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Return On Investment (ROI): A Different Perspective
By David Campbell On 02/28/2011 · Leave a Comment · In Investment Training
By Rob Kippel – Hassle-free Cashflow Investing Strategist
Most people, when asked why they want to invest in real estate, fall into two camps. There are those who use real estate as a vehicle to make more money and those who use it as a vehicle to have more free time to live the lifestyle they want. Of those who are convinced they are just using real estate to make more money, many of them don’t realize they are using the increased wealth to substitute hours of work with hours of quality living. For those who only want to make as much money as possible to buy material things without regard for time, you may not gain much insight from this article. However, for those looking for more time to do the things they love, I must ask “If we are investing to ultimately have more time and our investments produce positive returns on money invested but also create more work that requires even more time, is our return on investment still positive?” To answer this question we need to quantify our return on investment in terms of time.
Time is the great equalizer (pardon the pun) of all time. While individuals may have limited control over the amount of time they spend on this earth, their time, unlike their money, will be the same as anybody else’s. Whether you are born into rags or riches, you still have sixty minutes in an hour, twenty-four hours in a day, and seven days in a week. Each individual has full discretion over how they utilize their time just as they do their money but their time, unlike their money, cannot be devalued. A minute today is worth sixty seconds just like it was back in 1913 when the Federal Reserve was created, unlike the Dollar which has been devalued by ninety-five percent since then. To put this into perspective, if a minute were devalued by ninety-five percent, it would be worth three seconds today. At this rate, the average expected lifetime in the U.S. of 78.3 years would be over in just under 4 years. Imagine having a mid-life crisis at the tender age of two! But I digress.
To calculate return on investment (ROI) in terms of time we must recognize and quantify the opportunity cost of time. Opportunity cost in terms of time means that for every hour you spend doing one thing you lose the opportunity to spend that hour for a higher and better use, whatever that may be. For example, if you spend eight hours a day at work, that’s eight hours a day you could have spent with family, pursuing a hobby, working for a higher rate, investing, etc. Going forward we will operate under the assumption that every dollar that you earn from your investment is a dollar that you don’t have to earn by spending time at work and therefore, have that time available to you for whatever you choose. This basically means that as your income from investment increases, your time at work decreases until the point where investment income equals your current income at which point you no longer have to work to maintain the lifestyle you currently have. We will further assume that your current lifestyle, in the material sense, will remain static so that there are no changes in expenses. Therefore if your investments can produce the income you currently earn, you will no longer have to spend the time you currently spend earning what you currently earn to achieve the means you currently have.
Before calculating ROI in terms of time let’s first calculate return on capital invested. ROI is calculated by dividing the amount of your profit by the amount of your investment and multiplying the result by 100 to get a percent. Say we use $50,000 to make a profit of $5,000 we would have a return on investment of 10% ($5,000 ÷ $50,000 X 100 = 10%). Let us now convert our profit in Dollars into profit in time. It may be helpful to think of hours as a currency just like Dollars and as such we are just converting our Dollars into hours like you would when you go to a foreign country. We will make this conversion when we go from the “country” where they invest for money to the “country” where they invest for time. When you are in the “money country” it is the dollars that matter to you but when you live in the “time country” it is the hour currency that you use to judge if you made a profit. We convert Dollars to hours by taking the amount of Dollars and dividing it by the rate (Dollars per hour) we would normally earn otherwise working at our job. Let’s say Joe earns a net $20.00 per hour at his job, his 5,000 Dollar profit from earlier is equivalent to a 250 hour profit ($5,000 ÷ $20 per hour= 250 hours) in terms of time because using our earlier assumptions, Joe now doesn’t have to work 250 hours to make that $5,000 since his investment did it for him. It is interesting to note that if Joe were paid twice as much hourly at his job, his profit of $5,000 would actually be worth half as much to him in terms of time ($5,000 ÷ $40 per hour= 125 hours). This occurs because the higher rate allows Joe to earn that same $5,000 in half the amount of time. Therefore, Joe only frees up an extra 125, as opposed to 250 hours, with his $5,000 profit he made from investing his $50,000. But Joe didn’t just invest his $50,000 to get that profit of 250 hours, he also invested his time. We must recognize that Joe has already spent 2500 hours to earn his initial capital to invest ($50,000 ÷ $20 per hour = 2500 hours) but we will not introduce this into our calculation for reasons I will elaborate on in a moment. Let us assume that between all the time spent on activities related to the investment, Joe has spent 250 hours to make his profit. At first glance it would seem that this would be a 100% ROI in terms of time (250 hour profit ÷ 250 hours invested X 100 = 100%) but this is not the case. Let me explain.
When we invest capital it is acceptable to receive a profit of less than 100% of the capital we invested because after we receive our profit we get our initial capital back. From our example, when Joe invests his $50,000 he is more than happy to receive a 10% ROI of $5,000 because he now has $55,000 (initial investment of $50,000 + profit of $5,000 = $55,000) which is more than the $50,000 he started with. This is not the case with time. When you invest an hour to get an hour you are no better off than when you started because you do not recapture the initial hour invested like you do when investing capital and are therefore net zero. To come out ahead, accounting for the lost hour invested, we need to have a return on investment in terms of time greater than 100%. Accordingly, we can modify our ROI formula to account for this fact. The resulting formula would look like this:
ROI expressed in terms of time = (profit expressed in time ÷ time invested) -1 X 100
Let’s apply this new formula to Joe’s situation. Joe made a $5,000 profit which expressed in time for him is 250 hours (remember we divided the Dollar amount by his wage rate which was $20 per hour). He did this by investing $50,000 and spent another 250 hours on the investment to make his 250 hours profit. Using our formula, Joe’s ROI in terms of time = (250 hours ÷ 250 hours) -1 X 100 = 0%. How can this be?! In terms of Dollars Joe had a 10% ROI. But remember Joe lives in the “time country” where they use hours and not the “money country” where they use Dollars. When converting his profit in the Dollar currency to the hour currency, Joe actually had a 0% ROI when measured in the hour currency. Joe is therefore no better off in terms of time than when he started even though he made a 5,000 Dollar profit!
So the question then becomes, “if I am investing for hours and not dollars, what can I do to increase my ROI expressed in terms of time?” Looking at our formula we have two options. We can either increase our profit expressed in time or decrease our time invested. Sure we could simply neglect our investments and just spend less time on them but this would most certainly have the effect of reducing our profit in both Dollars and hours. Just imagine what would happen to your return on capital if you were to not spend time finding a good investment, not spend time on due diligence, not spend time maintaining your investment, not spend time accounting and record keeping, not spend time reviewing your financial statements, not spend time strategizing with your attorney and CPA……… I think you get my point. This type of behavior would most likely have the effect of you actually losing money which makes your profit expressed in time negative even if you spent no time! This is an important point. Making a profit in Dollars is prerequisite to making a profit in time because you cannot offset a negative profit in dollars by spending a negative amount of time. Hypothetically, the least amount of time you can spend on an investment is zero in which case a negative profit in Dollars will always produce a negative profit in time when converted (which means you have actually lost time because now you have to work at your job to make up for the loss in Dollars if you wish to maintain your current means).
So if we cannot reduce time spent investing by simply not spending it, can we effectively reduce time to increase our profit expressed in hours? We can! Increasing our efficiency can effectively reduce time, without compromising results, through the use of technology, knowledge, skill, and experience which all take time to develop. Although it is advisable to continually strive to become more efficient and develop your knowledge and skill, you can short cut this process by introducing leverage. Just as in financial leverage where you can invest more money than you have, it is possible to use personal leverage to invest more time than you have! Personal leverage is the use of another person to accomplish your objective. This is usually done by paying, or otherwise compensating, someone else to do what you cannot do at all or cannot do as well or as efficiently. Although this will eat into your profit in the amount of the compensation to that person, when the right person is chosen the profit you ultimately reap will be much higher than what you could have gotten yourself and in addition you have reduced the amount of time you had to spend. When we look at the effect this has on our ROI expressed in time equation, the results are profound.
When you leverage the time, skill, expertise, knowledge, and relationships of others you dramatically reduce your time spent while simultaneously increasing Dollar profit which profoundly increases your ROI expressed in terms of time. In searching for ways to increase our ROI expressed in terms of time, we have just successfully explored the bottom of the equation which is the amount of time invested. Let us now explore the top of the equation which is profit in terms of time. Being that the conversion from profit in Dollars to profit in hours is fixed for a given individual, we shall simply look for ways to maximize our Dollar profit which will concurrently maximize our time profit. When seeking maximum profit in absolute terms (not in percentage terms) there are few options. Simply stated, they are increase the principal invested, the rate of return, the leverage on principal, or any combination thereof. Hypothetically the maximum possible return is achieved by investing the maximum possible principal at the maximum possible rate of return using the maximum possible leverage. If you have a propensity towards gambling and are a little sick in the head, this strategy may be a good one for you, but you should be aware of the dangers. To start with, investing all of your capital into one investment vehicle, while leaving you highly exposed to success should the investment be profitable, also leaves you completely exposed should it go bust. The lack of diversification is generally undesirable and the complete investment of your entire capital leaves no reserves should things go awry. The next problem is that when endeavoring to maximize rate of return it gets increasingly harder to find higher and higher rates and, while not a direct correlation, higher yielding investments do often come with higher levels of risk. On a side note, do not draw the conclusion that lower returns equal lower risk. A perfect example today is US T-bills, T-notes, and T-bonds. While yielding next to nothing they are extremely overvalued and very likely over the coming years to deliver to their investors massive capital losses if sold prior to maturity and insidious erosion of principal by inflation if held until then. All from “the world’s safest investment,” but again, I digress. Back to leverage. Just as with the leverage of time, leveraging capital can be an outstanding way to increase your ROI but leverage on capital, unlike time, comes with added risk. Leverage on capital will magnify both profits and losses, so it is extremely important to control for risk and have adequate reserves. On our quest to safely maximize profit in absolute terms, it therefore seems a prudent course to invest low to moderate amounts of our available capital at moderate returns, given the risk of loss is low, and then using maximum leverage to increase our return.
Here at Hassle Free Cash Flow Investing we combine very high leverage on money invested with extremely high leverage on time invested to deliver a truly superior ROI. Thanks to our creative financing and investment techniques we provide leverage that is nearly unmatched in today’s lending environment. We also have an experienced and knowledgable staff, as well as the systems and relationships in place, to provide you with a nearly turn key approach to drastically reduce the amount of time you spend implementing the Hassle Free Cash Flow Investment strategy. These two aspects of our business combine to deliver to our clients impressive returns on investment when measured in both Dollars and hours. For a free consultation to find out if our services and products are right for you, contact me at Rob@hasslefreecashflowinvesting.com Until next time, stay sharp!
-Rob Kippel, Hassle-free Cashflow Investing Strategist