Episode 003 - The Magic Formula

We get into the meat & potatoes of financial sustainability, introducing "smart income" and the importance of expenses management. We counter a number of socially accepted norms, by questioning the value of money and the flaws in the FIRE movement's approach.

The financial sustainability methodology covers both the generation of "smart income" along with questioning expenses, particularly also questioning the real concept of money.  We look at the purpose of money and how it has been butchered by banks to turn currencies into debt models.

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Show Notes

In our prior episodes, we introduced the context of why you would want to live unconstrained. The freedom that comes with the unconstrained lifestyle is incredible. You get your life choices back, you get your freedom back , your ability to travel and the release of stress from the day to day grind that we have all found ourselves subject to. In our second episode, I introduced the concept of Financial Sustainability and that we are all participants in a capitalistic system and need to embrace the art of business to thrive in that system. The core goal here is to make Net Profit in our lives - not focus only on net income.

In this episode, we get into the weeds with Financial Sustainability.

So what exactly is Financial Sustainability? It is very simple and commonsense. You don’t spend more than you earn. It is that simple. I mean we all got taught that as children. But life in the western world challenged our understanding of that simple teaching and we are constantly told to ignore it. We consider “wealth” as having all the things in life you want now. Not later. The problem is that you haven’t earned them yet. So you sacrifice your future for them. You sell your future working self out now, to have those things that your future self will be burdened with paying for later. That could be a car, a house, or once the banks started realizing that they could generate better return on their capital with higher interest rate products, they created a world in which EVERYTHING is about having it now and paying later. You can’t book a rental car or a hotel without a credit card. It is next to impossible to not use someone else’s money for anything these days. We even have some western countries threatening to abolish cash.

If one is to embrace the concept of not spending what we haven’t earned yet, we get our future back. But in order to make this work, we have to be reasonable. There will always be a “BURN RATE” that it costs for all of us to exist. We need food, shelter, clothing, communications, healthcare, utilities, etc. and these are often physiological needs. Our existence relies on them. Yet we rely on third parties to provide the bulk of these things. So we have to earn money to pay those third parties for the things that we don’t have complete ability to generate ourselves. Maybe the goal would be to remove that, but often that can be a bridge too far for most. It only really has been in the past 10 or so years that generating your own power was an option – prior to that, we had no choice other than to pay the power company for electricity. And you need healthcare and insurance for adverse events, so that isn’t something you can generate yourself. The reality is that we need other people and ideally they need us too.

So what if you could turn this upside down and focus on the real costs that you have to make each month, and some buffer for unexpected circumstances. Then work out how you can make that level of income without having to sell your time by the hour to someone? That’s the magic formula.

This is often referred to as “passive income” but I really don’t like that term. It tends to suggest it is lesser a thing than “active” income. What I prefer to call it is “smart income”. Smart income is money you make when you sleep. It is when you defer to things you own to give you rent or some dividend. They require far, far less human labor to maintain than employment does. They don’t often require your presence although they might take more work up front to establish. And they also don’t make as much money in lump sum form. For example, if you bought a vending machine and you filled it with stock, the effort up front to acquire the machine, find a location to put it and make a deal with the location owner to share the profits, then buy the inventory to fill it, and go out and fill it, after establishing security, power, etc. – well that is a lot of work. But once you do this, then it just works.

You don’t have to do that level of effort again. You then just “attend” to the machine. You collect your coins and money from it every week or so, and that small income stream is established. Will this pay your rent? Probably not. But if you consider that your level of effort to buy the inventory, drive out and fill it up, collect the coins, etc. is scalable across 10 machines, then the dynamic changes. You might be able to visit the wholesaler and buy enough stock for 10 machines for about the same amount of time required to buy for 1. Although you will be driving out to visit 10 machines, you can probably leverage the effort so that this work done in 1 day per 2 weeks, could represent enough income to cover your burn rate. Or at least maybe 50% of it. The thing is that you should aim at having diversity of income from multiple sources.

Many will tell you that they don’t want to have to do that – it’s too much work. But they won’t tell you that they sell 8-10 hours of their time per day to an employer who expects them to do that 5-6 days per week, and if they become unable to go to work due to illness, injury, etc. then they will lose that income stream. They sit in a cubicle all day staring at the walls contemplating that there has to be a better way. Well what is better? Working 1 day every 2 weeks, or working 10 days every 2 weeks? And what generates income when you sleep, or when you are sick, or if you don’t feel like going to work that day?

So let’s start to get specific as to how to do this. The first thing is going to be to focus on your Burn Rate. You need to get that as low as possible, so the distance to generating enough smart income is able to be covered. Smart income takes time to generate – it comes in more like a consistent trickle of money rather than a massive onslaught of money. That means you need to understand and manage not only your burn rate, but also your cashflow needs.

See… I’m going to use business terminology here. That’s why, in the past episode, I explained that you have to understand the art of business and it’s syntax in order to follow along. If you haven’t done that, then you probably have some homework to do. I suggested taking a class in small business accounting because the techniques there apply to your personal income too. So if I am using terms you are not understanding, you need to understand them. Write down any terms I use and then Google them to understand it. Pause the episode rather than misunderstand a term because they are pivotal to financial sustainability. Now let’s continue….

You probably need capital to acquire assets. As I record this, there has never been a better time to get financing to acquire assets. Yes, I know – I advocate for no debt. But the reality is that there is good and there is bad debt. Bad debt is when you go into debt to buy something that doesn’t make you money. Good debt is when you go into debt to acquire assets that generate cashflow – cashflow that is more than enough to service that debt, so that time can pay it off and eventually you are 100% freehold. But ideally in such a way where the spread of what you make on the asset is more than enough to not only service the debt, but to make a profit on top of that which adds to your smart money flow.

However if you are willing to trade your time for money to get the capital, that’s fine too. Just not for the long term. We need to stop that default behavior as soon as possible, but yet – you will need capital and either you have it, you borrow it, or you generate it.

Whereas vending machines are relatively affordable as one way, there are many other asset classes from dividend stocks to rental real estate to technology assets, etc. that all conform to the generation of “smart income”. And a diversified method is best – this way you are not exposed to any marketplace issues that may come or go.

The acid test of any asset class that falls into the category of “smart income” is:

  • Does this investment require anything more than an initial amount of human labor, and some limited maintenance to generate income?

  • Can I generate income if I am sick or unable to work?

  • Can a third party be employed to perform the tasks if I can’t or am unwilling to do any work on this? (ie. A Property Manager)

  • My income is not subject to the variations of the market and considered “low risk”

  • Can I generate the income if I am not present near where the income is being generated?

It will take time for you to get your smart income strategy in place, but you can immediately begin to reduce your burn rate. The sooner you start that process, the faster you can generate any down payment to acquire assets.


The real secret

Just as we are all hypnotized to follow a path that someone created for us in life such as going to college, having a career, retirement, etc., there are other default assumptions that we rarely question that hold the key to being unconstrained. The biggest one is the concept of money.

We rarely question money. We exchange goods and services between each other by finding a valuation system that we agree on, and then measure the value of goods & services against that valuation system. A loaf of bread is priced at this amount in “dollars”. A gallon of fuel, an hour of labor, etc. All measured in dollars or euros or yen, etc. The money measurement becomes like a weight scale. Prices go up and down, but really what is happening is that the value of goods & services are measured differently in money. I’m going to use the term “dollars” to represent your currency – just replace that term with what is your native currency in your region if it is not dollars.

We forget the goods and services we need, and focus only on the dollars. We work and earn in dollars, we shop in dollars, we perceive our net worth in dollars, etc. The entire fabric of our perception of value is done in dollars.

But what if you could, little by little, distance yourself from dollars and start to obtain the things you really need (food, shelter, clothing, utility services, transportation, communications, etc.) without having to convert what you had and what you need into and out of dollars all the time? The simplest example of this is if you grow your own food. You need to eat. The normal position is that we go to the store and buy food. We exchange dollars that we hold for food that the vendor holds. But if we had an unlimited supply of food, we would never need to exchange with the vendor. The same could be true of power. If you invested in solar panels for your house, you could generate enough power to satisfy your needs. There are a lot of variables here, but follow me down this path for a minute. If you were “off the grid” so to speak, you would never need to exchange something you earned through labor to dollars and then pay a utility company for something you needed. You would have direct access to the sun and cut out the middle man, so to speak.

You see, if you are able to self-generate what you need, you reduce your need to exchange labor for dollars to then exchange dollars for what you need. You go right to the source. The exchange between what you have that others want (labor, goods, etc.) and what you want that others have (food, shelter, etc.) requires a common and agreed upon measurement, which is usually a national currency. And in this exchange, the wealthy insert themselves to take a small fee. The merchant pays credit card processors up to 3% of the transaction for the exchange. The banks charge a fee to hold money, or a fee to provide checks or make an ATM withdrawal. It is not surprising that in some countries, Mexico for example, the largest industry in the entire country is not tourism, or oil, etc. – it is monetary exchange. Because more money flows in and out of Mexico, it generates revenue for the big banks at the ingress and egress points than the actual value of those goods & services.

What people forget is that there are many, many currencies. And you can use them as a different way to exchange what you have for what you need. In doing so, you can break free of this predetermined path.

Sometimes this is almost impossible to avoid using money as currency. But if you have the knowledge and skills to be able to measure all of the accounts in your profit & loss statement, create a budget for what you need for your cashflow, and then look at each item in that budget, you can probably determine how you will find the money to meet your needs. If you could satisfy that need without actually requiring money, or that you had a source of income that was smart income – self generating – and you apply it just to that line item, it reduces the overall need to generate money to meet the gross total of your expenses.

This is what I mean. You have the tools to measure your actual expense lines in Quickbooks, for example. You have it connected to your bank accounts and credit cards to download the transactions with little effort on your part. You create a budget in Quickbooks based on real data that tells you what you need per month or per year for each account. Then you zoom into each account to determine how you will meet that budget. The creative way to do this might be to remove the account entirely from the expenses area because you don’t need to generate money to satisfy the budget need. Take food, for example. If you are growing your own food, or have a source of food that doesn’t require you to exchange money for it, then you can remove it from your expenses. It is self-generating. That’s probably unlikely because we all need variety and you probably don’t have the land or means to do that. But what if you had some interest in food production in multiple places – you had a friend that was a farmer and could supply you with a side of beef in exchange, for example, for you to babysit their kids once a week. Or that you look at the items you have that others may need the use of, and you rent the use of those items when you don’t need them, to generate something but rather than being paid in currency, they provide you with something they have that you need. I guess we could call this the “barter system” but the reality is that this happens everywhere. We just don’t see it for what it is.

If you could reduce your burn rate based on dollars by peer to peer sharing of what you have and can do for someone with the need for them, in exchange for something other than currency, then you could break free of the need to sell your time to someone for currency. And if what you have doesn’t require you to expel labor (time) to generate it, then you meet the criteria of smart income.

There is a popular term called “House Hacking” in that people buy a place that can have multiple residents in it, they live in one room or unit and they rent out the other rooms & units. They take the income from that provision of shelter and pay off the bank mortgage. They use the other tenant rents to pay off their debt load to the bank, and they live for free. This is a simple form of rental real estate investment that allows one to begin to acquire equity by using other people’s money to do it. We will spend a lot of time on this podcast talking about the power of rental real estate, but rather than focusing on the mortgage vs. rental income, focus on the fact that you are living for FREE as a result of that arbitrage. If you did this, then one entire line in your budget is destroyed.

What if you could apply the very same logic to the other lines? Creative ways to self-generate what you need and where possible, do it without the need to exchange into and out of currency.

This is how in history things used to be. Neighbors sharing with neighbors. We have so much waste in this world that isn’t just the landfills of garbage, but the fact that you pay for something and use 10% of it, and the 90% goes to waste. Take, for example, your Internet. We all pay a large amount for fast Internet so that we can watch our favorite shows on TV over Netflix or communicate over Facebook or email, etc. But when we are at work, we don’t use it at home. Maybe our neighbors work a night job and they don’t use their Internet at night. Sure, the service provider doesn’t want this but there is a thing called Wifi, and if you gave your neighbor your Wifi passcode and they gave you theirs, and you had a mutual agreement as to when each could use it, could you not pool your expense items together and both get what they needed?

What else could be pooled and shared? We have created an entire “sharing economy” around this with services like AirBnB, Uber, etc. that leverage things that we have and ways we can generate income from those things when we don’t need them. As long as that doesn’t involve you having to expend your time (which removes Uber from the options), I encourage that it be a part of your strategy.

You see, the control you have over your expense line items, and finding creative ways to get what you need without having to exchange money reduces your entire need to generate that money. And that means you have far more flexibility to find ways to generate the money that is smart income.

But you have to start at the expense items first – you have to ask yourself if you really have found the most creative ways to meet those needs. And that you are hooked into a community of people that are in search of the same thing. Travel hacking is a major way to generate airline tickets, hotel room stays, etc. without directly having to exchange money to acquire those things. By using credit cards (responsibly) to generate points, you can travel for free. This is a common practice and many do it. But if you can generate the points without having to take on debt or liability, then you remove “Travel” as an expense item completely from your profit & loss statement. The key is to be able to identify each line item and find creative ways to either reduce the budget to $0 or at least offset the costs substantially by changing how you do it.

Yes, it often takes more of your time to do it. But never as much time as you have to sell to a boss for a job you don’t like, that costs you too much money to have, that is taxed and that creates the constraints in your life that removes your flexibility. We don’t spend the time needed to question the social norms here enough. That’s why we fall prey to them. We just assume we have to buy a car and make a car payment. Why? What problem does this actually solve? Maybe the solution isn’t worth it – maybe the problem could be solved by you moving closer to where you needed to be. Maybe using Ubers to get around makes more sense. Maybe a bicycle is the solution. Or public transport. I don’t know your specific need, but you have to realize that the car is a luxury solution and before you just assume you need one, have you really thought this out? And do you constantly return to the problem solving approach as your “use case” changes?

Assumptive spending is the biggest cause of entrapment. We have to question everything. The reason why we need income is because of expenses. If you really start to nullify the expenses, you don’t need so much income. And by doing that, you can find ways to make what you need sustainably so that you don’t have to sell your time for money.

The formula here is to turn the profit & loss statement upside down and first focus on the expense items and your burn rate. If you get that down to the lowest possible levels, you can find ways to meet the income needs without human labor or time required. In a way that has far more guarantees of continuity than your job has. And that gives you back the currency of time – the most valuable currency we have – so that you can spend it in far more meaningful ways.

There are many ways to achieve this and one way is not the answer for everyone. Many people follow the FIRE (Financial Independence Retire Early) model, which is to save up millions and invest them in equities, etc. to generate income. The problem with that approach is that it defers income generation to the very same industry that created the social model that entraps us – banks. They use Index funds to generate interest, but in 2019 this model has some serious flaws.

The biggest flaw is that just as we question the concept of Currency as a way to exchange what we have for what we need, the banks and government are doing the very same thing. They realize that paying interest to hold your net worth is not only a liability on their balance sheets, but it isn’t required in a world where they can acquire capital at record low interest rates from each other by producing it with no backing from their peers (ie. Gold) and lend it out for 20% interest rates. Why would they want to encourage you to save, then they have the obligation to hold your investments and pay you for doing that? They are moving to a model where their currency isn’t dollars, but is debt. By increasing the debt burden on all of society, then they make massive returns that they can’t make on the savings side of the equation. Remember, your asset (cash) is their liability (obligation to pay it back to you). This is reflected in the incredibly low interest rates paid for your capital. They basically don’t want it.

As they have the vast power that exceeds even governments, they have entrapped the most powerful governments in the world to spend more than they earn, and as a result create social policies to force interest rates low for savers. Every time you see the US Federal Reserve manipulating interest rates, and then see the spillover effect on the stock market and politicians doing a victory lap because they tell you we have this great economy, it is pure fiction. It is a way that the cartel of banks and governments have gotten together to serve their mutual interests – banks make more money in interest, governments have more capital to spend. But you lose because the value of your capital assets drop and your interest rates that you get paid for that capital reduces.

So knowing this, and that you need to withdraw let’s say 4% on your capital to meet the currency needs you have, what low risk form of investment is going to give you 4% in 2019? Or even 2%? Higher interest requires higher risk, and in a world that shows us that economic collapse happens about every 10 or so years (1989 S&L crash, 2001 Dot Com crash, 2008 Global Financial collapse, etc.) it is insane to put your assets in that level of exposure just to get a higher rate of return.

If you are able to meet your income needs by reducing your reliance on currency and looking at truly what you need to be sustainable, then you take the need to engage in higher risk activities off the table and you don’t need to be playing Russian Roulette with your money. Sure, you might enjoy the world of investment, gambling, etc. but for most of us it doesn’t end well. We don’t advocate higher risk activities unless we really know the environment that we are playing in. Maybe if you are a Wall Street trader you know that environment so you are most comfortable with it. But for most of us, that is not the case. To blindly follow down a path that others are on, in a world in which we don’t have any mastery of it, is the same herd like practices that got 80% of the population in the pay check to pay check mess, and what we are 100% against as a matter of philosophy on the Unconstrained Podcast.

So I’ve given you a lot to think about. This is an ongoing process of constant re-evaluation as to what your use case is, how to identify your actual requirements, how to construct a solution to that, and how to implement it. Pure engineering approach. But we have to question the norms in order to really be able to analyze the problem before we launch down a path to the solution. Measure twice – cut once, as they say.

We know the magic formula – we have to earn income without selling our time that exceeds our burn rate, and we have to master our expenses, ideally without needing to exchange into and out of dollars (or your native currency). And that some items won’t be solved without trading in your native currency, but to reduce them down to the bare minimum, we have a chance of reaching true financial sustainability.

On the next episode we are going to deep dive into your Burn Rate and how to measure, manage and reduce it. That sets you up for the wonderful world of smart income generation.

So for now, keep fighting the good fight. We’ll see you on the next episode.

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