Chapter 7
The seeds of greatness

Money can't really be used for that many things. We can certainly buy countless items with it, but from a category viewpoint there are only a few things we can do with money. Once we understand these categories it really becomes quite simple to accumulate more money and make your life simpler, financially at least.

We start off with two choices once money arrives, say as a number in a computer somewhere: we can either spend it or save it. That's it, the only two options. And here's where I have to drop a couple of truth bombs. It may sound like cultural heresy, but there is an infallible, historical truth about money: the ability to save is key to everything. I'm not saying you have to be a miser, but unless you can save a portion of what you earn, you'll never become self-reliant or live an independent life. It doesn't matter what ‘type' of money you earn; unless you keep some for yourself, everything else becomes futile. There are many ways to phrase this truth, and it is useful to cover a few maxims relating to it, to provide both a context and a quantum to how much it really matters.

Spent money vs invested money

American entrepreneur and billionaire W. Clement Stone built his fortune in insurance and publishing, but he was a strong believer in basic financial principles. He once said, ‘If you cannot save, then the seeds of greatness are not within you'.

Wow, what a powerful statement. What I love about it is its accessibility. He didn't say how much you have to save, or how much you have to earn, just that you need to be able to set aside an amount of it. Even someone on minimum wage can save 1 per cent of what they earn. It is the most basic financial challenge to prove to ourselves we have the capacity to think ahead and delay gratification in a small way. If we can't exercise enough self-control to save, then it would be a waste of our time to even try to start a business. It's really just an attitude; even a small percentage of a modest income is enough to provide direction and momentum. Anyone who has saved money understands the pride and self-esteem that come with it. You can start to believe in the upside of your decisions.

I was once told a simple life hack that's so obvious yet I'd never thought of it: ‘Save half your money, and only work every second year.'

Think about it. If we could save half our income, we'd be able to take every second year off work! We could go and pursue something else, learn something new, explore. That's the power of savings right there, articulated in a different way. Saving creates options. I'm not saying you'd want to or even could do that, because you'd be back at ground zero every two years, but it opens the mind to the power of savings.

Remember, you ‘get paid' for savings because they become money type number two: invested money. Spent money is dead money — it disappears. Even worse, often the things we buy need to be maintained and serviced, so they cost money to own, not just to buy. Cars, clothes, phones, computers, houses, almost everything we spend money on, require us to spend more money just to keep them alive. They need to be kept functional, cleaned, insured, topped up, updated, enhanced, furnished, stored, secured. They are not isolated, one-off expenses but carefully designed money drains that feed the industries that produce them. It's always worth appraising the maintenance cost of anything we buy, and, as you can imagine, it's rarely in the interest of the seller to tell you what those costs are likely to be. It's why they invented small print.

This leads us to the number one financial problem people, in developed economies at least, face today. The root of it is not that they have credit card debt, or that they can't afford the rent or the car repayments. It's simply that they spend money they should have saved. When they have a choice to spend or to save that dollar, they spend more than they have. Today greedy financial institutions make it far too easy for us to buy on credit. If you can't afford it, don't buy it. If I don't have the money in cash or equivalent to buy something I want, I will not buy it. Yes, it takes discipline, but I'd rather carry the small weight of frequent and valuable disciplines than break my back later under a tonne of debt.

FORMULA FOR MISERY: SPEND MORE THAN YOU EARN.

FORMULA FOR HAPPINESS: SPEND LESS THAN YOU EARN.

A person earning $2000 a week and spending $2200 will always be poorer than a person earning $1000 a week and saving $200 of it. The $200 either side of the earnings equation makes all the difference. It's not just a financial thing either; it soothes the soul of the saver.

Where did it go? The necessities confusion

Okay, so we need to be a bit human with all this savings stuff. Saving is totally vital to success, but life is to be enjoyed. As I said, it's not about saving every cent, it's about that habit. Using your earnings to buy stuff is incredibly enjoyable. Travelling, eating out, shopping for clothes, toys and technology, especially when rewarding work done, are among the great pleasures in life. But we must always remember that if we spend more than we earn, we'll always be a widget in someone else's production.

You've probably read in the mainstream press that the cost of living is surging and it's never been harder to make ends meet. The truth is, as I argued in my first book, The Great Fragmentation, a bigger lie has never been told. It's hard to think of things that are more expensive now than they were 10, 20 or 50 years ago. Here's a fact that should bust this cost-of-living conspiracy wide open: among the items we all buy are groceries, television, family car, clothes, phones, data, computers, hotels, flights and food … and they've all become much cheaper to buy. The simplest confirmation of the truth about prices is this: the CPI has been lower than the wages growth index on average since 1946 in Australia. The cost of living relative to what we earn has gone down. What hasn't declined is our insatiable appetite to consume.

Part of the problem is the consumer culture mind trap. Luxuries are passed off as modern-day necessities. Streaming pixels on retina screens of shiny, life-enhancing potential. Handheld devices crying like babies for redundant updates. A virtual community of ultra-consumers, carving out a path to the supposed life worth living. The Kardashians show us what this looks like, and we mere humans mistake these accessories for essentials. We need to remember that most of what we see in the media and advertising is a façade that has little to do with happiness.

While we seem to be constantly assailed by novel ways to divest our funds for the useless, it seems the problem isn't new. Eighteenth-century French political philosopher Charles de Montesquieu wrote:

If we only wanted to be happy, it would be easy; but we want to be happier than other people, and that is almost always difficult, since we think them happier than they are.

My bet is that the Kardashians are miserable.

Most of us tend to remember growing up with less than our kids have, or at least our parents tell us how much more we have than they did. This is not some kind of parental chicanery to make us appreciate life a little more. It's mostly true. When we were discussing current standards of living, my father asked me a few questions that helped remind me how much we now spend on the nice rather than the necessary.

‘When you were a kid, how many times did we go out for breakfast?'

‘None.'

‘How many times did we stay in fancy hotels for a holiday?'

‘None.'

‘How many times did you catch an aeroplane before you were 18?'

‘Once.'

‘How many pairs of shoes did you have?'

‘Two — school and runners.'

‘How many televisions did we have?'

‘One.'

‘Did you have your own bedroom?'

‘No, I shared it with my brother until I was 18.'

‘When did you get your first phone?'

‘When I left home.'

‘Where did most of your clothes come from?'

‘My older brother.'

‘How many paid lessons [swimming, musical instruments, languages] did you have?'

‘One. I was learning to play drums.'

‘How many birthday parties at a catered party venue did you go to?'

‘None. Parties used to be in the backyard with a homemade cake, pin-the-tail-on-the-donkey and musical chairs.'

‘How old were you when we got lucky enough to buy brand-name goods and clothes?'

‘Well into my teens.'

‘How many families had big SUV cars?'

‘None. We all squeezed into sedans.'

‘Where did you get your hair cut?'

‘At home. Mum used kitchen scissors.'

And you know what? The times I look back on with the greatest fondness are those when we made do with what we had. They taught me both how to be happier with less, and how to appreciate the upside I've been lucky enough to achieve.

We spend so much of our income on the nice-to-haves that we've confused them with necessities. They are the new normal, and humans are great comparison machines. I'm not going to list the nonessentials, but we know what they are deep in our heart. We also know we could find a way to save at least a little of our income to start on the trajectory towards a surplus.

When I left the corporate sector for the first time to do my own startups, I had to make some hard decisions on going without certain comforts. I had a very nice car, but I decided to sell it and catch public transport instead. Yes, it took me two hours to get to meetings that would have taken half an hour in the car, but I was driven by the truth of doing what was necessary to achieve what was possible. I used the down time to prepare and read and learn. I turned it into a positive experience. I moved back into my old bedroom at home to save cash I could put into business so I wouldn't get dragged back into the corporate vortex. There were more of these examples, but you get the picture. I'm not saying you need to go back and live with your parents, but when we honestly assess our expenditures we'll find we can do without many things that are nice to have, at least temporarily, to get in front with our savings ratio. The ratio that gives us a chance to try something else — the freedom fund.

IF YOU CAN'T AGREE WITH WHAT I'VE SAID HERE ABOUT SAVING, THEN YOU SHOULD PUT THIS BOOK DOWN AND NOT INVEST ANY MORE TIME IN READING IT. BECAUSE I CAN'T HELP YOU FROM HERE. IF YOU DO NOT UNDERSTAND OR BELIEVE IN THIS TRUTH, THEN YOU WON'T BE ABLE TO IMPLEMENT THE ADVICE THAT FOLLOWS.

Society says spend

It's not just the perception of perfect lives conveyed in public social forums that influences us to consume. It's part of the fabric that holds modern society together. Just think about the incentives of society's most powerful institutions. Our government collects funds through taxes, which are generally based on consumption. They get a clip when we buy anything. They get 30 per cent of the profit any company makes selling stuff to us. Income tax is collected mainly from people working for companies, who employ people only when they sell enough stuff. Corporations survive only when we spend. Even our financial institutions, the one set of corporations who are meant to be on our side, financially at least, do better when we put money down on the plastic magic carpet credit card or get a loan. They make money when we spend money we don't have. It's no wonder we don't hear much about the comparative advantages of saving rather than spending our money.

Saving doesn't make anyone rich but you. This is why almost every advertisement you've ever seen provides advice on spending. The government and our corporations have no incentive to teach people the importance of saving. The more people spend, the more ‘jobs' and taxpayers there are, and the less pressure there is on social services. I've seen lots of government service announcements on things we should be doing, never one that tells us the importance of saving our money. But I know they know that saving is important, because every other advertisement they run is telling us what to do so we save them money, discouraging behaviours that are expensive to society — driving safety and health messages, for example. I can't remember ever getting a lesson on what to do with money in school and, given the above, it's not surprising. So it's up to us to teach each other, our kids and our friends — we owe each other that much.

So next time, before you spend money on something you know you can't afford, ask yourself if you'd rather a temporary pleasure and comfort now, or the opportunity for infinite comfort later. Our ability to delay gratification is a core human principle, both psychologically and financially. It is true for study, work, eating, exercise and everything that affects our wellbeing: the ability to endure short-term pain or deprivation is what puts us ahead of the pack. If this isn't quite motivating enough, then we can always remember the sage advice of Tyler Durden, lead character in the movie Fight Club: ‘The things you own end up owing you'.

Finance is a game

I'm very aware of the contradiction in all this. On the one hand I'm talking up the benefits of saving, while on the other I'm saying that ‘inventing money' through organising factors of production will lift you to the top of the financial hierarchy. The need to save is the opposite of what I'm encouraging you to create (people's need to spend, so you can profit from their spending). I get it, it is kind of strange and paradoxical. But it is in some ways a game. Finance is a game we are all playing, and we really don't have a choice. The only way we can stop playing is if we go find ourselves a place under a banana tree somewhere and live off the land.

Living in a modern, civilised, technological society means there will be winners and losers in all this. And it is not as if we have to convince people to go out there and spend; there's enough of that happening without any extra encouragement needed. In any case, the way we make money (more on this in Part III, ‘Reinvention') can have a very positive impact on other people's lives, if we create something better or more efficient, providing greater benefits than what it replaces, so it isn't all bad anyway. The crux of it is this: some will do better than others. You're making the effort to read this book, and I'm trying to share a winning formula with those who care enough about their future that they'll invest time in improving it.

The three places money can be stored

Non-consumption money, like tangible things, needs to be stored somewhere. Sounds weird, right? But as with grain or milk, where we put it has an impact on its shelf life. Like food, it can go bad. Like water, it can evaporate or accumulate. Where we put it is what makes all the difference. Now we know we have the choice to either spend or save, and we've agreed that we need to save a portion of the money, or should I say revenue, we generate, where can we put it?

When we say ‘stored', we are talking about where we allocate our savings. And it turns out there are only three places that money can be stored. It can only ever be stored as cash, property or equity.

1. Cash

This is the money we keep in our purse, wallet, pocket or backpack, under the bed, in the freezer (don't do this; criminals always look here), or as cash deposits in bank accounts. It is money we keep ready to use. It's transactional in nature, on hand when we need it, say for unexpected emergencies. It shouldn't be a place for permanent storage or for storage of large sums of money. The reason is that money stored in this way goes down in value. It does this in a couple of ways. The first is that it is far easier to spend money which is readily available. Stored here it can steal from our savings and increase our consumption.

But the more important factor is that a dollar tomorrow is worth less than a dollar today. A dollar that we don't put into the market doesn't get a return. It's worth less, because a dollar that is put into the market, where it generates dividends and rents, comes to be worth the original dollar plus whatever it earns. Accountants call this the time value of money. If the money itself is not invested where it can get a return on investment, its value declines compared with money that is active in the market. It's the difference between active and inactive capital. It's a bit like our body: the less we use it, the less power it has to generate something on our behalf. We should keep only small amounts of our available money in this place — money for security and transactions — because it is the least effective place to keep it.

OUR GOAL SHOULD BE TO PUT EXCESS MONEY TO WORK AND USE IT TO GENERATE MORE ‘INVESTED MONEY' OR TOWARDS ENTREPRENEURIAL ACTIVITIES THAT ‘INVENT MONEY'.

2. Property

This is money we put into real estate — land, houses, apartments, buildings, factories, warehouses and offices. We can choose to live in them, rent them out to other people to live in or rent them out to businesses.

These are good places to store money because they most often generate a return on the money invested. Furthermore, unlike cash, the value of the dollar we put here is usually worth more the next year. This happens in two ways. First, we get rent for the use of that property, or we reduce our own cost of living by reducing our need to pay rent to live somewhere else. The rent puts money into our hands simply because we control the property asset. Interestingly, we don't necessarily have to own the property to extract rent; we just need to control the asset. Second, when we own the asset, we also gain money as it appreciates in value. If it is worth 10 per cent more next year, the original money we put into it will then be worth 10 per cent more. We can sell it at a profit, and keep the money we made from rent. Because the money was ‘invested money', it continues to grow in value.

This has been the greatest source of wealth creation since the dawn of time. Land, by definition, is scarce, has a limited supply and, when chosen well, can generate above-average returns on investment. But the real reason property generates more wealth than other sources is that it is viewed as more secure. Of course there are exceptions to this — mortgage-backed securities during the GFC come to mind — but because property is seen as secure, and when it is backed by rents and leases, financial institutions will lend money to acquire it.

In this case, if you have only 10 per cent of the funds to buy some real estate, and you borrow 90 per cent of its value, and it goes up by 10 per cent in a year, then in real terms you've doubled your money through borrowing other people's money. This is why property has such a success rate in generating wealth over time. Of course a property's value can drop, and for this reason it should be viewed as a place to store money for the medium to long term. Getting in and out of property is time consuming and costly, which is restrictive but also part of the reason for its stability. It also should not be undertaken unless the return is reasonable, and it is likely to be in demand by others if the renter (people or corporation) leave town.

Historically, over the long term property goes up in value. It also requires a far lower skill base than most other investments. Dumb money can do very well; often all the investor needs to be able to do is ‘hang on' long enough. Simple economics of supply and demand drive this, but even taking into account wages growth over time (2 to 3 per cent per annum in Australia for the past 60 years), we can see that people have more money to compete for property purchases every year.

3. Equity

Equity is money we put into a business of any kind. It could be a business we own and operate, a business someone else owns and operates, a tiny mum-and-dad business, a giant enterprise … or anything in between. It could be a private company or a public company traded on the stock exchange. It includes money put into an investment fund, superannuation or a 401k, stocks we buy ourselves on the share market, a small business we buy, a partnership we form or even money we put into a startup business. It could involve investing in a business that is well established or bearing the risk to get something new started.

This is also a good place to put money, because we get a return in the form of dividends. In short, this is putting money into organising the factors of production for a profit. Putting money into equity works in a similar way to putting it into property. Instead of rent, we get dividends — our share of the profits the company made through ‘inventing money'. It's just a different type of investment. As with property, we hope for regular returns, and for the value of the thing we invested in to rise.

Equity investments have a few important differences, though. The dividends tend to be less frequent than rent — generally quarterly, bi-annually or annually, rather than weekly or monthly. Equity investments also tend to be higher risk, with greater fluctuations in financial performance affecting both the value of the equity asset and the dividends (profit). And the reason is simpler than you might imagine. Consumers are fickle; they change their minds about what to buy on a whim. Businesses serving consumers can be affected very quickly by changes in the marketplace. Competition, trends, fashions, commodity prices, interest rates, elections, consumer sentiment, even the weather can have an immediate impact on a business's performance, and in doing so affect the profit of an equity investment.

While these things can and do affect property prices and rents, it takes much longer for such changes to take place. Also, there are generally fewer available substitutes for property. Moving house takes time, and we all have to live somewhere. Changing warehouses also takes a business time. Shutting a factory is no easy task, and even retail (probably the most volatile sector in property) isn't immune to forces that make it difficult to close a store. But with equity, many things people spend on are discretionary, meaning we can choose not to buy them or to buy fewer of them and generally tighten our belts. So equity usually commands a higher return on the money invested to take into account the heightened risk. Similarly, equity stakes in consumer staples (think food) are usually safer because people have little choice but to buy such goods. Very well established large businesses and brands tend to be less volatile because they reach wider and deeper into people's wallets.

Equity, in a business or a portion of a business we own, has two important sub-categories: passive capital and active capital. Passive capital is money we invest in a company or business that we don't control, that is not ours, or where we don't have any say in its decision making or operations. This includes investment funds and direct share investing. It's the act of entrusting our money to others (hopefully with a history of providing good returns to investors) so they can grow the money on our behalf.

Active capital is money we invest in our own ventures. We put money down hoping to make a profit from the activity. It could be as simple as opening a store on eBay to something as complex as starting a manufacturing company. It's the act of being an entrepreneur, regardless of the size of the venture, which defines active capital.

Anyone who wants to be successful at equity investing always has a better chance of success when they play in both the active and passive capital spaces. Knowledge in one informs the other. If you've run your own business, or faced the challenges of starting a venture, it's far easier to assess passive investment realistically.

All of these types of storage places can be called on, or converted back into money, and have the potential to generate more money while it is being stored. Even cash can generate small returns if held in bank deposits. But the key distinction we need to remember between the three places we can put our money is how differently they behave around accessibility, return and risk.

These, of course, relate to expectations over time (see table 7.1, overleaf) and, as with any investment, unexpected results can and do occur.

This much can be said about property and equity: if, over the long term, you put your money into these things, instead of into stuff, you'll end up with lots of money. The money tends to go up in value. When it doesn't go up, and you lose it, it hurts a lot, but you tend to move up the learning curve really quickly, so it doesn't happen too often. It reminds me of the two investment rules of the world's greatest investor, Warren Buffett:

Rule number one: Never lose capital invested.

Rule number two: Refer to rule number one.

But my basic rule is this: if we want financial freedom, then we have to accumulate money, and the two best ways to do that are to accumulate property and equity.

Where to allocate our dollars

I hope we've all agreed that saving is key, and you've kept reading since I challenged you on discriminating between necessities and luxuries, so, bottom line, what do we do with our dollars? How should we allocate the money we earn in percentage terms?

The following basic formula, applied to every dollar earned, will create maximum opportunities for financial freedom. This is still the best economic model I know. It's the 70/30 money rule:

• 70 per cent to live on
• 30 per cent to save and invest.

We should never spend more than 70 per cent of the money we earn. We need to learn to live on 70 per cent of our income and to save 30 per cent. Sounds like a lot. But there's a very good chance you used to know how to do it but you've just forgotten. This is especially so if you've been working for a few years. When you used to earn less money than you do now, you somehow managed to get by, and to live a good life. You may even look back on those days fondly, even though you probably earned a lot less than you do now. A simple calculation shows that a pay rise of 3 per cent per year equates to a 31 per cent income hike over 10 years. We all managed to survive on what we earned in the past, so we know we can do it, but all too often we upgrade our living standards in direct alignment with our income increases. We're all guilty of it. When our income goes up, we get a nicer car, we go to nicer restaurants, we buy fancy takeaway coffee, nicer clothes, our holidays are a little bit more luxurious. And we deserve it, right? We worked hard to get it! So now it's a simple choice only we can make, but people who have more discipline now always end up with far more than they expect later.

If you're a little older, like me (I've been out of school for more than 20 years), the 30 per cent might seem like too much. If it is, and you are serious, then there are a couple of things you can do. The first port of call should be to think about what financial commitments you can cut loose. Do you really need that Netflix subscription? How much data does your phone need? Could you downgrade your car? Spend less on going out? I promise you there are more nice-to-haves on the expenses side of your ledger than you imagine. If you don't believe me, do this exercise to prove me wrong: For one month, write down every single dollar you spend and where it went. I promise you'll be surprised by how much of your spending is, well, let's say ‘optional'.

If you're a little younger, not like me, start the habit now while the numbers are small. Don't get into the habit of living it up before you've earned the right financially. If you start young, the 70/30 rule will make you a laureate in the major of economics.

The easiest hack for saving 30 per cent is to put it where you can't touch it the moment you receive it. Some people call this ‘paying yourself first', which is a great way to express it. In this sense, we define pay not as the lump sum we get at the end of the week or month, but as the amount we put aside. That's the bit for us, because quite literally the other money (the 70 per cent) is going to go all over the place to pay other people. It's going to pay the grocery store, the landlord or bank mortgage, the electricity company, the clothing store, the café. Everyone else will get their pay from what we earn, so we need to flip it in our favour by paying ourselves first, literally. It also makes it much harder to spend money that isn't easily accessible. This is why it's vital that it goes into a ‘future fund'. I learned a long time ago a difference in attitude between people who become financially independent and people who don't. The key difference in behaviour is this:

• Financially independent people pay themselves first and spend what's left.
• People who struggle financially spend first and savewhat's left.

Those who spend first and save as an afterthought rarely have anything left to save. They struggle because they have the order back to front, not because of how much or little they earn.

If you've studied your expenses and it just isn't possible for you right now, hold onto the principle but modify the numbers. Maybe for you a 90/10 ratio is an achievable way to get the good habit started. Or if you've overcommitted yourself financially and are in debt and in really bad shape, maybe 99/1 is the best you can manage. But at least then you're in the game, and a better pattern becomes set. What really matters is the principle of setting savings aside. It's important here, though, that you don't cheat yourself by putting aside less than you can. Doing less than you can always messes with your ego.

Of course, this advice is for mature people, for people who want to be honest with themselves so as to set up their future. It takes a mature mindset to understand the truth about money. It might sound like cultural heresy to claim that everyone can do this. I'm aware of that, and I'm saying it anyway because I know it's true and it's still possible in these tough times to get ahead. Even people who have dug themselves into a deep hole can start small by setting themselves minimum viable savings (MVS).

The 30 per cent split

The 30 per cent is split equally among the three places money can be stored — cash, equity and property:

• 10 per cent cash
• 10 per cent property
• 10 per cent equity.

Cash will be allocated for emergency safety money, cash in the bank and easily accessible funds. This is for unexpected expenses or in case of emergency. The good thing, of course, is that if no unexpected expenditure is needed, then the savings can be redirected to the two other storage categories.

Property will go into a future fund. This should be put aside for future investments in property. It will take some time before you can buy or invest in a property, but that's what this fund is for.

Equity will go into an account earmarked for investment in shares (passive capital) or starting a business of your own (active capital). This category is a bit different from property in that it doesn't take much money to start investing. Anyone can buy a few hundred dollars' worth of shares or investment funds electronically through most banks. Your first entrepreneurial venture could be selling a few items online or offering your services on a digital platform. Ways to get started with active capital and inventing money are covered in Part III, ‘Reinvention'.

You might be wondering why you don't just save 30 per cent and keep it in one account, so reducing the complexity a little. Here's why: the habit is what matters most. We want to get you thinking about your economic life as a portfolio of options. Options that make you future proof. Even if the amounts are small, this new approach, which creates a portfolio of investments, is the start of becoming bulletproof no matter what the economic conditions. It stimulates the mind to the possibilities. You can watch the amounts add up in each account and get excited about what you can do with these funds. It's an important part of the change in mindset from being a subservient wage earner to becoming self-reliant. It feels incredible and builds confidence. It's the start of taking control.

It's bigger than you

Saving habits matter because they have the added benefit of creating access to more money. It's not just important for you personally; it's how the people who control the money make decisions. Your banker never asks to see your school report! Neither does a venture capitalist or an investor in your business. What they both want to see is your financial score card, and it's a pretty basic thing. They want to see how much money you generate and how much you set aside. They'll use different terms and forms, but that's what they're interested in. If you can show them your good habits, then they're more likely to decide you're a good risk for them to take with their money. People invest in your habits more than anything else. It's as true for money, for job interviews and for startup investors as it is for most things across the economic landscape.