Sunday, 17 February 2013

Conserving Capital: It All Made Sense Until He Said That EVERYONE Profits

Conserving Capital with Kyle Cameron

It All Made Sense Until He Said That EVERYONE Profits

I have decided to give a central theme to my blog posts for the Finance Society from here on out.  This first post will explore the theme chosen, its centrality to finance, and the chat that inspired the idea. 
Capital conservation has to be the most important topic in finance, and as such deserves a little defining.  Finance poses the question: How do I best allocate assets?  As a subcategory, capital conservation concerns itself with the logical follow-up: How do I avoid poor allocations of assets?  Indeed, capital allocation is what Warren Buffett was referring to in his quote, “The first rule of investing is don't lose money; the second rule is don't forget Rule No. 1”.  However, despite the world famous investor’s reference to capital allocation as the first rule, I would argue that most people – financiers, economists, and other businessmen included – believe finance and investing to be the pursuit of asset allocations producing the largest gains; a cheery view that ignores the often frightening concepts of loss and risk.  This unfortunate view is akin to the gambler who always bets the max and assumes such action will produce the largest gains.     
Upon hearing that I was studying finance, my acquaintance decided that I must be made aware of this business he was involved in that would help save me money.  He began to tell me about, a website that he claimed would allow me to save money on the items I normally purchase.  Responding positively to my prodding, he went on to explain that in exchange for the opportunity to purchase this vast array of discounted items, I would need to contribute a small initiation fee in addition to monthly dues.  At this point, his claims have seemed reasonable – in fact, seemingly comparable to my family’s Costco membership.  Like the flip of a switch, however, the conversation turned as he explained how he had made money from selling product himself and networking to find other individuals who would sell products.  I then made the very pointed question, “What percentage of distributors profit from the sale of goods?”  His answer: “100%”.  I will not recount the conversation any further from there, but I did give the acquaintance my contact information and a promise to buy product if he would share his books and prove that he had, in fact, made a profit from his participation in 
I am supremely confident that my acquaintance is exponentially more knowledgeable about his business than myself.  However, I am just as confident that he does not understand capital conservation.  It is highly likely that a significant portion of the  “profits” he has made from product sales, cost savings, and networking to bring in other sellers are illusory.  Such “profits” are surely being destroyed by being tied up in inventory, future purchase commitments, marketing efforts and time, monthly fees, and increased unnecessary purchases.  I hope my acquaintance truly is profiting from, but I also know that his mention of everyone profiting from the business is proof of his own complete ignorance of the risks involved.  Even if my acquaintance has profited, his dearth of knowledge around the risk of loss means that he is not conserving his own capital.   
Now ask yourself, are you conserving your capital?  

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