Road Rules to Wealth Creation

In our years of managing and creating wealth, we've come to liken the process of wealth creation to driving a car. Travel at the right speed and you'll be well on your way to effective wealth creation.

The type of car you're driving, the route you choose to take, and the road and traffic conditions all determine whether you'll reach your destination, safe and on time.

Each one of us has a financial car, it is the sum of all our resources. Our assets, liabilities, income, education, tolerance to risk and loss and our overall emotional temperament and make-up. All of these come together to form our financial potential, our car.

"Life is short. The sooner that a man begins to enjoy his wealth, the better." Samuel Johnson

None of us mortals have the luxury of an unlimited supply of time, so we need to look at strategies for creating wealth that won't take an eternity. The strategy that stands out from all the rest is that of borrowing to buy assets that appreciate in value, commonly known as gearing. We think of debt as the engine that powers our wealth creating car.

The accelerator of this car is something called the debt to asset ratio - that is our total assets divided by our total debts. This ratio determines how fast our car moves forward. Hit the accelerator too hard and you're driving dangerously too fast, and touch it too lightly and you won't be moving very fast at all. The right ratio for you - your safe traveling speed - depends on your cash flow. Managing and using this cash flow efficiently will find you driving 60, rather than 300, in a 60 zone. While it may be true that a Ferrari may get us from A to B faster than a Volvo, how we drive either car is more important. Regardless of which financial car you begin your journey with, it is how you manage your resources that enables you to create and manage wealth. There are generally three types of financial drivers whose behaviours? each result in very different outcomes.

"Playing safe is probably the most unsafe thing in the world. You cannot stand still. You must go forward." Robert Collier

The first type of financial driver, the ?anti-driver?, leaves the car locked up and protected. Resources are left untapped, and, forced to walk wherever they wish to go, most will never get to their desired destination.

What inhibits this type of driver from getting on the road is usually a fear of risk. Financial risk is always going to exist, however, avoiding it altogether is not an efficient use of resources. Fear prevents this driver from engaging with the market in any capacity. If the car isn't going anywhere, then neither are any wealth creation prospects.

"My problem lies in reconciling my gross habits with my net income." Errol Flynn

The second type of financial driver, the ?lead foot?, hits the accelerator hard and fast, travelling around corners at lightning speed and pushing the car to full capacity. The ?lead foot? driver generates huge amounts of debt through borrowing every last penny. By failing to balance the debt to asset ratio and simply fuelling the journey through copious amounts of debt, there is a high risk of crashing, killing themselves and everyone around them. Far from generating a steady and sustainable foundation of wealth through continual and prudent investment and risk management, this type of driver fails to manage and protect assets.

"Risk comes from not knowing what you`re doing." Warren Buffett

The third type of financial driver is the only one we can consider to be a good driver. Savvy yet sensible, they realise it's never a matter of avoiding debt altogether by refusing to drive at all. The good driver knows they have to take the car out of the garage in order to get to their destination. They also realise it's important to abide by the speed limit, obey all the rules of the road and regularly service and maintain the car.

Just like a good driver on the road who understands their level of experience and their own limitations, a good financial driver is able to figure out the most appropriate debt to asset ratio in order to achieve the desired financial outcome. Driving sensibly means that the engine, or debt, is subsequently balanced with the assets.

Your driving decisions, at any stage of your life, should be calculated, thoroughly planned and well executed. Temperament is therefore an integral component of financial success.

On the road, a good driver is alert and focused, yet able to remain calm enough to make decisions in the face of changing circumstances. Experienced drivers monitor and control the driving situation more effectively and manage potential risks than inexperienced drivers, who tend to be more reactive, less aware of their situation as it evolves and less able to manage the continuously changing traffic situation.

Buying your first home is a classic example of a common journey which most of us will embark on in our lifetime. When you purchase your first home, you may press the accelerator really hard in the early days, maybe running at 90 in a 60 zone. Expenses are tight, mortgage repayments are high and it will initially take some getting used to. Slowly but surely, you come to terms with the situation - you are no longer frightened by the debt anymore.
Your income slowly rises, the value of your home rises too, but your debt slowly decreases and you progressively become a steadier driver through the course of the ownership. Your debt to asset ratio starts to drop and you wake up one day and you are doing 60 in a 60 zone.

Eventually you continue to slow down until one day, you've paid off the mortgage and decide to park your car in the garage and end up walking for the rest of your life.

Publicly listed companies are an excellent example of effective drivers who manage capital efficiently. They are constantly keeping one eye on their asset to debt ratio knowing that borrowing too much means their share price falls, while by not borrowing enough their share price falls yet again. Travelling 60 in a 60 zone is the only way to achieve balance and reap the rewards - we will explore this concept in more detail in future posts. The point is that there are positive and reinforcing examples of responsible management and wealth creation all around us; reckless and dangerous driving doesn't necessarily get us anywhere. It might be good for a quick fix, but it's not useful in ensuring and protecting a sustainable financial future.

Being a good and prudent driver means being conscious of your speed at all times, making sure that you're always using your resources in the best and most prudent way possible. No one considers a parked car prudent, and no one considers doing 300 in a 60 zone prudent either. Travelling 60 in a 60 zone represents our ultimate investment approach, just as it is the only way to safely drive a car and be able to navigate all the risks and changing situations that come your way.

"I have always believed deeply in the importance of people and personal relationships. I still am as convinced as ever that successful long-term financial relationships are far more a matter of personal knowledge and interpersonal relationships than of just supposedly ?objective? numbers and technology." David Rockefeller

Some of us need guidance and direction on the roads, so we engage a chauffeur. This can be a very positive move, especially if the chauffeur is experienced and able to help us reach our destination safely. But it is important to recognise that there has to be a balance of control. Though you may be riding in the backseat, you still have to participate in making decisions about your direction, even if the chauffeur is the best person to navigate the direction for you.

Find yourself a great chauffeur - one you can trust, that knows what they're doing and is prepared to work with you over the long hall to get you to where you want to go, and beyond. Find yourself a great financial adviser and develop a close and rewarding relationship with them.