Being a business student, I find the structure and thinking of much of the business world a useful lens for viewing aspects of my personal life. Once a year, I imagine sitting with my ‘board’ and presenting my progress for the year. If I’ve done well, I could imagine that external investors (my girlfriend, my boss, my family and friends) would see me as a good investment. So let me ask you a question;
If your household were a business, and I was an external investor, would I be interested in ‘buying into’ your business?
If I’m looking at a business which generates £100,000 a year in revenue and has managed to grow that amount 10% every year for the last five years and maintained stable costs. I’d consider it a good bet if the price were right.
If I looked at the business next door which only generated £75,000 in revenue, also growing this by 10% a year, but also growing their costs at the same rate, I might not think it such a good deal.
My thinking behind this is quite straight-forward. Although both companies are growing their revenues, the second company is growing their expenses, squeezing profits, as compared to the first company who are growing theirs. If this trend were drawn out over ten years, the first company would likely be sat on a sizable pot of capital, some of which would be reinvested and some of which would be returned to me as a shareholder.
The second company, however, would be in a worse position, having both larger costs and higher prices to maintain the same profit. After a few years, dividends would likely be slashed and the company could be faced to take on debt, increasing risk and reducing financial flexibility.
Which company best represents your household?
As an investor, I am primarily looking for companies which have sustainable and growing dividend payments derived from solid profits over the long-term. These companies tend to grow revenues faster than costs (boosting profits), reinvest their profits to grow their business, invest in productive assets and innovative ideas, pursue opportunities in the market and only take on debt to grow their business and increase financial flexibility.
The profit generated by a business is considered the mark of success and sensible managers will reinvest in the business to drive down costs and widen profit margins.
Coming back to our original question, the profits in a household are its savings; the difference between total income and expenditure. The difference between most households and companies is the definition of ‘success’.
Keeping up with the Joneses
We all have different personal measures of success. Some of us want to be CEOs, others are desperate to be parents, some want to be great artists or travel the world. Ask ten people what their vision of success is and you’ll likely get ten different answers.
Broadly speaking, individuals are measured on how hard they work, how ambitious they are and if they have a well-paid job. But these aren’t the only measures of success; turn on a television and you’re bombarded by adverts and ‘reality’ TV which seems to tell people that they’re only ‘successful’ if they’re good at spending money; consuming and living today, because ‘You Only Live Once’.
These adverts and shows discourage people from investing or saving because that creates no visible sign of success. These messages are throughout our society, leading households to focus on a totally different set of priorities from businesses.
You only earn to spend
If we take this as true (which clearly I do), then high levels of household consumption and expenditure are considered ‘successful’.
In the context of a household, let’s say that the young couple living there are high-flying executives, bringing home £250,000 a year between them. They’ve had a pay rise every year for the last five years. They’ve ‘made it’.
Few people would argue with that assertion, even if I was to reveal that their household also has two mortgages worth £1.5m and annual expenditure of £260,000 which is growing at a rate of 10% a year.
What would be the result? Accumulated wealth will be run down and debts taken on as the household attempts to support their ‘deserved’ lifestyle. Determined to keep up with the neighbours (and yes, there’s always someone with more), high consumption is literally destroying the financial stability of that household.
If a company were presented to me which had a comparable set of financials, I’d avoid it like the plague. Just think about it; no real assets, an enormous mortgage, falling savings and growing costs. A company with debts of more than three time yearly profit is considered highly leveraged – but thanks to the string of commercials, mind-numbing TV shows and a society which teaches us that consumption is good, few people would agree with my assertion that this family is risky and a poor financial investment.
The harder we work, the more money we bring home; the more money we bring home, the more we spend. It’s a never-ending race – one which I argue puts a terrific strain on us for very little benefit. Households usually only have a single source of income, which might increase to keep pace with people’s growing lifestyle demands. The longer this continues, the harder it becomes to change these demands.
Escaping the rat race
Consumerism isn’t necessarily an evil thing, but it can get you to a nasty place if you let it. Are you really pursuing the life you want and living the values you believe in if you’re living hand-to-mouth from paycheck to paycheck? The answer?
Save your money – as much and as often as you can. Don’t settle for 5%, push for 10% and when you’re there, 15%, 20% – I even hear of people saving 50%+ of their monthly incomes (and no, they’re not all earning six figures…).
Invest in productive assets – diversify your income stream across property, P2P lending, shares, private placements, commodities and side jobs. Get your time, your money and your education working for you, instead of the other way round. This is what successful companies do; they keep costs down, grow profits and over time become behemoths.
Ask yourself the question again after reading this article, and be honest about the answer. Are you saving your money, or spending it? Are you a good investment, or a financial disaster waiting to happen?