Gordon Gekko and Honest Business Principles:
There is no doubt there is a certain amount of greed and unscrupulous behaviour in Corporate America. This type of behaviour is probably best epitomized by the fictional character Gordon Gekko in the movie Wall Street. It’s important to realize, however, that not all strategies used in big business involve lying, cheating, or deceit. Many strategies used in the corporate world are based on sound business principles that have proven their value time and time again in the bottom lines of many companies. This post will focus on five strategies used in the business world that can help you to try and build wealth like Gordon Gekko without acting dishonest and deceitful like Gordon Gekko.
The Art of Making Money
Over the last hundred years or so a whole field studying the art of making money has evolved. Many top executives spend years studying this field in reputable business schools all around the world. Then they step out into Corporate America and start putting these ideas into place. Some businesses fail and some succeed. Some large corporations, however, seem to do extremely well and make more and more money for their shareholders every year. Respectable corporations such as Colgate Palmolive, Johnson and Johnson, Procter and Gamble, and 3M, have provided their shareholders with an ever increasing stream of dividends for over fifty years.
Having gone to business school myself and having worked for one of the above mentioned large multinational companies, I’d like to present five effective wealth building strategies that get taught in business schools and get used by some of the large multinational companies mentioned above. Even though these strategies are successfully used in the corporate world to generate ever increasing streams of income, they sometimes get overlooked by individual investors. My feeling is they are paramount for success.
Five Strategies Used by Corporations to Make Money
- Have a Business Plan
- Cut Costs and Control Expenses
- Create Reliable Cash Cows
- Appropriately Manage Risk
- Borrow to Invest
Have a Business Plan
I think every project I ever did in business school started with a business plan. Then, when I went to work in the corporate world, it became apparent that business plans were considered absolutely essential for success. Every employee in the company I worked for had a business plan. Every department had a business plan. And, finally, the organization as a while had a business plan that all our individual plans tied into. A great deal of time and effort went into creating these business plans and having a shoddy business plan was not something the company took lightly. During this business planning process targets were made, strategies agreed upon, and actionable items written down and followed. If results weren’t proceeding as planned, strategies were changed.
The importance of a well thought-out business plan is difficult to overstate. A well thought-out plan is one that considers all options and then chooses the options that are most likely to lead to a successful outcome. A well thought-out plan also clearly lays out how each objective in the plan will be achieved. By writing down a plan that describes how you will achieve your objectives, you will guard against distraction, confusion, and procrastination, all of which can prevent you from achieving financial freedom. As author Napoleon Hill states, “Riches do not respond to wishes. They respond only to definite plans, backed by definite desires, through constant persistence.” After you come up with this plan, stick it on your fridge or somewhere else where you can see it every day. This will help to keep your plan top of mind. Then go out there and execute this plan. Successful corporations make more and more money every year not only because they have a well thought-out plan to do so. They make more and more money every year because they have a plan and then they go out and execute it. If you want to achieve financial freedom and retire well ahead of schedule you need to do the same. Don’t just plan to have a million dollars someday, plan to have a million dollars in a “x” amount of years by investing “x” amount of your income each month in a proven strategy to do so. Then do it.
An example of the plan my wife and I used to achieve financial freedom can be found on The Plan page of this website. We followed this plan religiously and we succeeded.
Cut Costs and Control Expenses
Successful businesses are always looking for ways to cut costs. In fact, every decision they make involves a careful consideration of costs. It doesn’t matter if that cost is a major purchase, such as a factory, or if it’s a smaller purchase such as the office supplies that go in that factory. It doesn’t matter if it’s the cost of employing their workers or if it’s the cost of the internet used by those workers. No matter what the costs are, they are closely scrutinized so that more of the company’s earnings can be protected and used to fuel its future growth. This needs to be your plan as well.
If you want to achieve financial freedom and retire much earlier than most, you need to be constantly looking for ways to cut costs. You need to save as much as you can as often as you can, and you need to get this money invested and working for you. Make it a goal to save and invest a certain percent of your income so that you can meet your target retirement date and then follow this goal.
If you want to retire much earlier than most, there is no getting around the fact that you will need to save and invest a greater percent of your income than most. Figure out how much you need to save to reach your retirement goal and stick it in your business plan. A good way to save and invest a greater percent of your income than most is to buy a house for less than you can afford and then pay yourself first with all the savings you realize. This strategy is discussed in my previous post “Buy a House for Less Than You Can Afford and Get Rich”
Create Reliable Cash Cows
You will never be able to achieve financial freedom or an early retirement by stuffing all the money you earn under your mattress. Instead, you need to invest this money so that it can start growing and providing you with an ever increasing stream of passive income. Successful corporations do a good job at creating products that provide them with reliable streams of income year after year and require little work to maintain. You need to do the same.
In the corporate world these reliable streams of income are referred to as “cash cows”. Take a second and think about some of the cash cows created by some of the successful large multinational corporations mentioned above. Tylenol, baby shampoos, baby lotions, and Listerine, for Johnson and Johnson. Toothpaste and toothbrushes for Colgate-Palmolive. Post-it notes and Scotch tape for 3M. Pampers, Tide, and Head & Shoulders, for Procter and Gamble. All of these products provide these companies with a perpetual and reliable stream of income, year after year.
Even better, not only do these successful corporations get to sit back and collect the money from their cash cows, they also have the benefit of reinvesting the money they receive to make even more money. This has to be your strategy too.
For the average investor, the easiest way to create cash cows is to make periodic long-term investments in the stock market using a proven strategy such as index investing or dividend investing and to be sure to continually reinvest the dividends. Just like the companies mentioned above, reinvesting your dividends will ensure that you make even more money. The simplest way to achieve this would be to buy a low cost ETF that mirrors the S&P 500 Index and sign up for a dividend reinvestment plan (DRIP).
The compound annual growth rate (CAGR) of the S&P 500, in the period between Jan 1, 2006 to Jan 1, 2016, has been roughly 7.3% per year (assuming reinvestment of dividends). Even with the financial crisis in 2008, if you had invested in the S&P 500 over this time period, you would have earned an average return of 7% per year. The CAGR generated by the S&P 500 over the thirty year period between Jan 1, 1986 to Jan 1, 2016 works out to be 10.5% per year (again, assuming reinvestment of all dividends). And that thirty year period includes black Monday (October 1987), the recession in the early 1990s, the dot-com crash between 1999-2001, and the financial crisis in 2008.
Is the growth of the S&P 500 going to stop? Not likely. The S&P 500 has been growing for centuries. The idea that the corporations that make up this index are going to somehow suddenly stop making more money is not realistic. Sure it might go down in some years, but if you are investing a little bit every month and are investing for the long term it’s hard to believe you won’t make money.
Appropriately Manage Risk
The large successful companies mentioned above excel at managing risk. How do they achieve this? Three ways – (1) they don’t speculate, (2) they diversify, and (3) they get insurance. You need to make sure you do these three things as well.
The companies mentioned above all invest in diversified lines of business that have a history of earning money. Don’t throw your money away on companies that may or may not make money someday. Instead, invest in companies with a proven history of increasing their earnings. Furthermore, invest using proven strategies such as index investing or dividend investing.
These corporations also manage risk by ensuring that their businesses are properly diversified. All of the companies mentioned above receive multiple streams of income from many different products in many different countries. Johnson and Johnson, Colgate-Palmolive, 3M, and Procter and Gamble, all produce thousands of different products and sell these products in over one-hundred countries. Follow these successful corporations lead and make sure you diversify as well. Don’t just invest in one good company in one country, invest in many good companies in many countries. Furthermore, don’t just invest in stocks, diversify your holdings and hold some of your portfolio in stocks, some in bonds, and some in real estate. Don’t put all your eggs in one basket – you just might end up dropping the basket.
Finally, all the companies mentioned above have taken steps to ensure that they are properly insured. And many, if not all of them, have created their very own private insurance companies to manage the risks their companies face.
A captive is an insurance company that only offers insurance to the company that created it. Captives enable businesses to better insure themselves against a variety of risks. They also allow companies to insure themselves more effectively than a traditional insurance company could. A captive’s sole purpose is to insure its creator against as much risk as possible. Take a page from these companies’ playbooks and make sure you have enough insurance to protect you, your family, and your retirement fund, from any sort of catastrophic event.
Catastrophic events that severely damage property or severely affect health can happen to anyone. Events such as fire, floods, and earthquakes, could all result in the total destruction of your property. Illnesses that severely affect your health are even worse. In fact, a 2013 study from Nerdwallet Health indicates that medical bills are the single largest cause of bankruptcies in the United States. The best way to protect yourself against these types of catastrophic events is by having proper insurance.
Borrow to Invest
Corporations borrow money and invest it when they believe their rate of return will exceed their cost of borrowing. They borrow money to make money. And if you want to achieve financial freedom sooner rather than later, you need to consider using this strategy as well. The corporations mentioned above have billions of dollars in debt and its all working to earn shareholders even more money.
Even though debt is constantly frowned upon by most individuals, debt isn’t always as bad as many people make it out to be. The key is to borrow money to increase your wealth, not to squander it on money sucking maggots. Someone that borrows money to buy an investment property and then rents this investment property out so that the rental income covers all the expenses, will likely be much wealthier, over the long-term, compared to someone that never borrowed any money to invest. Sure there might be years when the property decreases in value, but it’s hard to imagine a scenario where you don’t come out ahead if you can find an appropriate investment property, position yourself to hold it for the long-term, and have the tenants pay the mortgage and other property related expenses for you. For more information on borrowing to invest check out my previous blog post “Should You Borrow to Invest”
Having said all of this, the truth is that any amount of leverage is more risky than no leverage at all. This is because, not only does leverage have the effect of magnifying gains, it also has the effect of magnifying losses. If you invest $20,000 to buy a $100,000 investment (effectively borrowing $80,000) and that investment increases in value to $105,000, then you haven’t just gained 5% of your investment ($5,000 of $100,000), you have gained 25% ($5,000 of $20,000). Conversely, if you invest $20,000 to buy a $100,000 investment and that investment falls to $95,000, then you haven’t only lost 5% of your investment ($5,000 of $100,000), you have lost 25% ($5,000 of $20,000). If you don’t feel comfortable with this extra risk, then simply stick with the first four strategies.
In the end, the goal is to treat your goal of financial freedom and early retirement more like a business. And just like the successful businesses discussed above, create a plan to achieve your goal and then use the strategies outlined here to ensure you achieve it.