August 2, 2014

The Small Things Matter When You Are Making Your Fortune

I was performing the annual review of fiscal 2012′s income statement, balance sheet, and cash flow statement for my household and one of the lines caught my attention. 

My family has two smartphones – a Samsung Galaxy Note and an iPhone.  Combined, the annual charges are $2,328 for the service alone (that doesn’t even count the cost of the phones).  That has to be paid for in after-tax dollars, so pre-tax, we are talking about more than $3,600 in income required to fund what amounts to two lines when you start looking at Federal and state taxation. 

Even though $3,600 is an insignificant portion of my household’s annual income, given that I always have an iPad with a wireless plan on me, or am near a computer, or a physical landline phone, it makes absolutely no sense to maintain this situation.  Last month, the combined minutes from both cell phones: Sixty.  As in one hour.  Total text messages?  Twelve.  We use Face Time or Skype for everything, pressing a button and instantly video chatting with family and friends.  The phones are just … antiquated.

We ended up going to Wal-Mart earlier this week, getting cheap Samsung flip phones and a 1,000 minute T-Mobile card for $100, switching over the same technology that was available ten years ago.  It looks, and feels, ridiculous in my hand but the benefits are huge. 

Here’s what I am doing with the savings: I setup an automatic transfer out of the CCDA for $2,328 every year to buy limited partnership units in a natural gas and oil pipeline.  The distributions are reinvested at a 5% discount to the market value of the units by taking advantage of the direct purchase plan.  All else equal, I should have an extra $38,000 sitting around ten years from now from this single decision.  If yield distributions are the same, it should be producing $3,040+ in cash per year at a very low tax rate due to some of the accounting mechanisms available for these sorts of securities.

Oil and Natural Gas Pipeline

The $2,328 in after-tax cash that was going to the two phones is now going to buy limited partnership units in an oil and natural gas pipeline.  The difference in assets and income in 10, 20, 30, and 50 years is significant.  It’s one more thing I can give to charity or transfer to my children and grandchildren.

Don’t Stop Calculating Your Opportunity Costs, Performing Periodic Reviews

The question is one of trade-offs and opportunity cost: Would I rather have an Android or iPhone in my pocket or $38,000 in extra assets, producing $3,040+ in additional household income when I am ten years older? 

Saving Money on Cell Phone

Find the things in your life that don’t provide you much utility and reallocate the dollars. Think of it like reassigning employees to a different job.  Your money has one responsibility: To work for you to provide more purchasing power for your family.  If it isn’t being productive, no matter how small the slack, put it to better use.

Imagine that ten years from now, I decide I am done with the program.  Not only do I have the $2,328 I am saving from the lack of a smartphone, I have the $3,040 in cash generated by the oil and natural gas partnership.  That is an extra $5,368 per year in free money, just sitting in the bank.  I could give it to charity.  I could go to Las Vegas and bet it all on black.  I could donate to a local food pantry.  I could add it to my spending cash for my trips to New York when I have suits or shirts made.  I could put it into the Christmas fund and give wonderful gifts to friends and family.

All of those things have more utility to me than keeping around a phone that serves no purpose given my work routine.  To someone else, that may not be the case.  If I worked for a big law firm, was constantly on the phone with clients, and had to ride the subway to work for my morning and evening commute, I would probably be obsessed with my smartphone.  But I don’t.  I go where I want, when I want.  I’ve set everything up so it is convenient for me.  It makes no sense to have this additional expense.

This is what I mean when I say that millionaires are accumulators.  This decision looks tiny but I’ve spent my whole life doing things like this that grow into giant oak trees.  It doesn’t seem like much in the short-term – $194 or so per month, which is nothing compared to the few shopping trips I’ve shared on the blog.  But after a decade, it starts to add up to something meaningful. 

After two decades, I’d be looking at $133,336 in extra assets producing $10,700 or so in additional annual household income.  I’d only be fifty years old. 

By the time I was Warren Buffett’s age?  It would be $3,283,479 in extra wealth generating $262,700 in additional annual household income.

The lesson: The small things count.  Find the stuff in your life that you think you “must” have because everyone else does and figure out if they are really necessary.  As I’ve said too many times to remember: There is no right or wrong answer.  Things that may seem ridiculous to others but are important to you are perfectly fine.  If you want to give up a car, biking instead, so you can afford spending a month every year in Italy, do it.  It’s what Napoleon Hill and Sam Walton were teaching didactically all along.  John D. Rockefeller’s wealth was, at its height, equivalent to roughly 10% of the entire nation’s economy, yet he would walk around his house at night and shut off the lights to avoid unnecessary expenditures.  It’s not about the money per se; it’s a habit; a way of thinking about expenditures so that money becomes your tool to get whatever it is you want.

The purpose of intelligent capital allocation is to make money work better for you as an employee.  Sometimes you need to reassign the job a certain group of dollars has.  My “phone” dollars are now hard at work buying me a pipeline.  I like pipelines better than phones.  I like the cash they produce.  Pipelines are good.

  • Vinay

    Hi Joshua,

    I was curious to know how did you plan your allocation in your twenties?? Did you also follow the rule of no more than 35% in public securities then ? Or should this happen at a later stage with all initial savings going into stocks ? I know that you are far more focused and better at time management than most people will ever be, yet I cannot understand how you have businesses and find the time to manage them and yet manage to read constantly ??

    Regards

  • Paarthurnax

    Deligation allows one to step back from the daily workings of a business. Sit on a board of directors and attend meetings every now and then to make sure things are moving forward, and spend your time doing the things you love. Read, play music, go fishing.

  • http://odai.me/ Odai

    This is a sort of paradigm shift for me. It reminds me of obsessive optimization of computer code that I do, only with money instead.

    I use Virgin Mobile for my smartphone, and it only costs $35/month, or $38 after tax. That’s $456/year. But now I’m considering switching to a flip phone as well, since I have a tablet and hardly use my phone.

  • http://www.joshuakennon.com/ Joshua Kennon

    Absolutely.

    I tend to use the historical inflation rate between 1900 and 2000 (4%) and not the lower inflation rate of the past few decades (around 3%). The former captures periods like the 1970′s where prices were rising rapidly and I think is a safer long-term bet.

    Adjusted for purchasing power, the $3,200,000 in principal would be worth $416,310 in today’s money and the $262,700 in annual income would be $34,176 in today’s money.

    In “Prius” terms, I could either sell the limited partnership units and buy 10 nicely equipped Prius cars at once, or I could hang on to them, never touch the principal, and use the annual cash distribution income to buy 1 nicely equipped Prius car every year.

    • Andrew

      I noticed something peculiar regarding inflation with these opportunity-cost studies that you might find interesting. A pattern.

      I’ll email you further details, Joshua.

  • preston nelson

    You probably looked into the various MVNOs when you made the switch in phones. I think they are the best way to go.

    I’m only paying 2 cents a minute with lycamobile (T-Mobile) but the minutes never expire as long as you use one minute every 3-4 months. And it gets free incoming calls. Since I rarely have a need for an actual phone its as close to free as I can get and still have it should I want it.

    And you can bring your own phone so you can use an iphone or whatever
    smart phone you like. Though not upgrading smart phones adds to your savings.