On the importance of having capital

by Philip Brewer on 26 August 2007 3 comments

One of the most frugal things you can do is have capital. Whether it's money in the bank or a nice chunk of reasonably liquid investments, having capital not only makes money (through the investment return), and gives you security and flexibility, it also cuts your expenses.

I wrote a while back on the difference between voluntary simplicity and poverty, even if the amount of money spent each month is about the same, and how the difference had a lot to do with choices.

There are two key elements to the difference. One is spending less than you earn, which gives you flexibility in almost every aspect of life. The other, though is capital. Having some capital often makes all the difference in what choices you have available to you and how you are treated.

The extra income, security, and flexibility are nothing to sneeze it, but for this post I want to talk about the frugal aspects of having capital.

The most obvious way that having some capital lets you save money is that it lets you arrange your purchases to take advantage of deals. If you have capital, you can take advantage of store sales and seasonal low points in prices . You can also make bulk purchases. (To take full advantage you need to have a clear idea about both what you're going to need and about what is a good price, and you need the storage space and the organizational skills to put things somewhere and find them again.)

Less obvious are the frugal options that come when you're in a position to put some money at risk. For example, suppose there's a house-sitting gig available where the owners haven't found anyone they know personally and are considering strangers. If you want that gig, your chance of getting it might go up quite a bit if you're in a position to offer a substantial damage deposit.

To carry that example a bit further: Suppose after the house-sitting gig wraps up the homeowner tries to cheat you, offering to return only part of the damage deposit. If you lacked capital, you might have to settle for what they were willing to give back, because you needed the money to rent your next place. If you've got some capital, you can play hardball for what's owed to you--not only refusing to settle, but also credibly threatening to go to court.

Note that none of these things actually cost any money (except perhaps the interest that you might have earned on the damage deposit). Because you had capital, you had additional opportunities without needing to actually spend extra money.

People with capital get the best rates on loans--in large part because they're in a position to forgo the loan and just use their own money, if they're not offered a good rate. They also get freebies from banks and investment companies--advice, personal service, access to special programs, and so on. Even just a little gets you free checking.

And, if only as a psychological effect, being prosperous can make you feel less like you need to look prosperous, making it easier to resist the urge to spend money merely to keep up appearances.

It's a truism that the rich get richer. This is part of the reason why.

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In times of liquidity crunches, cash is king. One direct example is the necessity to have cash in a market that is contracting. Many in the housing market got a false sense of easy capital without having any capital. They operated under the other people's money (OPM) model of investing. In addition, they somehow mistook credit with capital. That is many folks saw their home with zero equity or their leased car as an asset when in fact, it was a drain on their wealth.

In addition, cash provides the leverage needed to buy deals in shifting markets. Buy low and sell high is easier said than done. Having the fortitude to withstand market mania and not becoming too pessimistic when blood is in the streets. With the amount of credit floating in our economy, couldn't agree more that having liquid capital is a safety net for many folks.

Dr. Housing Bubble

Guest's picture
WholeWheat

Interesting. So perhaps we can append to our vernacular, an alteration of the familiar old addage as: "You have to have money to save money (or at least it's easier that way)."

I am fascinated by the psychology of it as well. Referring to the next to final paragraph, it seems that the symbols of success can take a higher priority for those who are aspiring than for those who are experiencing. And as Dr. Housing Bubble points out, there can be real confusion about what is a viable personal asset and what is not. I often ask what would motivate someone to sink 'would be' capital into symbols of success using extractive financial instruments. I wonder if it is holes in the financial education? impatience? Aspiration-based self deception? It's a puzzle, and it is frustrating to witness.

In any case, Philip, I think you're spot on here. A little capital goes a long way in the frugality and flexibility department. Thanks for the post.

Myscha Theriault's picture

Cash is definitely king. It is way more expensive to be broke. I've felt that for a long time. We use our extra cash to do several of the things you suggested, buy bulk, take advantage of sales, and know that if we want to take advantage of our liquid savings interest rate, we can pay off the balance on cards while getting interest for the month beforehand. Having all the cash in advance is a large part of being able to do this. And I definitely agree with you on the point of people crawling out of the woodwork with advice, better investment opportunities, etc. Access to better advice and deals seems to increase in direct relationship with your bank account balance. Wish I'd known that earlier on in life. I might have scrimped a little harder to get where I am sooner.

As usual Philip, great post!