A hidden risk of reward …

I have postulated before on the $5m5y Phenomenon: why is it that 80% of lottery winners, winning absolutely life-changing amounts such as $5 million (all the way up to $150 million) lose 100% of their winnings within 5 years?

Think about it, it’s a staggering amount of money: how would you even go about spending $1m+ a year for 5 years, starting from an almost zero spending base?

Jake hits the nail on the head for at least one of those reasons:

When you hit your number or are well on your way toward it, how do you deal with family that are not making progress to their number (or likely ever will get there).

Specifically, how do you keep a cordial relationship – i.e avoiding acting like a heartless a-hole but also avoiding being the family patsy / sucker who pays for everything.

If you are making good progress toward your number, you are likely very hard working, talented and lucky. Chances are that family members lagging behind are lacking one or more of those traits, often the one associated with hard work.

Yes, after the houses, boats, vacations, girl/boy friends, and Ferraris come the financial-vacuum-cleaning carpet snakes:

Your friends and relatives

Having had [AJC: too much] personal experience dealing with exactly this type of issue, let me try and give you some random pointers, which you will need as your journey progresses:

Stage 1 - When you are still on your journey towards your Number

- Lie about your financial circumstances; the corollary is to keep your spending under control, which has the side benefit of actually helping you to reach your Number

- Complain about everything: business is bad, your investments aren’t doing as well as you hoped, and so on

- Take a preemptive step: actually try and borrow money from those most likely to put the hard word on you [AJC: don't try too hard though, you don't actually want to owe your relatives anything]

Stage 2 - Just as you reach Number

- OK, it might be difficult to hide behind a veil of poverty (unless you are some sort of miser); so, you will need to rely on the old “can’t confirm/deny anything” … this is best done by attitude rather than words: in other words, when one of your friends says “Frank’s really loaded now”, just smile wryly or – if you have to say something - try “don’t believe everything you hear”

- You could still try and borrow money from your relatives to “help pay some back taxes that I owe … nothing serious”; this works best if you also put a For Sale sign on your Ferrari.

- At least try and keep your post-windfall spending spree in check; and, it’s likely – if you’ve been following the advice on this blog – that your Lifestyle isn’t going to to take a big jump, rather you will not have to work to maintain it.

Stage 3 - Making Money 301

You have your Number, but you forgot to build into your chosen lifestyle a certain amount for ‘paying off the friends and relatives’ [AJC: if you're still calculating your Number, now's your chance to put something in there], what to do?

- You will have no choice but to do certain ‘good deeds of kindness’; for example, we paid for two tickets for family members to fly to the US to see us. We flew them coach, provided no spending money, looked after them generously while they were with us (we paid for all meals, etc.), but they were grateful.

- Keep these ‘acts of generosity’ few and far between, or they will be soon seen as ‘rights’ and you will end up wearing all the cost with none of the benefit.

- Simply accept it as a ‘cost of doing [family] business’ that you will be the one footing the bill at all family events; we find ‘prior engagements’ for as many of those family functions as possible: out of sight, out of our pocket.

- Give 30% to 50% (only for family … friends get no more from you than anybody else) more generously for gifts than others; it will be expected and there’s not much you can do.

- Ditto for tips; if they know who you are, you had better be a little more generous if you want to avoid your food being spat in.

- Listen politely but offer little when friends and relatives come asking you for ‘advice’ … they are really sounding you out to ask you for money (they will call it a ‘loan’, but you know it for what it really is); your only protection is preemptive (see above).

- You are far better off to be seen doing ‘good works’ and giving to charity; the aim is to be seen as a good role model and something that your good-for-nothing-freeloading-ex-friends-and-still-relatives can aspire to when they make their own money.

Just remember, unless you built a huge Charity Case Buffer into the calculation of your Number, you have no choice but to let your friends/relatives do the right thing and work on their own Numbers … unless, you no longer want to be able to live your own Life Purpose?!

You are already wealthy!

This guy actually talks a lot of sense … the subtext being that – in historical and/or Third World Country terms – we are already wealthy …

… so, don’t make your life about making money, make ‘making money’ about supporting your Life.

No more, no less

Risk is in the eye of the beholder …

Our Philip Brewer Confest is almost over, and it’s time to thank him for his articles and inspiration for a series of posts exploring the concepts of safe withdrawal rates [AJC: which has more to do with financial planning than family planning ], however I did want to wind up by exploring one of his comments:

I think your step 1 is the most important: Decide what you want to do with your life.

I wanted to write fiction. That doesn’t take much money, but it does require time (and high-quality time at that). So, for me, getting free of a regular job as soon as possible was a much higher priority than accumulating a vast amount of wealth.

For me, too, the turning point for my financial life – indeed my whole life – came in Step 1: finding my Life’s Purpose then using that to calculate my Number. For me, though, it happened to turn up a Large Number / Soon Date … that may not be the case for everybody.

Just remember that Time = Money and if you are desperate to achieve that financial freedom (e.g. in Phil’s case, so that he can write that book) you may need a lot of both …

… IF so, then I have a hypothesis [AJC: tested on a subject of one i.e. me] that goes like this:

When you find your Life’s Purpose, you will most likely find that you will come up with a Large Number / Soon Date [AJC: remember, this is just my hypothesis albeit, now, supported by a little research] and you will not stop until you get it …

… your priorities (including your financial priorities) will drastically change.

 But, what about Philip’s thoughts about risk?

I would like to suggest, though, that your ideas on which assets are secure and which aren’t could use some fine tuning.

It’s true that you may not be able to work during your retirement, but most people will be able to earn at least some money if they need to. It’s also true that government pensions can be taken away—but so can anything else.

And don’t forget all the other ways that things can be lost or taken away—declining market can sap your portfolio, a lawsuit can seize your assets, a natural disaster can destroy your house.

My point is not that it’s hopeless, but rather that while racking up assets may increase your standard of living, at a certain point it no longer increases your security. (A flood can destroy a house worth $1 million as completely as it can destroy a house worth $100,000.).

At some point—and to my mind the point is well before you have $7 million—you don’t get as much security from adding another million to your portfolio.

I beg to differ: until I made my $7 million Number, my thoughts were EXACTLY about ” adding another million to my portfolio” … but, that’s only because I calculated that I needed it – not want, not desire, but need – to live my Life’s Purpose.

But, that may not be you; like Phil, you might just need a little extra time to write your book or to support huminitarian projects like backpacking to hotspots like Haiti, so your Number may be $100k, $1 mill., or … ?

And, unlike me, your assessment of your Number may include allowances for earning extra income through part time work, income producing projects, pensions, inheritences, or even handouts.

In that case, I challenge you to substiute your Number where, in my blog, I use the $7m7y illustration … the principles won’t change much.

[AJC: unless, you have a "<$1 million in >20 years"-type Number, in which case this blog is NOT for you ]

So, substituting your Number for mine, here is the second part of my hypothesis:

- While you are trying to reach [insert your Number] so that you can achieve your Life’s Purpose, ‘hold back’ concepts such as risk take a backfoot to ‘push forward’ concepts such as REWARD, suddenly opening your eyes to the ‘benefits’ of burning the candle at both ends, starting a business or three, trying to become a stock market and/or real-estate mogul, etc.

BUT

- Once you reach [insert your Number], somehow your brain resets such that RISK (i.e. protecting your nest-egg) seems to become much more important than reward (i.e. growing the nest-egg) and all of a sudden CD’s, bond laddering, (dare I say it!?), index funds, 100%-paid-for-by-cash real-estate, etc. becomes much more attractive.

At least, that’s how it happened for me …

This doesn’t mean that risk isn’t important (after all, we spend a lot of time on this blog covering strategies to manage risk), it’s just that in some respects, it’s in the eye of the beholder

The Ideal Perpetual Money Machine …

So,  it seems that creating a mix of bonds and stocks and then picking some magic withdrawal rate (e.g. 4%) is not the ideal way to plan our retirement (a.k.a. life after work) after all …

… instead, it seems that we need to create our own Perpetual Money Machine: a renewable resource of cash

The ideal Perpetual Money Machine - at least, according to my liking - is Real-Estate (more wealthy people build their own Perpetual Money Machines using real-estate that any other investment, even more so than cash, CD’s, bonds, mutual funds, or stocks):

1. Real-Estate (particularly commercial real-estate, when purchased well) protects your capital and keeps pace with inflation; it will last as long as you do, and then some!

2. Real-Estate (when managed well -and, this is something that you CAN confidently outsource) protects your income (i.e. net rents; they will grow with inflation).

3. The bumps in your real-estate road can be managed with insurance and provisions: you can insure against most catastrophic losses (and, you can spead your RE investments to minimize even those risks), and you can keep a % of your rents (and, starting capital) aside to help smooth your income stream (against vacancies, repairs and maintenance, etc.).

For example, with $7 million (aiming for a $350k per year gross income - indexed for inflation – which should net $200k – $250k after tax), you could:

1. Keep $500,000 as a two years of living expenses cash buffer (one year to allow for the rents to start coming in, another year “just in case”),

2. Invest $6.5 million CASH into 5 x $1.0 million to $1.25 million dollar properties (allowing for closing costs, etc.),

3. Which should provide 5 x 7.5% x $1.0 million to $1.25 million = $400,000 gross rental income

4. Of which you would pay tax of 30% (say) and divert another 25% of the remainder to your ‘emergency / provision fund’ leaving $215k (PLUS, tax benefits such as depreciation, tax deductions of cars, certain travel and other business expenses etc.).

After every few ‘good years’, you can trim your provision fund back to two years of living expenses, allowing you to buy some more real-estate (therefore, providing the basis for another future pay rise!).

If you don’t like real-estate, then you can always lower your spending expectations and dust off your bond-laddering books

The fundamental rule of money?

Here’s the difference between conventional personal financial advice and 7m7y thinking in one slide; according to Brian Taylor the fundamental rule of money is to:

Either earn more than you spend or spend less than you earn.

Simple … and, much better than the alternative (spending more than you earn) …

… but, wrong!

There is only one fundamental rule of money:

Earn more than you spend

Can you see why? Your financial future depends upon it

Fitting a square peg into a round hole …

The real problem with any of the so-called ’safe withrawal rates’ that we explored yesterday – with 4% currently being perhaps the most popular amount advocated - is that they all assume a fixed annual spending amount, but are actually generated by a totally volatile (some would say random) portfolio.

We’re trying to fit a square peg (fixed annual spending) into a round hole ( a ‘random walk down Wall Street’)

But 7m7y readers have an even more fundamental problem with planning our ‘retirement’ based on this type of common industry wisdom: we are planning on retiring early, hopefully, with a very large Number and a soon Date!

Most retirement models assume a 30 to 35 year retirement lifespan …

… I don’t know about you, but I retired at 49 and intend to live AT LEAST another 40 years

Many of my readers will be aiming to reach their Numbers even sooner .. and, may expect to live even longer!

The bottom-line: traditional retirement planning models don’t work, because we need money that will last as long as we do … we need a Perpetual Money Machine, because we don’t know how long we will live once we stop working.

A Perpetual Money Machine is anything that:

a) Protects your capital over the long-run, even allowing for the ravages of market changes and inflation, and

b) Produces a reasonably reliable stream of income, that also (at least) keeps pace with inflation.

Neither stocks nor bonds – the traditional tools of retirement investing – fit the bill for us:

1. Stocks are too volatile, and the income tends to be artificial (e.g. so-called dividend stocks attempt to fix the level of dividend provided even as the company’s profits fluctuate).

[AJC: Raiding marketing, R&D, and other seemingly non-essential budgets in lean years in order to protect the dividend stream is - to my mind - the mark of a poorly run company]

2. Bonds provide a very safe return, but the % returned each year is too low, meaning – at least, to me – an unnecessarily reduced lifestyle, especially after allowing for reinvestment to try and keep up with inflation.

That’s why my Rule of 20 is exactly that: a planning rule, NOT a 5% spending rule!

[AJC: Otherwise, I would have called it the 5% Rule, d'oh!].

In other words, my advice for PLANNING your Number, is to decide what initial income you want and multiply that by 20 in order to find your Number …

… but, my advice for LIVING your Number is to turn on your Perpetual Money Machine and live off whatever it happens to produce, after allowing for taxes and provisions against inflation and contingencies.

The One Minute Business Checkup!

My blogging friend, Andee Sellman has unveiled a corker … but, I have a STRICT no advertising, no product placement or promotion policy …

[AJC: it's the only way that I could think of to convince people that I'm genuine, after all, do I want to say to people "I made $7 million in 7 years, plus an extra $4 a week from my blog" ]

.. so, I’ll just gently lead in with a story instead:

Many years ago, in a very short-lived experiment, my parents bought my sister a flower shop [AJC: mistake # 1].

However, because they knew that she wouldn’t take any of their advice (just the shop sans advice) they asked me to take the other 50%, which I agreed to [AJC: mistake # 2].

Unfortunately, I had no business experience in those days, so it was like ‘the blind leading the blind’ … however, I did go looking for help.

One of the first things that I tried to do was get some help on the NUMBERS that the shop should run according to; things like:

- What % of our sales should the flowers and other materials that we bought account for?

- What staff and other administrative costs should we allow?

- What salary should my sister draw?

Unfortunately, my accountant wasn’t much help [AJC: he basically told me to come back when I had a tax problem ... when the problem was, we weren't making any money, so there was no tax!], and I did find a benchmarking report on florist shops, but it didn’t really tell me what the numbers meant or, much more importantly, what to do with them.

That’s why I was really interested when Andee sent me a link to his new tool – I’ve checked and it is totally free - called the One Minute Business Checkup … I think it would have been of great benefit – even though it is fairly simple, and works on just three (that I could see) critical benchmarks:

A. CUSTOMER VALUE MEASURE

This measure looks at how much of the customer value you are retaining in your business by looking at the value the customer pays you and deducting the cost you incur to make those sales.

From experience we know that if the customer value measure falls below 20% a business will struggle and may fail completely so that is why the benchmark is set at 20%. i.e. retaining 20% of the customer value as a return to the business owner.

Example of Measure

Sales		$500,000
Product	$250,000
Business Owner	$50,000
People	$50,000
Marketing Costs	$20,000
Distribution Costs	$30,000
Total Costs		$400,000
Customer Value Retained		$100,000
Percentage to Sales		20%

B. TRANSACTION FLOW MEASURE

The transaction flow measure is about determining the volume of sales that is running through your business. A business may have very high customer value (margin) but only a trickle of sales to take advantage of that value.

Our quick way of measuring transaction flow is to look at administrative cost compared to the sales in a business.

We have found that to be sustainable a business needs to spend no more than 12% of sales on its administrative costs. Often small businesses need to INCREASE SALES rather than decrease administrative costs to achieve this percentage.

Example of Measure

Sales	$500,000
Administrative Wages	$30,000
Administrative Expenses	$20,000
Total Costs	$50,000
Percentage to Sales	10%

C. MONEY FLOW MEASURE

The money flow measure is designed to find where the money is hiding in your business. Does money flow easily or are there places in your business where it gets ‘stuck’ and takes time to flow through to you.

A very significant place that money hides in your business is called working capital. There are three significant items:

1. Inventory – this can be raw materials, work in progress or finished goods
2. Accounts Receivable – this is money owed to you from customers
3. Accounts Payable – this is money you owe your suppliers

Money can get stuck in inventory and accounts receivable. It can also be lost from the business by undisciplined payments to suppliers.

The activity in your business can be measured by sales and this needs to be compared to the working capital invested in your business. We have found that to be sustainable and to give your business the best chance to grow, working capital should be no more than 12% of sales. Beyond this, too much of your money gets tied up in the business and is not available to fund growth.

Unlike the other two measures the money flow measure can be negative.

Negative working capital is a very dangerous situation needing urgent attention.

Example of Measure – Positive Working Capital

Inventory	$30,000
Accounts Receivable	$55,000
Accounts Payable	-$35,000
Working Capital	$50,000
Sales	$500,000
Percentage to Sales	10%

Example of Measure – Negative Working Capital

.

Inventory	$30,000
Accounts Receivable	$55,000
Accounts Payable	-$95,000
Working Capital	-$10,000
Sales	$500,000
Percentage to Sales	-2%

If you have a small business, I recommend that you give this a try [ http://oneminutebusinesscheckup.com/ ] and let me know what you think?

Three feet from gold …

This video summarizes a book hailed as the successor to Napoleon Hill’s classic: Think and Grow Rich. I’m not sure that you can just think your way to $7 million in 7 years … but, having a burning reason why you might need that much / that soon sure seemed to help me.

But, I can’t help feeling: did I think, therefore attract … or did I happen to think and happen to attract? I guess we’ll never know for sure, as we are all an Experiment of One

Reader Poll: Manifesting Millions?

IMPORTANT: Please read this post in full, THEN choose the FIRST answer that applies.

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There are two groups of people in this world:

- those who believe that there are two groups of people in this world, and

- those who don’t

At the risk of parodying myself, I think there are two groups of people in this world:

- those who believe in The Secret, and

- those who don’t.

I want to conduct an experiment, right here / right now, to see if The Secret works …

First though, in case you’ve been living in a cave for these past few years (in which case, you have probably already developed powers far beyond those of The Secret), you will already know that The Secret is the most recent in a long series of books, blogs, and banter about the ‘power’ of creative visualization …

… see it in your mind and you will manifest it into reality.

Believe it, and it will be so.

I don’t know how The Universe works, so I can’t tell you whether I manifested my millions (perhaps by concentrating on my Life’s Purpose and the Number required to get me there) or was merely driven to make it at all costs … you could certainly mount an argument either way.

Also, I am an experiment of one …

Fortunately, we have Steve Pavlina who is an expert in these matters, and  is also the creator of a very interesting project, aptly called the Million Dollar Experiment:

The goal of this experiment is to attempt to use the power of intention to manifest $1 million for each person who chooses to participate.

From what I can see, the experiment ran from November 2005 until July 2007 … just over 18 months. Here’s what happened:

In that 18 month period, nearly 1,600 participants reported ‘manifesting’ anywhere from $504,873.56 (in just one day; if you choose to believe him) down to just one cent.

The average was closer to $3,500 in less than a year, with the median being just $180.

I’m not sure what you would count as a worthy ‘manifestation’ amount (I mean, would you dream of anything less than $10k in a year?), but 120 people - just 7.5% of those participating - ’manifested’ $10k or more in that period.

Cast your mind back 18 months: how much have you manifested in that timeframe? I guess by ‘manifested’, I mean by following Steve Pavlina’s instructions to his own readers:

Only count the new money you feel has come into your life as a result of your participation in this experiment (i.e. the manifestation of this intention), not your regular income. Obviously your interpretation of that will be subjective, but this is a subjective experiment. Just do your best, and trust your intuition.

Just pretend that you signed up to Steve’s experiment 18 months ago … what money (if any) that came into your life since then would you have reported on Steve’s blog?

Oh, and feel free to tell me what you think about the power of The Secret, Steve’s Million Dollar Experiment, and/or this post … but, don’t forget to scroll back up to the top and make your poll choice first

Popular in Finland …

I seem to be popular in Finland these days, with my blogging friend over at Kohti taloudellista riippumattomuutta still sending me the most new visitors daily [AJC: reciprocating may be a little hard as I am guessing that more of his readers are fluent in English, than my readers are in Finnish].

I also receive referrals from my other Finnish blogging friend Tarkan markan blogi, who asks (thanks to Google Translate) Million Not Enough For Any:

And, The Economist does raise a valid point:

How much money do you need to count as wealthy in the first place? Merrill Lynch’s wealth-management report starts counting at $1m in “investible assets”. That excludes people’s main homes, which may seem reasonable. But it means that a Londoner who sells his home and decides to rent can suddenly find himself “rich”.

After all, a portfolio of $1m these days would generate an income of only $30,000 if invested in Treasury bonds, which does not leave much scope for the playboy lifestyle.

I’m not sure what amount that you need to be ‘rich’ - I define it in terms of having enough to live your Life’s Purpose - but, I certainly agree that $1 mill. (even if it doesn’t include your own home) simply doesn’t cut the mustard