If you currently do not have a business and it is your desire to build a business around your invention, you can do it, but it becomes a much more risky proposition. In the example above, the business owner can lose some money if the product fails, but he is not likely to lose the entire business unless he has risked the company’s stability on the success of that product.
If you choose to build an entire business around a new product, not only will you need a substantial amount of start up capital, including enough to survive until the company becomes self-sustaining, you will need to be virtually certain of the success of the product. There are some astounding success stories of people who have built profitable businesses around a single product. It can happen. But, the odds against huge successes with businesses built around a single product seem to be getting steeper. One important reason is that the buyers for the major retailers will not even allow single-product vendors an appointment to show their product to them.
If you have only one product to sell to a major retail chain, you are not likely to be given that opportunity, no matter how great your product may be. While the retail stores are made to look cheerful with bright colors, bright lighting and background music to enhance the shopping experience, to the retailer it is very serious business and each inch of shelf space is allotted to a particular manufacturer in a map of the store, known as a planogram.
Getting your product on that planogram is not an easy task if you have but one product.
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Marketed as simple and easy to own, stocks are actually the most complex and emotionally challenging of all asset classes. Powerlessness,
unmanageability, regrets, fears, social pressures, herd behavior, and complexities galore are the norm. Stock investors are primarily an optimistic group. They believe that stocks they purchase will increase in value. They all know stories of stocks that increased in value by 100 times or more. The potential rewards appear unlimited. Of course, most stock investors are aware of the risk of loss, so they diversify and employ other cautions. Still, every stock investor believes that one or more of his stocks or mutual funds will have fantastic returns.
Businesses issuing stock encourage this belief and are all too happy to accept the investor’s cash.
Investors also rely on society. Stable economic conditions are important for investors. Investing concerns the value of currency. Inflation, deflation, supply and demand: All are part of the investment scene. Ancient savers relied on the utility of the product saved, not the currency value of the paper interest in another’s actions or productivity. However, investors’ reactions to their relationship with their investees are much more powerful than their reactions to economic conditions.
For a fee, many parties facilitate the transfer of investment capital to investees. Stockbrokers, Realtors, bankers, money managers, mutual funds, newsletter writers, and other financial professionals siphon off pieces of investment capital. While investors seek to make high returns with little or no work, financial professionals seek to obtain high wages with little notice. This relationship is the source of many troubling emotions.
Investing involves small segments of society: businesses, individual farms, buildings, and entrepreneurs. Only recently, with the advent of index funds, has investing concerned the whole of a large market: the stock market. Index funds are mutual funds that buy shares in every stock in a given segment of the market. Buying index funds, you can buy a piece of the whole stock market. Still, the stock market is only one segment of society, though currently a large segment.
The investor trusts the investee. When this trust is broken, strong emotions are unleashed. Utility stockholders are furious when a utility cuts or
eliminates its dividend. When a tenant defaults on a lease and forces a property into foreclosure, the property owner has a wide range of emotions triggered by the breach of trust. Some vow never to own real estate again.
Sometimes the investment exceeds expectations. Wal-Mart investors saw their small regional chain become the largest retailer in the world. Berkshire Hathaway went from a shell company to one of the world’s largest corporations. Success triggers grandiosity in some, frivolity in others.
Many successful investors are disoriented and unhappy. However, faith is also a part of investing. The borrower, tenant, or business owner believes the application of science and technology to business practices will produce more than the sum of capital and labor, thus enabling him to pay the rent, interest, dividends, or capital appreciation plus enough for his own savings. Productivity, technology, and efficiency are the creed of investors.
Investment relationships are not identical to romantic, family, and social relationships solely among people. Though people, often with conflicting interests, are involved in investment relationships, the primary relationship is between the individual and an inanimate object: money. At first, it may seem odd that a relationship between a person and an inanimate object could be dysfunctional. In fact, our society is saturated with such dysfunctional relationships.
It is estimated that 10 percent to 15 percent of the U.S. population is alcoholic; essentially more than 30 million Americans have a life threatening dysfunctional relationship to an inanimate object: alcohol. One out of every three adult Americans are obese, based on their dysfunctional relationship to food. Sixty million American families have larger credit card debt than they can afford. Their relationship to material goods is dysfunctional.
In fact, consumerism dysfunction has reached new heights. Compulsive shopping is portrayed in the media as fun, not as an illness. Yet in the booming economy with a roaring stock market of the late 1990s, the number of personal bankruptcies had never been higher: 331,000 filed for bankruptcy in 1980; 413,000 in 1985; 783,000 in 1990; 927,000 in 1995; and more than 1,300,000 filed in 2000. In recent years, Americans as a whole have spent 1 percent more than they earn.
Let’s look at another example. Sally is carrying a $10,000 balance on her credit card. Sally’s monthly minimum payment is 2% of the balance, or $200, and the interest rate on the card is 18% annually.
If Sally makes just the minimum payment each month, it will take her 57.5 years to pay off her balance! Not only that, the $10,000 she put on the credit card will have cost her $33,930 by the time she gets it paid off.
But let’s say Sally always makes her minimum payment, plus an extra $100, or $300 a month. In this case, it will take Sally just under 7 years, instead of 57.5 years, to eliminate this credit card debt. In addition, her $10,000 that she spent on the credit card will only end up costing her $16,000. That’s a savings of over $17,000, which could have been used to eliminate other debts sooner.
Keep in mind as well that this example used a credit card that is charging 18%. With credit cards that charge higher rates (30%+) and things like payday loans, you can spend the rest of your life trying to get caught up. In either case, you’ve got to take drastic action to cut your debt now.
When we talk about minimum payments, we’re not just talking about credit cards, which is what “minimum payments” are usually associated with. Many other types of loans, such as “payment optional” mortgages, give consumers a lot of room to minimize their monthly payments, as long as they don’t go below a certain dollar amount.
The problem with this is that compound interest continues to march forward on your balance, especially when you pay just the minimum. In fact, your balance can actually grow if your minimum payment was less than the interest that was actually added to our account for that month.
Unfortunately, making minimum payments is human nature. To get out of debt, you’re going to have to go against the very fabric of who you are. By nature you instinctually avoid pain, and paying down a debt when there are other fun things that you can use your money for is painful! When given the choice between using all your disposable income to pay off a debt, and using some or most of it to enjoy life, you’re going to choose the latter. In fact, over the years, I’ve come to observe that when most people open their credit card statements, their total balance is not the first number they look at. People actually tend to check their minimum payment due before the balance!
We have now talked about enough different forms of risk that the relationships between risk and change should be clearer. In psychological terms, the word change tends to have positive connotations, and the word risk of course has negative connotations.
But they are much the same thing. Some kinds of change are statistically predictable and hence manageable. People are born, work, retire, and die. Their activities—whether they are inventors or thieves—affect the lives of others. Their presence or absence creates myriad opportunities and threats, and adjusting to these changes creates both opportunities for gain and some dangers. In addition to the activities of individuals, new combinations of circumstance for gain or loss arise constantly owing to the activities of markets and institutions.
Each day brings new prices for securities and new values for currencies and commodities. Other events blow through the global economy with some regularity: hurricanes, election surprises and coups, strikes, earthquakes, terrorist attacks, transportation accidents, and so forth. Conventional risk-management tools seek to minimize the hazards and perils; in a global economy with massive financial resources, a lot can be done and a lot is done.
Human and intellectual capital are only valuable when embedded in an enterprise. This point is seemingly obvious but needs to be repeated now because it has some less obvious ramifications.
If I am unemployed, my education and experience are doing me little economic good. But the day I show up on the job, I create a revenue stream for myself. If my employer chose wisely in hiring me, I will subsequently add value to the enterprise as well.
Indeed, the value of a human asset will depend enormously on the nature of the enterprise in which it is embedded. A great quarterback will be more valuable on a good team than on a mediocre one—if only because he will be given more time to throw and because his receivers are more likely to be open.
Furthermore, if he is traded to a contender, he may take that team to the Super Bowl—he is more valuable on the contending team. From a value viewpoint, his present team should value not only his direct services, but also the option of trading him to a competitor, provided that is a realistic business option. In effect, he has no intrinsic value; his value to the Chargers is the difference in their value playing with and without him; his value to the Bills is likewise the difference with and without his services.
If the first number is substantially larger than the second, the Chargers and the Bills have room for a deal that creates additional value for both teams. Of course, his value is zero to an organization that isn’t into football, say a ballet company, which cannot use his talent at all.
Intellectual property is equally situational; a patent will be more valuable embedded in a firm with a position in the market than in a firm without such access.
When the value of an asset is sufficiently situational, there may be important opportunities to create value by framing options.
Specifically, the asset, like the quarterback, may be less valuable in the enterprise in which it is currently embedded than in alternate uses.
In the case of hybrid ARMs, both the purchase and rate and term refinance (no cash out) risk multipliers are greater than 1.0. At first blush, this seems counterintuitive, especially in the case of the purchase loan, which is generally perceived to be stronger. However, we believe the findings are due to the following:
Purchase borrowers may be first-time borrowers or “stretching” to purchase their home. In addition, they may employ a second lien loan to finance their down payment. In either case, they may be overleveraged.
In addition, purchase borrowers have, by definition, no time in property, and this may influence the propensity to default.
Rate and term borrowers are not extracting equity but rather seeking to lower monthly payments. The reluctance to extract equity or the absence of equity available for extraction may signal a weaker borrower relative to a cash-out refinance.
Fixed rate and term refinance default risk is less than refinance cash out or purchase. This borrower is most likely reducing rate and/or extending term. This, in turn, lowers the borrowers and reduces the probability of default.