# Applying the Formula for Wealth – Part II

The first part of the \$7million7year Formula For Wealth is pretty simple, therefore so is its application:

Where (W)ealth is a function of (C)apital and (T)ime

It’s pretty useful for teaching your children to save part of their allowance; other than that, you need more help than I can give you if you still don’t know that you should be investing at least some of your money (i.e. capital) 😉

But, what about a more difficult questions? Like deciding whether or not you should pay off your mortgage early?

Dave Ramsey would suggest that you pay off your mortgage NOW and INVEST (presumably, once those funds are no longer required in order to pay off your mortgage) LATER.

According to the base formula, you are still putting your money into an asset (hence, creating Capital), and allowing that to sit for a long time, which has to be a good thing, right?

Of course it’s better than spending the money – perhaps literally eating your capital (fine dining, anyone?) …

… but, is it optimal from a wealth-building perspective? For that, you need to turn to the third part of the formula – the X-Factor:

The two sub-sections of this part of the equation simply suggest that (Re)ward is offset by (Ri)sk; you have to rely on other studies (or common sense) to realize that Risk and Reward are related: as you increase Reward, so – to a greater/lesser degree, depending where you are on the Risk/Reward curve – so do you increase Risk.

In other words, Risk is a dampener for Reward – otherwise, we’d be traveling to work by jumping out of planes and playing the options market, as a matter of course!

But, the same cannot be said for (L)everage and (D)rag …

Leverage is the ‘big secret’ of building wealth: increase leverage and you MULTIPLY your wealth.

Using other people’s money is one way to increase leverage … but, by paying off your home mortgage, you are DECREASING leverage!

According to the formula, that’s bad 😉

Interestingly, Peer to Peer lending also fails the leverage test.

You see, peer to peer lending, mortgage ‘wraps’, and other products where you are financing other people, reduces your Capital and increases their Leverage … the polar opposite of what you should be doing!

So, why do banks lend money, potentially reducing their leverage?

Simple!

They’re not lending their money; they are borrowing money as well. They are leveraged to the full extent allowed by their law and their board of directors.

Which brings us back to risk:

As the banks proved before the financial crisis, applying too much leverage can be bad for your financial health.

What about risk and your home mortgage?

The argument often cited for paying down your home mortgage is one of decreasing risk. Yet, if you intend to live in the house for some extended period of time how is your risk increased / decreased by paying down debt?

How have you applied leverage to improve your wealth?

# Reader Question: How can I start a small business with no capital?

I guess some of my readers appreciate small / online business advice as well as personal finance advice, so I’ll keep the mix going for a little while longer.

On that note, let’s take a look at Jeff’s question; it’s a very common one, indeed:

I have always wanted to run my own business, and I know what business it is. I have planned out all the details, even got as far as making the business plan for startup, short term and long term. But i keep becoming discouraged at the idea when I hit the same wall every time. Which is startup capitol. Do you have any suggestions as to where or how someone who is smart and determined, but has virtually no personal capitol, can get the means to start a small business?

I don’t have enough (any) information on Jeff’s personal financial situation to make any specific recommendations. However, since this is such a common reader question, let me try and answer it for everybody in this situation.

Startup capital almost always comes from the Four F’s:

– Founders – What does your personal ‘balance sheet’ look like? Do you own a house, car, etc. Many a business has been started by refinancing existing assets, borrowing money on credit-cards, and so on. Desperate times call for desperate measures.

– Friends/Family – These two groups will invest small amounts – from \$100 to \$10,000 each. Pull a few together and you may get enough. Usually, they are investing in YOU, so financial results are less important to them. But, if you have a business plan that reads well, and you have a wide circle, you’re ready to start asking!

– Fools – These are seed-stage investors who MAY invest in an idea, but they are VERY hard to come by. You probably need more than one cofounder (one-man businesses are usually seen as too one-sided), and you will need to demonstrate a business with good upside.

Putting together business plans is one giant step forward for Jeff.

But, now he finally needs to decide if he’s going to drop it, or go for it. Only Jeff can make that decision 🙂

# Anatomy Of A Startup – Part VI

If you’re a Dave Ramsey Fan, welcome!

But, you probably won’t stick around … no Baby Steps here, just Giant Leaps in (mainly) personal finance and (sometimes) business from a genuine mult-millionaire (that would be me!) who went from \$30,000 in debt to \$7 million in the bank, in just 7 years … no BS 🙂

We don’t pay off our mortgages early, here. We don’t debt snowball. And, we don’t save until we bleed (but, we do practice delayed gratification).

We DO find our Life’s Purpose, use that find our Number, and do any one of a hundred things to get there, If you do choose to stick around (unlikely, I know) … enjoy! And, feel free to drop me a line to tell me what you think [ajc AT 7million7years DOT com] …

_____________

We’ve done a little bit of FaceBook advertising while we are waiting for the ‘better’ landing page to appear, with mixed results.

What is clear, is that advertising is a great way to test your New Product Idea, but a very expensive way to acquire customers; which is OK, as right now, we are testing various strategies.

One of the things that we learned is that keywording on your more established competitors names is A GOOD THING … for us 😉

One of the other things that we have learned is that the key technical feature of our site may be a lower takeup than we expected, which is why the ‘pivot’ was invented:

Basically, a pivot is a fancy New Age Term for “doing less of what doesn’t seem to work, and doing more of what does”. Also known as: common-sense.

So, right now, we have a nice, new design idea that could be disruptive in its own right.

We will launch with this …

But, that means that I have to change the Executive Summary:

Click to download the  Executive Overview <<<<==== CLICK HERE

The Executive Overview is the two or three page document that outlines what your business is all about:

– What problem you are solving,

– How you are solving it,

– What your ‘secret sauce’ is,

– Who your competitors are,

– Your business plan (how you intend to make money),

– Your marketing plan (how you intend to acquire customers)

– Your implementation plan.

This document – with various sections added or removed can be given to partners, key staff, investors, and bankers.

Oh, and don’t forget that it begins with your USP.

PS Obviously, the documents that I am sharing are NOT for my current venture. Sorry. 😉

# Brick Wall Retirement

[pro-player width=’530′ height=’253′ type=’video’]http://www.youtube.com/watch?v=MdmbkeJe6zo[/pro-player]

Late last year we had some discussion about so-called “safe withdrawal rates” i.e. what is the ‘magic percentage’ that you can withdraw from your bank account (or other investments) each year, once you are retired, so that you don’t risk running out of money?

Jacob from Early Retirement Extreme said:

It’s fairly well-established (by the original Monte Carlo paper) that the 4% rule is only good for 30 years. Also it only pertains to a broad market total return portfolio. For shorter periods I’ve seen people quoting up to 7%. For longer periods, 3% or less seems to be in order.

He also suggested for a “more extensive discussions see Bob Clyatt’s book”, which we started discussing last week.

Bob undertakes a reasonably good strawman-analysis of some of the existing thinking on Safe Withdrawal Rates then uses some of his own analysis to come up with three rules:

1. It’s OK to withdraw between 4% and 4.5% of your portfolio each year, but

2. You only need reduce the \$ figure of the previous year by 5% to cushion the effects of a down-market, as long as you

3. Follow his recommendations for a highly diversified portfolio of stocks, bonds, bicycles, and sausages.

[AJC: OK, I made up the bicycles and sausages bit ;)]

If you follow these rules, here’s your chances of NOT running out of money, depending on your time horizon:

Now, a few things bother me about this, indeed most discussions on this and other so-called Safe Withdrawal Strategies:

1. Here’s a bunch of people who generally advocate NOT to try and time the stock market, yet, in most cases (including Bob’s strategy, if you take the 5% option) you are trying to TIME the worst possible market of all: how long you expect to live!

2. There’s always a chance that your money will run out before you do – including  in 7 of Bob’s 8 (recommended as ‘safe’ and ‘sustainable’) categories; and, in the one ‘safe’category, you still have to run the gauntlet of a nearly 20% chance of perhaps losing your money for 2 whole decades.

3. Even if you wind down your % to Jacob’s suggested 3% withdrawal strategy, Bob’s numbers [AJC: you’ll have to see the book for this one] still show an almost 15% chance of losing your money in the first decade.

Now, there are other Monte Carlo studies that show that withdrawal rates on 3% to 3.5% are pretty damn ‘safe’ … BUT:

a) Personally, I expect to live forever and expect my money to do the same, and

b) How close to ZERO (but never quite reaching it, according to the statistical analysis of 3% – 3.5% withdrawal rates) do I allow myself to get before I panic?

I can’t help thinking that you need to substitute the words “safe withdrawal %” for “the right length and strength of vines” in the video, above, to really understand what it would mean to suffer a prolonged market downturn in retirement 😉

I’ve said it before, and I’ll say it again: unless you have a perpetual money machine set up, there ain’t no safety in withdrawal rates!

# The problem with P2P lending …

I am not a fan of peer to peer lending, so please forgive me, when Glen Millar of Prosper – one of the leading P2P lending sites – sent me the following e-mail, if I didn’t fall all over myself with excitement:

As a personal finance blogger we thought you might have interest in Prosper (www.prosper.com) and peer-to-peer lending.  You may know that Prosper was the first peer-to-peer lending marketplace in the US.  In 5 years, we have originated over \$215 million in loans on our site.

In fact, here’s what I said in my reply:

My argument in that post was about risk; Glen responded with a link to the following:

The basic argument being that Prosper manages loss/risk better than competing P2P sites through their proprietary rating system which “allows [Prosper] to maintain consistency when giving each listing a score. Prosper Ratings allow you to easily analyze a listing’s level of risk because the rating represents an estimated average annualized loss rate range.”

Which is all well and good until it is YOU that suffers the statistical loss/es (you can get unlucky and lose on a number of your loans); I don’t know about you, but I don’t like any system where I play statistical roulette without at least some measure (OK, illusion) of control.

The only control that you can really apply here is diversification: take out lots of small loans in your risk/reward categories:

In fact, if this risk-rating-system is so good, why doesn’t Prosper simply knock out the competition by adjusting the interest rate earned by the rating-weighted loss-rate and carry the risk themselves?!

But, what’s your for/against reasons?

I would like to hear both from readers who swear by P2P, and those who wouldn’t touch it with a 10 foot pole …

# Applying the Formula for Wealth – Part I

There’s no point in having a formula – no matter how simple it may seem – if you don’t know how to APPLY it.

So it is with the \$7million7year Formula For Wealth:

The beautiful thing about a formula like this – and, why I am so excited every time I get to share it with you – is that you don’t need to know anything about personal finance in order to answer the typical personal finance questions that arise … the formula makes the answers obvious.

Let’s take a really simple example, you earn money … so, you’re entitled to spend it right?

Well, what you do with your money is your own concern. But, if part of your plans include building wealth, what should you do?

Maslow’s Hierarchy puts physiological needs (food, water, warmth, etc.) right at the bottom, so you had better take care of all of the basic household expenses first. Then comes safety and security so you also had better take care of those brakes!

But, then come the ‘soft’ areas that cover the gamut of love and self-esteem, all the way to self-actualization and self-sufficiency. Which means that you have to take care of your future physiological needs etc. – but, that probably accounts for your basic spending and your 401k contributions.

Then you have to decide the tough issues: do you have more fun now (spend more now) or hold some back – better yet, invest – so that you can also have some fun later?

That’s a personal choice, but one that finding your Life’s Purpose will make much easier.

Which brings us back to the point where you’ve made the decision to build some wealth (e.g. your Number). And, that’s were the Formula For Wealth comes in really handy:

The formula for wealth merely says that (W)ealth is a function of (C)apital and (T)ime.

So, you need to start building capital – the earlier the better to also increase time – which means you shouldn’t spend that excess cash on going out and having (too much) fun, nor should you buy depreciating assets such as cars, furniture, and accessories (other than to satisfy the Maslow-needs for basic transport, protection and comfort).

And, the formula makes it pretty clear that the more your capital increases over time, the better. So, simply sticking your cash under the mattress probably won’t cut the mustard … you’ll need to start thinking about investments that grow your capital over (sufficient) time e.g. CD’s, bonds, stocks, or real-estate.

Nothing earth-shattering, so far. So, next time, let’s use the second part of the formula to answer one of the most commonly-debated questions in personal finance: should you pay off the mortgage on your home loan early, or just let it ride?

# On disasters …

Unfortunately, life isn’t all about how much money you have.

When an earthquake hits, it matters not the size of your bank account.

Having nothing at all to do with personal finance, I thought I would tell you about a conversation that I had on Wednesday:

I met a couple who were travelling from – more like escaping from – Christchurch, New Zealand.

They had been living through the devastation there from last week’s earthquake, now horrifically overshadowed by the series of natural (and, man-contributed) disasters in Japan.

First, he told me that he lived the the horror of driving from work when the quake hit. His car was shaken badly, the suspension magnifying the effects of the quake, rather than my expectation that the shock-absorbers would diminish the effects.

He watched a 7-story building sway like a palm tree, then a rising cloud of ‘smoke’ which he soon realized was the total collapse of a much older building behind. He then was witness to a man being killed as a piece of concrete fell off a building and hit the car behind.

‘My man’ was lucky enough to escape unhurt.

But, he really brought home the magnitude of such a disaster, that extends far beyond the terrible news reports of deaths, with these two anecdotes:

1. He knew a young lady who was engaged to be married. She was caught in a building during the quake and escaped with her life but lost three limbs.

2. One family – lucky enough to escape any physical injury – is being torn apart by psychological injury as mother and son escape to Auckland, too scared to return to Christchurch which has suffered over 4,000 earthquakes in the past 6 months. Their husband/father remains in Christchurch where his business / livelihood has miraculously survived. Even the damage to their home is repairable, but their family life is not.

These two small stories bring home to me the devastating effects on lives and families far beyond those who have died in disasters such as that in Christchurch … or, in Japan, a disaster 10 to 100 times as far-reaching as that in New Zealand.

I have no advice, other than to live your life because, on a cosmic – or, even natural – scale, money just doesn’t seem that important, does it?

# Reader Question: What to do with my patents?

Since nobody complained, here’s a great question regarding patents from an IMHO genuine and Certified Smart Guy, Erik, who took the trouble to e-mail me with this question regarding patents and how best to commercialize them:

I am writing you because I have ideas, but, do not know how to turn them into a business.

While at my university, I have been busy developing ideas and protecting these ideas with patents. I currently have 3 patent applications and am currently working on 2 more with a patent attorney. These are all through the university, so they do own 50% of rights to the patent, but at the same time, they are shouldering 100% of the costs. At this point in my life, that seems like a pretty good deal to me. Later when I have more money to invest, I can use any profit generated from these patents to own 100% of the rights to my work.

The problem is that I don’t really know how to move from owning a patent to creating a business to enable the idea and generate profit?

Erik  is talking about transitioning from idea to business.

Firstly, I would propose that ideas (and, their patents thereof) belong in the receptacle offered by the device in the carefully selected image, above …

… it’s all about execution. And, as we know; that’s 99% perspiration 😉

Given that, it seems Erik has quite a few paths available, to take Useless Idea # n to Highly Profitable Business # 1 […  and only. Because lighting rarely strikes twice yadayadayada], but I think I can summarize them into just two:

1. Become an idea/licensing machine: churn them out, begin the patent process, licence off … next idea!

http://7million7years.com/2008/09/08/if-its-not-passive-its-active/

2. Pick the idea that Erik feels has the most commercial promise, fail fast (which means assess the market quickly by trying to get sales and feedback … even before the product is ready), continue with that idea OR shelve and move onto the next.

http://7million7years.com/2010/04/28/the-no-marketing-plan/

And, this series: http://7million7years.com/2011/03/07/anatomy-of-a-startup-part-v/

Having never done 1., I can’t advise Erik (that may be where you step in?)  …

However, if Erik is contemplating going down the  second path, he should pick the easiest patents, first … preferably something that can be implemented (at least at first) as software … using open-source architectures wherever possible and ‘”off the shelf” programmers (i.e. no PHD’s to develop, unless that’s going to be Erik).

In terms of resources, Erik should follow interesting threads on quora.com … he’ll learn a lot, from experts (unfortunately, he’ll first have to learn how to discern ‘expert’ from ‘wanna be’).

He should also buy a copy of  TechStar Founder, Brad Feld’s excellent book about startups: Do More Faster: TechStars Lessons to Accelerate Your Startup, and Guy Kawasaki’s outstanding book: The Art Of The Start.

Once he has launched and has gained traction (i.e. significant customers and sales; not necessarily profitable sales … yet), Erik can start working on building his back-end ‘business’ … in which case, he should also read Michael Gerber’s business classic – mandatory for established businesses of ANY size: The E-Myth Revisited.

Until then, Erik should focus totally on Product (what do the customers want?) and Sales (will they buy?) …

He can start testing/asking/even selling RIGHT NOW.

Oh, and if Erik has the opportunity to take a job, but start this part-time … he should do so!

That way he’ll be able to afford to fail often 😉

# Anatomy Of A Startup – Part V

I’m not sure if this is a useful series for my audience; on the other hand, I do encourage as many of you to start a part-time business as possible – with the Internet being an ideal platform – so it should be useful.

But, do let me know if you want to see more/less of this business-type of stuff on this personal finance blog …

There’s been a lot of Internet chatter about so-called ‘lean startups’: as far as I can see, it used to be called “bootstrapping” (Guy Kawasaki, the legendary Apple early employee, angel investor, startup junkie, and raconteur famously started Truemors for a little over \$12k), but should just be called ‘common sense’.

Having said that, I’ve committed \$100k to my latest startup, which is currently being spent on partial salary replacement for one guy (apparently, he doesn’t like eating dog food), a padded cell (one small, windowless room, 4 desks, 3 people …. plenty of stale air), and a little bit of web-type outsourcing:

– We purchased a logo on hatchwise for \$250

– We purchased a home page image for \$19 and spent another \$36 on oDesk for two guys in India to turn it into a real web page with KISSinsights (\$29/mth), and MailChimp (one of the guys already has an account) integration. \$6 an hour buys an awful lot of basic code-cutting.

– We’ve also spent \$1,200 locally getting a real home page built, with plenty of back-end functionality [AJC: we need a few different types of home pages for some of the stuff we’re doing, all at different levels of complexity]; but, we’re doing that with the engineer that we want working with us, and this is a sort of ‘feel each other out first’ kind of project.

The other key part of Lean Startup / Bootstrapping / Common Sense is simply getting something out there real quick to test the market response. This is called a Minimum Viable Product (MVP) …

This should be taken to mean:

Get a landing page up now!

Fortunately, that’s really easy with the abundance of new tools and services that have been coming onto the market recently (including unbounce, mybetali.st and launchrock).

This is an example of one built using launchrock [AJC: no, it’s not mine … just some random one that I found; click on the image to get to the site, anyway]:

It’s probably not the best example of one that I’ve seen (why would you want to put down your name just to jump “square to square”?), and I’m betting that it’s a mobile app (think local) because the URL is usehopscotch.com …. but, that’s only a guess and it’s not really important.

What is important is to go ahead and sign up and see how launchrock gives you a share page, complete with a customized URL so that you can track which user has invited whom … and, you can incent them accordingly!

Fork.ly famously did this with the incentive of getting to the top of their beta-invite list e.g. “after 3 people sign up with your link, you make our “priority access list” and we let you know via email.”

The reason WE’RE putting up prelaunch home pages (as they are known) is so that we can test keywords to see (a) if we can drive traffic to our site (and our value proposition), if so (b) which keywords work best.

This is how to implement the strategy outlined in this post where I shared some great advice from my good online friend Brandon – it’s simplicity in itself … here’s what Brandon says:

Let me sum this up in one sentence:
As a startup or new business, the amount of time you spend writing up a sexy business plan to pitch investors would be better spent running a \$500 PPC campaign testing your idea.

[NotePPC = Pay Per Click online advertising]

You are lucky enough to live in a world with Google Adwords.  This is a good thing.  The costs of launching a new business online are hastily reducing to zero.  Testing a business idea or even a half-baked, half-assed business-sorta idea, is easy.  So do it.

Stop thinking about writing a business plan (that you mostly copy of some web template – be honest), and start here:

1. Register a domain name.  Doesn’t have to be good.  Starting a bird feeder biz?  Get birdfeederdepot1.com.
2. Get hosting, install the CMS [e.g. WordPress or Blogger] of your choice.
3. Make 3-4 landing pages.  Ask questions.  Find out some key answers to the market you are hoping to serve with your genius new idea.  Offer to sell your service right now.
4. Setup [a Google] Adwords campaign and spend \$500.
5. Read the answers you get.  Scour the analytics, the keywords and clicks.  Any sale or response is good.  Email your new ‘customers’ and find out more about them.

The point is, this is so easy and cheap to do, you should do it.  There’s no risk in doing so, and the upside is possibly priceless.

It could save you from wasting 9 months of your life chasing a bad idea.  It could teach you what people really want, not what you think they want.  It makes you get serious.

We’ve been experimenting right now with a FaceBook advertising (watch out Google!) campaign at \$5 – \$10 a day (!), and have already learned some interesting things for less than \$50 total spend (!):

1. Targeting our competitors’ names in our keywords is a great way to reach our exact target market,

2. Paying CPM is usually better than CPC: worst case, we seem to pay roughly the same CPC that we would have paid had we been bidding CPC (about \$1 to \$2 per click for our keyword niche) and, occasionally, we even see massive spikes where our CPC mysteriously (and miraculously) drops to \$0.01 on (comparatively) huge volume of clicks and signups.

… now, that’s good!

# My retirement hypothesis …

I’ve said it before, and I’ll say it again, I think that personal finance in America is broken.

I say it’s broken because advice is being doled out without any qualification: work hard, be frugal, save hard and …

… and, what?

If you start after college, you’ll work 20+ (probably, 40+) years, and you will aim to retire on what kind of income?

Let’s take a quick look at Bristol’s case he is 23 years old yet: he already has a stable job; he invests in his 401k up to his company’s match%; he has \$20k (split evenly between a savings account and some blue chip stocks).

He has run a few numbers through the CNN retirement calculator and realizes that, by age 55, he would need \$5.9 mill. (\$2.2 mill. in todays dollars) to “spend retirement happily”.

After some discussion, and more analysis, Bristol came to the conclusion that this is impossible on an 8% assumed after tax return.

Now, one of Bristol’s assumptions – and, one that I am guilty of supporting – is that he would need a minimum of \$90k annual salary (today’s dollars) in retirement.

But, is that the case?

I can’t speak for Bristol – I don’t know how he came up with the \$90k p.a. figure (hence, the \$2.2 mill. today’s dollars nest egg requirement). And, maybe my view is skewed because we – and almost everybody that we know – need a LOT more than \$90k a year in retirement (we’re budgeting for our current run rate of \$250k – \$350k per year to continue)?

So, do you think it’s acceptable to work for 20 to 40 years, be frugal, save hard, yet aim for less (keeping in mind the need to help support an adult family, partner, lifestyle, health … without any guarantees of government handouts and safety nets still being in place by then)?