How to Press Olives, Part One

This series of posts seeks to analyze Thales’ actions, as described in Aristotle’s fragment about business monopolies. I’ll connect Thales’ actions with contemporary practices one can use to gain financial independence.

Olive Pressing is a three-part practice. Like so many useful things in life, it has a beginning, middle, and end. The first part is what we’ll consider in this post: the beginning. In other words, how do we raise “a small sum of money”, as Thales did?

In contemporary economics, we’re talking about capital accumulation, and there are at least three ways to accumulate capital, as the popular aphorism states: beg, borrow or steal. However, I intend to maintain at least a semblance of ethics and dignity here, so we’ll discard the first and third options right out of the gate. That leaves borrowing, which is a less desirable option than saving, so let’s add saving to the list for two good options of capital accumulation: saving and borrowing.

Now that we have our methods of capital accumulation, let’s explore the details of their use. Aristotle says that Thales lived in poverty, so let’s assume he had no capital to start with. Let’s also assume that Thales had enough dignity and ethical stature to discard stealing and begging too. I think these are reasonable assumptions of most good philosophers, but a defense of this is a topic for another blog post. So, we have conveniently positioned our hypothetical character of Thales such that he has to save or borrow his “small sum of money” that he’ll later use to rent the olive presses. How does he do it?

Option 1 — Saving: Americans, the cohabitants of my country, are notoriously poor savers generally speaking. This needs to change, for more reasons than I care to list here, but the primary reason for this change is to “rent olive presses”. In other words, we need to make enough money to fund the good life, like Thales did. If you looked at the graph on the linked Economist article, and if you’ve read Early Retirement Extreme, then you know where I’m going: the easiest way to accumulate capital is by increasing one’s saving’s rate. This works for all individuals, corporate and biological.

How do you increase your savings rate? There are two time-tested methods to increase your savings rate: increase income and decrease expenses. For the first option, think of squirrels hoarding food for the winter — you work harder, you earn more. For the second option, think about the stereotypical  swami living in a cave in the Himalaya — you consume less, you have more resources left at the end of the day. Now, these examples aren’t to suggest that you should be a squirrel or an advanced yogi, although thinking about advanced yogi squirrels makes me smile. These are two ways you can positively affect your fiscal position, without anyone else’s help.

If you don’t believe me, check this out. This blog post shows the effect of one’s savings rate on how quickly one will be financially independent, it also analyzes different results of decreasing spending versus increasing income. Although, it is perfectly acceptable to use both strategies, decreasing your spending is the simpler and more powerful option: see the MMM article for details.

The second way to accumulate capital involves the help of someone who already has capital: we plebs call this borrowing. Unlike saving, Americans are very familiar with borrowing capital. However, we are bad at borrowing in a fiscally responsible way. Generally, we borrow to buy assets that depreciate before we throw them away: successful businesses don’t borrow in this way, and neither should you. The only time one ought to borrow is to buy an asset that will appreciate faster than the interest rate of the loan, which is known as leveraged investing: it’s risky and complicated. I can’t recommend it for most situations.*

Well now, where did we leave Thales? He’s waiting for us to accumulate capital: how does he do it? First, he reduces his spending, by buying no unnecessary items, such as the Pre-Socratic equivalent of iPads, new cars, and expensive designer food. He’s a rice-and-beans-and-6-year-old-laptop kind of guy until he gets enough money to lease the olive presses. If he can find good terms on a loan, and he can mathematically show that his return on investment (ROI) will be greater than his cost of loaning money, then he may borrow some capital to lease more olive presses too. However, the brunt of his capital should be accumulated by saving, since this is the least risky and most profitable capital available to him. The next article will cover part 2 of olive pressing, how Thales invests his capital when he leases the olive presses. Stay tuned.

* One example where leveraged investing may be useful involves the current housing market in the USA. It’s been touted for years that home loans are at record lows, and there’s no time like the present to buy a house. Enter leveraged investing: being a savvy investor, you reduce your expenses enough to save a 20% down payment and buy your house with a 15-year fixed-rate mortgage at 3.33% APR, which is the current national average mortgage rate as of this writing (bankrate.com). A survey of the various mortgage types are outside the scope of this post, so let’s assume this is the safest, lowest APR you can get. You now have a pathway to owning real estate at a low interest rate: since you’re already an expert saver, you have extra money piling up at the end of each month — even after you pay your mortgage. You can pay off the mortgage more quickly than this, or you can invest the leftover capital in asset classes that historically return a higher rate of interest over the long term. In this case, you’re leveraging your mortgage to invest in something like the stock market: rather than pay off your mortgage more quickly, you’ve effectively borrowed the cost of your house at 3.33% so you can invest money at 7% over the next 15 years. Note that there is risk in leveraging your mortgage to invest in stocks: if you lose your stream(s) of income, then you cannot pay your mortgage; and if the stock market also declines when you lose your income stream(s), you’ll be unable to sell stocks to pay the mortgage — when this happens, like it did for many in 2008 and 2009, you’re at risk of defaulting on your leveraged mortgage. What’s more, most loans available to individual investors don’t have such agreeable interest rates as current home loans, which makes leveraged investing even more risky because you need to invest in ever higher-returning assets to make the leverage work.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s