Tuesday, May 16, 2017

Money does grow on trees

There is a popular phrase that money does not grow on trees. The saying suggests that money is something that needs to be worked for, and it is not easy to acquire. Under this thinking, one should spend sparingly since money is not abundant.

I agree with this statement when an investor is in his or her early stages of accumulation. While starting out from scratch, an investor does not have any capital that can generate even more capital. In the early stages, the only way a person can generate money is by performing work and getting paid for the time and energy spent. This is a linear process and is dependent on one's hourly rate and the hours spent. Money during this early period is scarce and the "money does not grow on trees" feels completely true.

The frugal and "money is hard to find" mindset completely changes once one has sufficient capital. Capital can be deployed to generate more cash. Examples are rental houses or apartments and ownership of private or public enterprises. Conservatively, asset holders can also receive income from bonds by becoming a lender. In rental property, one can generate income from the rent the renter pays. In company ownership, the shareholders are the people who own the company, and any excess profits are distributed to the shareholders. Becoming a lender allows one to receive interest income from the borrower. This blog focuses on ownership is companies that pay excess profits to shareholders. For public companies this is called dividends. I look for increases in this dividend every year as the company grows and increases profits.

Money does grow on trees once a person owns sufficient assets that generate cash. Ownership of businesses and property is similar to owning a "money printing machine". Businessmen want to own as many "money printing machines" as possible, and it costs money to buy each machine. The asset generates cash to the owner every month or quarter. This payment of cash to the owner doesn't just come out of thin air. The cash comes from customers or clients who pay for the service or product that the business provides.

Over time money begins to flow like a river. The cash supply is limitless and there is no more of a need to grow money linearly through an hourly rate and hours spent. Eventually the cash received from simply being a business owner exceeds the money one needs to spend to live. Once capital generates capital, the process becomes exponential. A businessman or investor can harvest the cash the company he owns and then deploy that capital on "machinery" that can print even more cash. This positive feedback loop is a very powerful way to generate more and more cash. The initial steps to create this machinery is painfully slow and life will be frugal. But after the machinery is set in place, money is limitless. Eventually the small river of money becomes a large torrential flood of money, continuously being added to one's bank account in the form of reoccurring checks.

Owning shares of companies is not merely owning a piece of paper. Owning shares is equivalent to owning parts of the business. If the business generates money, that money will eventually flow into the hands of the business owner. It took me a while to finally understand the inner workings of our capitalist economy, and this realization is what sparked me in investing my excess earnings full time when I was 23.

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