Why everyone should know this basic tenet of finance
I work in finance, a career about which I am extremely passionate and with which I have a lot of fun doing. As a result, I see (almost) everything through a finance’s lens. Every problem looks to me like a nail when I have a “finance” hammer, an attitude of which I am and probably the people in my field are openly guilty.
That’s why I might (!) be biased in claiming everyone should know one basic principle of finance about spending and investment. I am writing this article, nevertheless, to “rationalize” my thought process of coming to a bold conclusion that not just a rather small and secluded group of people who work in the financial services industry but everyone, from white and blue collar workers to teachers and students, should at least be aware of this simplistic principle in finance. By doing so, they could apply the tenet to their own lives to make a better decision for themselves, for the organisations they work for, and for the society at large (through voting).
To begin with, finance, to me personally, is just a study of allocation of resource, whatever form of resource that might be (money, time, efforts, emotions, spirit). In essence, this rule is about eschewing resource-draining activities (the technical term for these types is Expense) and spending on assets that will hopefully generate positive yields in the future (we call it Investment).
Expense and investment are similar in that we have an outflow of resource at the beginning but their difference is what counts. While expense is mostly recurring in nature and is something we have to incur in order to sustain our livelihood (like monthly rent or transportation cost), it adds little or none to our development. On the other hand, we make an investment to grow in the coming years/decades.
Certainly the simplistic rule of cost discipline and aggressive investment for growth is, among corporate managers, bankers, and politicians, widely known. Yet it is seldomly observed. For instance, the primary reason why Adam Neumann was ousted as CEO of WeWork was his extravagant spending on corporate jets for executives or a purchase of a company that makes wave pools (coincidentally and incredulously, Mr. Neumann’s hobby is surfing). These purchases had nothing to do with the company’s growth ambition and everything to do with the flamboyant founder’s “prolonged adolescence”. As a result, the coworking space provider’s value, once at USD 47bn at its peak, crashed to USD 8bn 10 months later.
Another obvious yet somehow not visible example in the realm of politics is the US’s ballooning government spending during the pandemic. Not to dismiss the fact that everyone needed a little bit of help to get through Covid-19, the US has spent, since the start of the pandemic Covid-19, USD 5.3tn on Covid Relief Spending Program — more than the entire Germany’s annual GDP.
To put in perspective, lambasted by some Conservatives as the “Communist Takeover of America”, the Obama administration spent merely USD 800bn on the Great Recession of 2008. No wonder, despite relatively shielded from the Ukraine-Russia conflicts and the looming energy crisis that is engulfing Europe, the US experienced the highest inflation in 40 years, with core inflation (the effects of volatile components such as food and energy are already stripped out of the measure) running hot at an annualised rate of 5.9 percent, well above the desirable 2% inflation rate.
What is perhaps surprising to some is that the basic tenet of finance has far reaching applications to personal finance as well. Born in Vietnam to a relatively poor family, my family shares a saving mentality — cash outflow should be eschewed while cash/gold hoarding is encouraged. The mantra helped us survive the difficult years in the last years of the 20th century and the first few years of the 21th century when Vietnam was beginning to be open to and realize the importance of global commerce and capital markets (the US lifted sanction against Vietnam in 1994 — indeed a fateful year).
However, in the relatively open economy where one has better access to capital, this mantra no longer holds its validity. As individuals, even though expense (rent, transportation, “nhau”) should be cut as much as possible, we should not hoard cash/gold (especially now that inflation is chipping away the value of them) but invest aggressively for growth — be it in your education, in your relationships, and even in your iPhones.
For example, is buying a VND 40mn iPhone worth it? To put in perspective, that is almost equivalent of Vietnam’s GDP per capita in 2020. The answer is, as always, it depends on whether you “classify” your purchase as an expense or an investment and what you get from that iPhone. If you use it to facilitate your communication with clients that will reward you fat contracts, to build your relationships that will come to fruition, and to save valuable time that you could otherwise use more productively (i.e., the value you get over the lifetime of that purchase is more than what you pay for that it), more power to you. Nevertheless, as a typical college student, for example, it makes more sense to go for a less expensive phone, knowing that purchase is more a cash-burning expense than a smart investment.
Yet I am not advocating for a lifetime of “no frills, no fun”. Reward yourself an expensive dinner at a nice restaurant once in a while for your hard work. Organize annual corporate retreats to increase bonding within your organization. Shoot firework in the independence day to increase the sense of patriotism among the citizens.
Frivolity is good and nice in its place. There are also other non-quantifiable factors such as personal happiness, employees’ commitment, and citizens’ life satisfaction. And, by the way, you only live once (truly). Furthermore, it is up to everyone to decide for themselves whether something is an investment or an expense (as discussed earlier, an iPhone purchase can be an expense for some yetan investment for others). All I am just saying one should be deliberate in one’s finance to control spending and invest for growth.
In contrast to the contrary to the common notion that only an elusive group of bankers, corporate managers, and politicians (it is debatable whether they really know) understand this “Investment — Yes/Expense — No” mantra, everyone should at the very least adopt this spending/investment mindset. A deep understanding of the principle allows you to apply flexibly to each circumstance, make a good judgement, and take the right resource allocation decisions. By doing so, you can be, at the very least, mindful of your spending and, at a larger scale, become a more useful employee and a good citizen (if indeed you aspire to be one).