Everybody would like to have financial security. No matter how much we enjoy our work, most of us would like the option in the future of not having to work at all, or at least being able to choose the kind of work we do and how much time we devote to it. We want to enjoy our wealth and lead the life we really want.
There are thousands of books on building wealth, and many more blogs and websites on the subject. Everyone seems to have their own opinion on how to go about it. It all creates the impression that achieving financial security is very complicated. But a book called The Algebra of Wealth by best-selling author Scott Galloway explains how the rules for building wealth are actually very straightforward.
In fact, Galloway suggests you follow a simple formula:
Wealth = Focus + (Stoicism x Time x Diversification)
Let’s look at each of those components in time.
Focus
The first component of “the algebra of wealth” is focus, which is primarily about earning money. “Income alone won’t make you wealthy,” Galloway writes, “but it’s the necessary first step. And you’re going to need a decent amount of it.”
Focus, he explains, involves making deliberate career and financial choices that guide you towards your goals. The problem is, human beings are naturally inclined to lack focus. Even those who work hard are prone to wander aimlessly and get distracted.
So how do you develop focus? Choosing a career path early, Galloway suggests, is crucial, because it lays the foundation for future growth. A supportive partner can also boost your focus and productivity by sharing responsibilities such as childcare.
He also recommends developing your talents, with a focus on long-term professional growth. This also means finding hidden talents, perhaps by taking a personality test like the Myers-Briggs test, or by trying out different roles or working in different environments.
Stoicism
As well as developing their professional skills, Galloway encourages readers to develop their personal character. In particular, he urges them to learn from Stoicism, a philosophy that originated in ancient Greece and Rome
Stoicism emphasises courage, wisdom, justice and temperance, virtues that align behaviour with intentions and guide prudent and disciplined financial decisions. For example, a Stoical attitude helps you to spend money more intentionally and resist the temptation to buy things you don’t need. It also helps you keep your emotions in check when your investments sharply fall or rise in value.
“Stoicism is about living an intentional, temperate life in and out of work,” the author writes. “It’s about saving money, for sure, but also developing strong character and connecting with a community. This stuff matters.”
Building strong relationships and a supportive community of high-character individuals is hugely beneficial, he argues. And, while personal effort is critical, acknowledging the role that luck plays in your achievements helps to maintain humility and resilience.
Time
A key takeaway from The Algebra of Wealth is the vital part that time plays in building long-term security. “Time is your most important asset,” Galloway writes. “Time is the real currency, the one asset we’re all given at birth, and the foundation of wealth.”
So why is time so fundamental? “It starts and ends,” the author says, “with an understanding of the most powerful force in the universe: compound interest.” Simply put, small increments of capital, when invested over long periods, can grow substantially.
Say, for example, you invest £1,000 and it earns an average return of 8% a year, it will have grown to £2,016 after ten years and $10,062 after 30 years.
You also need to understand how earnings and spending evolve over a lifetime. Earnings generally rise in your 20s and 30s, peak in mid-life, and may decline at retirement. Similarly, spending varies with life stages and obligations. Recognising these patterns helps to facilitate effective financial planning.
Diversification
The fourth and final component of Galloway’s algebra of wealth is diversification, in other words, spreading your investments across different assets.
The author writes: “Diversification is… a road map for making sound investment decisions and for being an educated participant in the financial marketplace.”
Owning shares in companies in different countries and industries reduces your risk compared to investing all your money in one company, country or sector. It eliminates the risk of a significant hit to your portfolio if, for example, a publicly-listed company goes bankrupt or an issuer defaults on a bond.
Galloway recommends investing all, or certainly most, of your portfolio in index funds or passively managed ETFs, which gives you broad exposure to different segments of the market. In the long run, he rightly points out, the vast majority of actively managed funds will underperform an equivalent passive fund once fees and charges are factored in.
To illustrate the point, Galloway cites a $1 million bet placed by Warren Buffett in 2008 that an S&P 500 index fund would outperform a selection of hedge funds over ten years. Buffett won the bet comfortably.
Simple but not easy
That, in a nutshell, is Scott Galloway’s formula for financial security. By harnessing the power of focus, Stoicism, time and diversification, it’s possible to build substantial wealth.
However, we would add a note of caution. Just because the rules are simple, that doesn’t mean they’re easy to follow. Executing Galloway’s plan is far harder than simply stating it.
“That goes beyond finance,” the author writes, “beyond what you can capture on a spreadsheet… (It) doesn’t mean being a monk… But it does mean hard work (and) a certain amount of discipline.”
To maximise your chances of achieving your financial security, it pays to work with a financial adviser, someone who takes the trouble to get to know you, what you really want from life, and the specific behavioural biases you may be prone to.
A good adviser will also encourage you to show the effort and discipline required, and keep you on track to reach your chosen destination.
As Galloway says, it pays to set out on this journey early. But, if you’ve left it late, the next best time to start is now. So why not get in touch with us and start building your financial security today?
Building lasting wealth rewards discipline, and we help with disciplined, long-term investing and a joined-up financial plan. Speak to the rockwealth team.
