How you think about your finances and your self-image will act as constraints on the solution space of your financial future, creating artificial limitations.
In 2006, Rhonda Byrne published The Secret which outlines a phenomenon known as the “Law of Attraction”. The assertion made here is that an individual can manifest into reality the thoughts and desires they might have through Pure Energy, which then brings forth health, wealth, and positive relationships into your life.
It goes without saying that this is complete and utter bunk.
I’m picturing certain scenes from Looney Toons where Wile E. Coyote paints a tunnel on a solid rock wall into which the Road Runner uncannily passes right through at full tilt. If reality is an illusion, it is a persistent one.
But maybe it’s not COMPLETE trash.
See, our beliefs about what is true and possible in the world really do affect outcomes inasmuch as they constrain our actions. What I mean is, if you don’t believe you would ever be able to play professional basketball, you certainly won’t. This runs contrary to the Law of Attraction, though, as some poor souls on your [insert high school sports team] might have made clear, despite their best efforts and desires.
Here are some beliefs I try to help instill in my clients’ thinking so they don’t hobble themselves in dreaming the [otherwise] impossible dream.
Your Family Finances are your Business Empire
This is really true; you should absolutely try to think about your financial affairs the way that businesspeople think about running their businesses.
I quite enjoy working with businesspeople. Yes, personalities differ between folks, but there are many patterns of behaviour and thought that run as common threads. It’s a bit of a chicken-or-egg situation as to whether the beliefs exist and they bring about success, or perhaps the beliefs are hard-earned, bearing their own battle-scars. Regardless, let’s review some of these beliefs to help you hone your thinking about your own money management!
#1 – Debt is a Tool
This is one of my favourite conversations to have with new clients. I frame it as a gauge with three settings: 1) Bad Debt, 2) Debt IS Bad, and 3) Debt is a Tool.
We all know someone, perhaps a relation (maybe even Michael Jackson’s antagonist-in-the-mirror!), who has had their bout with debt; a mountain of student loans, an unsustainable mortgage payment, credit cards paying off other credit cards, or that dread species known as the Payday Loan (in the Latin, Cathartes Cathartidae).
And, so, debt can be a real problem. I observe that the most problematic debt tends to be that which is unplanned. Plan your debt. Get credit when you have a job; get insurance when you’re healthy. Because, when you lose your job or good health, you’re going to want the option or the coverage and no one is going to give it to you.
The completely understandable reaction for the witness of Bad Debt is the penultimately enlightened view of Debt is Bad. This is where most responsible folks find themselves.
I’ll never forget sitting down with a young couple for an initial consultation to discuss their financial goals. They reviewed a list of common goals and ticked off “Paying off my Debts” as a key priority. Naturally, I inquire about the nature of their debts, to which they respond, “Oh, we don’t have any debt, but we are thinking about getting a mortgage and want to pay that down.” Befuddled and bemused are words that come to mind, were one to describe my internalized response.
But there it is; a lot of people are VERY motivated to pay down their debts aggressively. And, in a sense, there is nothing at all wrong with that behaviour. Paying off your debts will absolutely put you in a better financial situation, who am I to criticize?
Except that there is a deeper reality at work. If you find yourself in my position as an Economist, needing to deploy as wisely as possible a set of limited resources to accomplish my personal goals. Then it’s worth considering how best to make such an application.
And, thus, we arrive at the enlightendest (all words are made up) view of debt – Debt is a Tool. What sort of tool? Debt is actually nigh on magical. It allows the most ordinary of people to achieve a scientific feat never accomplished by even the most sophisticated of Theoretical or Applied Physicists.
Debt is Time Travel.
Work with me for a moment here. Sure, you can’t translate your physical body into a novel or historical temporal phase, ok. BUT what if Future Nate were able to send financial resources to Current Nate to be employed at Current Nate’s discretion? Then I suppose CN (that is, Current Nate) would have an election to make as to how he might employ said resources. And what if CN were to invest wisely those resources such that, when CN catches up to FN, my future self enjoys greater wealth than he otherwise would have had there been no cosmic Money Gram? Well, then they might shake hands and say, “Job well done!”
This is a truth businesspeople inevitably engage with as they conduct their affairs. Corporate finance has two basic sources: debt or equity; take your pick and make your mix. At the end of the day, as long as you can manage your cash flow and continue to make profitable business investments the debt works to accelerate business growth that wouldn’t be possibly otherwise. Bringing us to the next lesson…
#2 – Cash Flow Issues vs. Accounting Issues
I was speaking with a friend recently who was asking me about a business interest I have that is among the harder hit by the COVID-19 pandemic shutdowns. It’s a really bad season for the business and our viability is a serious question which, due to the nature of the business, is no real secret to anyone. I’m a silent partner in the business so I don’t know much of the current financial well-being of the business. One of my business partners is an accountant and he handles that element of management.
What I told my friend is that we have a lot of money in the bank, I just don’t know who it belongs to.
What is a cash flow matter and what are accounting matters?
Cash flow what it sounds like. A bath-tub analogy is sensible. There’s the tap turned on at a certain rate of flow (current revenues), an accumulated reservoir in the tub (cash on hand), and then an open drain (current expenses). Cash flow challenges arise when the tap is pouring too slowly, and/or the drain too quickly, such that the tub is in danger of running dry. In our situation, we have a decent volume stored but the drain is sucking that back at a rate faster than the tap provisions the tub. It’s not a sustainable situation.
This is a problem a penguin can intuit.
Probably the easiest way to explain this distinction cash flow analysis vs. accounting might be to pick up apart the cost of home ownership. A typical list of monthly expenses to operate a home in Canada would include line items like property taxes, natural gas, electricity, water and sewage, and a mortgage payment (we won’t worry about repairs and maintenance). If you add up all those expenses you can establish the cash flow requirement to service those costs. However, from an accounting standpoint, were this a rental property, one of the expenses would not be fully deductible against your income for tax purposes; namely, the mortgage payment.
A traditional mortgage payment contains both principle and interest components. The principle portion represents a repayment of the mortgage and is not deductible. The interest portion represents a true expense and is deductible. It is still necessary to have enough cash flow to cover the full mortgage payment but, assuming a 25-year amortization, about half the mortgage payment is principle and puts money in your pocket over time.
I’ve seen many an amateur real estate investor stumble over this error in judgement. Don’t be that person!
#3 – Mental Accounting/Siloing
The final insight I’ll review here is the phenomenon of Mental Accounting or Mental Siloing.
Among the venerated economists of our time, professor Richard Thaler of the University of Chicago’s Booth School of Business coined the term “Mental Accounting” in reference to the observation that individuals are prone to applying labels to certain funds, tying them to a specific expense or goal (ie: this is my Boat Fund). It’s completely understandable as an extension of very sensible practices like building a personal budget.
Thaler argues that this categorizing can lead to irrational behaviour. Money is money is money, he might say, and creating an inextricable link between certain funds denies that excellent feature of money – it can be repurposed at will.
I am right now in the process of investing certain funds on behalf of a wealthy client who has loads of excess cash on hand. This person has a habit of Siloing funds meticulously (I won’t tell you which low-lying, north-western European country she descends from) and this cash is, in her mind, to be used exclusively for a large expense due in just over two years.
Did I mention she always has loads of cash lying around?
Due to the artificial constraint, I must assume a conservative mandate for the investment strategy. In reality, this money would serve her better under a long-term growth-oriented mandate, but because of her specification on use, my hands are tied. There will be no cash flow concerns when the expense comes due and such there will likely be an Opportunity Cost to her future net worth.
The best way to break this habit is to perform a Hypothetical Maximum Load test on your finances. Much financial stress is simply a matter of ignorance; fear exists in the unknown. Individuals and businesses that have been through the wringer due to any number of financial head-winds learn the hard way exactly how much they can weather.
The exercise is as follows: take stock of your current net worth and then imagine you had an immediate expense twice that amount. That is, if you are worth $500,000, imagine you had to cough up $1,000,000 by Friday. If you can come up with a plan to handle that expense you certainly will expand your mental toolbox and resource yourself to creatively solve future cash flow problems that might apparate from the ether.
Conclusion
As psychological creatures, we all are constrained in our actions by our thoughts and by our beliefs. Expanding your thinking to include possibilities you previously hadn’t considered will allow you to creatively solve problems that you thought were intractable.+
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