawn for the past thirty years had made them comfortable, their family’s real net worth, as he approached retirement, was something much more significant.

The key, his dad explained, was that unlike other dads who worked for a salary and then retired after a few decades, he had, by contrast, built up something very valuable at the end – his equity in the firm he founded.  He sold the majority of his investment business to a European bank for a considerable sum, which overwhelmed the regular salary he’d drawn over the years.  Being an owner made all the difference.

Suddenly my friend realized his family was more than just comfortable, it was inter-generationally wealthy.

The Goldman IPO

In my own life, I joined Goldman Sachs shortly before the firm went public via an IPO.  This event made hardly any difference to my career or net worth.  As an analyst with very little service to the firm at the time, I hardly rated any notable equity gift.

For people with longer service at the firm, however the lesson of the IPO – in particular the difference between fixed income and equity – couldn’t have been any starker. 

Managing Directors, the penultimate ‘rank’ at the firm, could expect a low seven-figure payout through the IPO award of stock and stock options.  That was nice, and I’d be the last one to ever feel bad for a Managing Director at Goldman. 

Partners, the highest rank at Goldman, owned the firm before the IPO.  I estimate Partners generally received a payout 30 times higher than Managing Directors at the IPO.  Amazing to me.

The Managing Director IPO amount was cool and comfortable, but probably didn’t change everything about the person’s life.  The 30-times-higher partner payout, represented blow-your-doors-off-never-work-again type money.  All because the partners owned equity, and the MD’s didn’t.

Managing Directors and Partners did the same jobs, worked themselves to the bone the same way, dedicated their every waking breath to advancing the firm, and had distinguished themselves at the top of the financial pyramid.  Usually the biggest difference between an MD today and Partner tomorrow was time – the Partners had typically joined the firm a couple of years earlier.

Although the Goldman IPO represented the extreme example of salary vs. ownership in my own life, I have come to think that that ratio holds true elsewhere as well.

My best guess is that the difference between fixed income and equity, when it comes to getting rewarded financially after a lifetime of building equity, is about 30 times higher.

You know those charts showing the difference between fixed income and equity returns over the long run?   I’m talking about charts where the returns from fixed income assets show a modest, steady rise due to moderate compounding effects, while the equity chart shows a rocky, but ultimately asymptotic upward turn?

equities vs fixed income

Those charts show the difference in investment returns from bonds vs. stocks.  And also the returns from working for a salary vs. owning and building a successful business.

I’m not insisting you be profit-oriented.  But if you are profit-oriented, you need to figure out a way to own your own business.  For the same amount of work, the financial payout is 30 times higher at the end of your career.

Caveats, qualifiers, clarifications on the for-profit life vs. other choices

Not everyone wants to work for profit, and I think that’s just fine.  Great even. 

Many people prefer to create beauty in the world, or to contribute to better understanding in human relationships, or to encourage the care and feeding of the soul.

Others seek to push the envelope on human knowledge, or to sculpt young minds, or to comfort the grieved or heal the stricken.

Others, perhaps a majority of the human race, just want to take in enough money on a weekly basis to allow some leisure time for beer, ice cream, and football.

I applaud you if you seek any of these things.

All of these goals, in their own way, are as valid, or more valid, than maximizing your pile of money.

So when I write about the advantages of entrepreneurship for maximizing personal profits, I’m addressing the profit-oriented person right now.

If you do plan to work on increasing your personal pile of money, you cannot afford to work for a salary, for someone else, on a fixed income.  You need to start building equity, like, right now.

See previous post on Entrepreneurship Part I – Equity is Ownership, Fixed income is Salary

and subsequent post on Entrepreneurship Part III – More differences between ownership and salary

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On Entrepreneurship Part I – Fixed Income vs. Equity or Salary vs. Ownership

love my bossA salary is Fixed Income

Earning a salary, working for someone else, is earning ‘fixed income,’ which means you hope it comes close to covering your lifestyle expenses.  Like all fixed income, however, it will be limited.  In the case of your salary, the limitation of your fixed income comes not from prevailing interest rates, but rather from the environment and decisions of people you work for.

Did your company do well this year?  Did your boss decide you are one of her key employees?  Does your company expect to still need your labor and time in another year, or three?  

If you can say yes to all three, then you can continue to earn your fixed income, otherwise known as a salary.  You cannot reasonably expect, however, anything above the minimum that your boss and company guesstimate will be enough to keep you around for as long as they need you.[1]

Business ownership is Equity

Owning and building a business feels completely different.

Owning and building a business is earning ‘equity.’

Equity typically pays less in dividends than does fixed income.   It also pays less often. 

Worse, equity has a nasty habit of losing value periodically.  Equity regularly goes to zero in value, which, if it’s your company, means you lost your investment and your business and your income all at the same time. 

It’s also potentially more costly emotionally to lose your business equity than to lose the fixed income of your salary.  Despite this terrible feeling – I’m speaking from experience here — here’s the surprising part of my strongly held belief:

Everyone in the for-profit world should aspire to build and run his or her own business.

On entrepreneurship vs. working for a salary, my own journey

During most of my college years I did not imagine a life in business, working for profit.  Truth be told, I dismissed working for profit, in my self-righteous college-kid way, as unworthy of serious consideration.

After a few years of actually working for a living, however, I realized I enjoyed it much more than I had imagined I would.  It felt ‘real’ in a way that pure academia did not.  The teamwork involved in the companies I worked for, producing a service for which customers happily paid significant sums, seemed ‘real’ as well, in a way that was new and surprising to me.

Once I decided making money was one of my goals, the next decision about working for a living became whether to work for myself or to work for someone else.

Although I enjoyed working in the for-profit world, I got it into my head that I would rather own my own business rather than work for a salary for someone else.

Please see next post on Entrepreneurship Part II – Ownership vs. Salary: lessons from finance

And Entrepreneurship Part III – Air, Taxes, Retirement

[1] Of course I know of bosses who pay above the minimum amount to keep you around.  But these bosses are relatively rare and therefore remarkable.  Also, they are violating a rule of market efficiency by paying you more than is necessary to retain you.  If they persist in paying you more than necessary, another competitor can pay its employees less and undercut your employer.  Which is what makes overpaying for you unsustainable, in the long run.  You cannot expect it to last.

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On Cars Part II – Acceptable Price of a Car

Cars 3Please see my earlier post: Cars I – On Not Getting Fleeced

Here’s several ideas that may help you pay the right amount for your car.

1.       Cars are not investments.  Unlike houses, cars only lose value over time.[1]  Cars are big consumer goods that depreciate quickly in value.

2.       As a result, all money you put into your car evaporates over time.  The more you pay for your car, the more money you’ve vaporized with consumption.

3.       Paying more for a car at the lot does not make it more likely that you’ll avoid dings, scratches, accidents, depreciation, or food spills.  In fact the monetary damage you inevitably suffer as a result of these events will be that much higher, based on your higher starting price.

4.       Used cars are offered at a lower price than comparable new cars.

5.       Buying a new car means you’ve got one day to enjoy your higher value consumer good.  After that one day, you own a used car.  The value of that car the next day, should you choose to sell, is significantly lower than it was when you bought it, yesterday.

6.       Paying cash, rather than purchasing with a car loan, is not available to everyone, and it does not necessarily guarantee a better deal at the car dealership.

7.       What paying cash does do, however, is make you a more disciplined buyer.  If you have only a certain amount you’re willing to spend, and it comes immediately out of your bank account, you’re less likely to be fleeced in all the various ways the dealerships will try to fleece you.

 

Accessories

On accessories, know that some car dealerships like to channel the Pentagon’s pricing scheme for paper clips, hammers, and toilets when it comes to car accessories.  Accessories are a major profit center for some car dealerships.

“Those little floorboard carpets there?  Hoo-boy, those will probably run you an extra $1,200.” 

“Oh, you actually want windshield wipers?  Well, that’s only available in the Deluxe model, which we sell for an addition $6,800 above the base model.  Not everybody requires windshield wipers, as you know.”

Obviously the cure for this type of bullshit is the Interwebs, which – when consulted in advance – clear up exactly what is ‘Base Model’ and what is ‘Deluxe.’

The weird and amazingly annoying thing is how often – in the present day – power windows, air conditioning, and a car stereo qualify for extra costs above base model.  Any car company who still considers these ‘Deluxe’ accessories should be publically shamed.  That’s my new rule.

Cash Back

If you’re walking away from a car dealership with extra money ‘cash back’ following your car purchase, you’re doing it wrong.  Just trust me.  This is not a good deal for you.

Zero money down, Zero % financing, Zero payments for 6 months

Same idea here as cash back.  File this one under the category: There’s no free lunch. 

So, you’re definitely overpaying for this thing you bought with zero, zero, zero conditions.

And yeah, I’m talking about a company like Mitsubishi, which had the zero, zero, zero offer a few years ago.  Any business which offers you a costly consumer good like a car[2] on credit terms like this knows, in their heart of hearts, they are fleecing you on the price.  Anyone who bought a Mitsubishi under those terms offered a few years back probably overpaid by about 30% for that product.[3]

Now, if you never intended to pay for the car and just wanted to take temporary advantage of an overly generous car offer, then you’re a clever cheater and Mitsubishi’s offer was just a nice way for you to cheat the system. 

But if you’re a bona-fide car buyer who bought a Mitsubishi under those conditions: I’m sorry but you paid too much for the car.

Please see my earlier post: Cars I – On Not Getting Fleeced

[1] I’m not referring to collectibles, smart-ass.  I am aware of that exception to my rule, which is irrelevant to this rule about car-buying.

[2] Or, even more typically, but on a smaller scale, home furniture.

[3] Of course I’m making this 30% number up. But I do have experience with the time value of money. Zero, zero, zero deals depend on customers, who have no idea about the time value of money, not noticing that the only way this makes sense is if the selling company WAY overcharges for their product.

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On Cars, from 99% Invisible

Modern MolochSpeaking of cars, this is absolutely worth a listen.  Fascinating history of car/pedestrian relations.  Also, an absolutely fascinating insight into tactics that the gun lobby has adopted.

 

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On Car Buying, Part I – Not Getting Fleeced

CarsI’ve been thinking lately about what we buy when we buy a car, and how to make the best personal financial choices when car buying.

Can you buy your personality at the car dealership?

From birth, until now, you have been taught that your car is your personality.

Are you Ford Tough?  GM Patriotic?  Audi Sporty?  Toyota Dependable?  Volvo Safe?  Mercedes Classy?  Lexus Svelte?  BMW Quick?  Volkswagon Quirky?  Hyundai Cost-conscious?[1] Without hardly trying, I can conjure a car to match each of those adjectives as quickly as I can type the words.

I am here to tell you the shocking news that your car is not your personality, and that instead your car is a transportation tool for moving your physical self from one location to another, via paved roads.

The more you purchase your personality at the car dealership, the more you will pay for something you don’t need, which puts you further from your financial goals.

On minimizing merciless fleecing at the car dealership

Many of us associate purchasing a car not only with purchasing our personality via a 2-ton consumer transportation device, but also with financial trickery.  The latter association is well earned – the ‘used-car salesman’ stereotype is no accident.

To minimize personal fleecing, the best thing you can do is limit the number of transactions you engage in with your car dealership.

When you walk on to the car dealer lot you may think you’re buying a car.

Frequently you’re simultaneously buying a car, trading in your old car, negotiating a loan, settling on an affordable monthly payment, picking automobile accessories, and discussing dealer warranties and services.

You do these transactions once every 5 or 10 or 15 years, whereas your counterpart from the dealership does this multiple times a day.  The information and skill disadvantage between you and the car salesman is extraordinary.  Each simultaneous transaction presents a fleecing opportunity.

My advice: Try to do only one thing at a time.

If you need a car loan, try, try, try, to get this loan lined up ahead of time, ideally from your local bank or credit union. 

If all goes well, you begin your car shopping at the dealership with a known price limit, interest rate, and monthly payment amount.  If, at the end of your car purchase the dealer can do better than your bank, so be it.  But you can at least leave all of that loan negotiation until the end, separated from price.

If you need to trade in your old car, you may find it most efficient and convenient to drop off and pick up a car in the same place, so I can’t frown too much on the practice, for non-financial reasons.  On the other hand, just know that the introduction of another ‘moving part’ to the transaction allows for another opportunity for your friendly car salesman to dip into your wallet.

Car loans – Your mortal weakness

The most effective way to fleece a car buyer is to focus his attention on the car loan monthly payment, and away from the price of the car or the interest rate on the loan.

“How much can you afford per month?” asks your friendly car salesman, who has thereby tilted your head back to better expose your throbbing jugular to his surprisingly pointy canines.

If you got your loan approval ahead of time at your bank, monthly payment is an irrelevant question that you can ignore.  

Ideally, you reviewed a maximum purchase amount, bank loan interest rate, and resultant monthly payment at the bank, away from the charged and scary atmosphere of a car dealership.

Even if you need the car dealer’s loan you should still ignore the monthly payment question while inside the dealership.  Focus first, instead, on the overall price of the car.  After that is firmly set, you can move your focus to the interest rate of the loan, which reflects the cost of money.

At the risk of stating the obvious, if you got the best price possible on the car itself and the interest rate is acceptable, then the monthly payment will be fine. 

Or it won’t.  But it will be the best you can get.  You should know your acceptable car price and interest rate – based on your income, and your credit rating and the local cost of money – before walking onto the dealer lot.

Please also see upcoming post Car Buying II – Thinking About Your Car’s Price

[1] I could go on with the less desirable traits earned by car brands: Are you Peugeot Undependable?  Jaguar Pretentious? Fiat Promiscuous?  Dodge Plastic?  KIA impoverished?  Mitsubishi Sub-Prime?

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Book Review: Your First Financial Steps – Managing Your Money When You’re Just Starting Out

Your first financial stepsYou know what’s funny?

Your First Financial Steps/Managing Your Money When You’re Just Starting Out, by Nancy Dunnan is funny.

I graduated from college in 1995, the same year Your First Financial Steps came out, so in a sense I am precisely the demographic who was supposed to buy this book, at that time.  I knew nothing about the topic of finance as a college senior, and I still recall the conversation in which a family member explained to me the difference between a stock and a bond, and the difference between the terms “fixed income” and “equity.[1]”

I’m interested now, in 2013, because I’m attempting to write a book for exactly the same purpose, for college graduates in 2014 and 2015.

Good advice on personal finance doesn’t change much from year to year, or decade to decade, and some financial writing from 1875 and 1949 still holds up well.[2]

But this book did not age well and ends up being kind of funny.

It’s not wrong, exactly, it’s just a time capsule of the way things were when I graduated from college.  Nobody would dream of buying, or reading, a personal finance book like this now.

A few choice features that made me chuckle.

1.       Dunnan frequently recommends readers photocopy pages of formatted tables from her book.  The reader can then use this newly photocopied page to fill in a set of information such as the anticipated costs of personal life goals or accumulated debts.  Something tells me nobody is going to photocopy tables from a book these days.  Not to mention the more important fact that if you’re writing down numbers that need summation or manipulation in some way, and that’s not in a spreadsheet, you’re doing it wrong.

2.       All of the useful sources of government or commercial information she references – from the IRS to credit bureaus to low-cost campgrounds for affordable vacations – come with an address and telephone number.  No websites, obviously, since in 1995 the World Wide Web was only on the verge of launch.  My God how did we know anything back then?

3.       Some of the advice seems to come from an earlier Norman Rockwell age, before the Federal Reserve was identified as the Star Chamber of the Trilateral Commission, controlling everything from global equity prices to ushering in a New World Order of black helicopters and United Nations control.  In 1995, however, a college student like me might have seen the Fed as another aspect – along with George Bailey’s Bailey Building and Loan Association – of the local banking scene.  In the chapter on banking, Dunnan lists the cities with regional Federal Reserve banks and advises the just starting-out student: “Call the one nearest you to find out about a tour.”  I don’t know why that made me laugh.  Does she want her readers to be disappeared forever?[3]

 4.       On getting a job, on page 63, Dunnan includes a special box entitled “Looking for a Job by Computer.”  This edgy piece of advice includes the name of a software program called “Jobhunt” that lists “the names, addresses, and info on 600+ employers, arranged by job type and geographic region.”  Send away for that program on diskette and start your job hunt today!

 Anyway, in sum, I’m enjoying the “literature review” of personal finance books – so I thought I’d share some of my pleasure with Bankers-Anonymous readers.  Please send me a telegram (or whatever) if you recommend a book on personal finance I should read or review in the course of my research.

 Amazon link to: Your First Financial Steps/Managing Your Money When You’re Just Starting Out

Please see related post: All Bankers Anonymous Book Reviews in one place.

 

[1] If you don’t know the difference, we’re both in luck!  I have a book you need to read.  Just give me about a year to get an agent, a publisher, and get this thing on the shelves.  You’re going to love it.

[2] On 1875 finance, I recommend Anthony Trollope’s The Way We Live Now, which I plan to review some time.  It’s so good, and all about Bernie Madoff, before Bernie Madoff’s grandfather was even born.  For the key book on investing from 1949 I’m referring of course to Benjamin Graham’s The Intelligent Investor.

[3] I kid, I kid. It’s a joke.

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