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Tuesday, December 21, 2010

Accumulation of Capital:The Proper Use of Parsimony




"Capitals are increased by parsimony, and diminished by prodigality and misconduct"~Adam Smith from "Wealth of Nations" BookII Chapter III

Reading this quote from the great Adam Smith provides various thoughts. For starters, what is parsimony and prodigality? How does this quote correlate into the process of building wealth? For starters, lets define Parsimony as stated in Merriam-Webster(online)

Parsimony(noun)
1.the quality of being careful with money or resources :thrift
b : the quality or state of being stingy
2
: economy in the use of means to an end; especially :economy of explanation in conformity with Occam's razor

Most people when presented with the word stingy or frugal, images of "Scrooge" come into their minds(see him above). Lets focus on the second definition of Parsimony for this blog.

Prodigality(noun)-from the root word prodigal

Prodigal(adj)-(Merriam-Webster)
1. : characterized by profuse or wasteful expenditure : lavishprodigal feast> <prodigal outlays for her clothes>
2
: recklessly spendthrift prodigal prince>
3
: yielding abundantly
When Adam Smith wrote "Wealth of Nations", he was speaking to the wealth of the entire nation, and the principles that it takes to have a "wealthy nation". These same principles can be applied to the individual. It is the individuals IN a nation that determine the wealth or poverty of a nation.
I know I hear you stating, "But I am working as hard as I can in my business, Job, etc, how can I SAVE my way to wealth?".
Let's take the premise that money is your steward or your employee. Adam Smith also states the following, "A Man grows rich by employing a multitude of manufacturers: he grows poor by maintaining a multitude of menial servants." In other words, your money needs to be working for you productively, otherwise it will leave you poor and broke.
Many of us are taking our profit(income from Job, business, etc) and purchasing "menial servants". An example of menial servant is a NON Asset. Many Americans purchase depreciating assets which provide zero cash flow, thus reducing their net worth. As of 2006, the average United States citizen has a savings rate of <4%> (negative). This is due to the over leveraging of debt used to purchase "menial servants" or bad assets.
Purchasing Assets(things that place money IN your pocket) turns your employee from a "menial servant" to a industrious manufacturer(worker). Your money must be working 24 hours per day and 7 days per week. There are various examples of purchasing Cash producing Assets:e.g. Income Producing, Real Estate, Bonds, a profitable business(large or small)
If you are a business owner, you may not see the way that you can "Save" your way to wealth. I will provide an example. Let's suppose that you own a Lemonade stand. You sell a glass of lemonade for $1.00 per glass. The cost to produce and make the lemonade is about .50 cent/glass. You finally open up your stand, and you sell 2 glasses of lemonade! Success! Here is where the important decision is made: You can take that $2.00 and spend it on a bar of candy, or you can take or "SAVE" that profit and choose to reinvest back into your growing enterprise.
Choosing the parsimonious direction, "saving" your profit and reinvesting back into your business will help grow your business. Your wealth will be measured in your ability to produce more lemonade AND capital that is accumulated from your enterprise. As you grow your enterprise, you will need more equipment, employees, advertising, marketing, etc. All of this requires money, which will come from the parsimonious use of your gross profits!
This same principle can be applied to a person who is in a low end job. He can use his "profits" from his paycheck to place money to the side to pay for improving his job skills. His "wealth" is measured in his ability to improve his job skills. As he improves his job skills, he has the ability to earn more income, thus providing an opportunity to "save" more money to work for his objectives. This same person could also start a home based business with a low entry fee, and develop the capital from his growing business to expand his wealth. It all starts from the individual making the decision on how he will spend his "profit". At each pay day, all of us have a choice to be poor or wealthy, regardless of our economic stratus.







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