How you can generate more surplus cash flow

In the latest of a series of articles, former lawyer and City money man Peter Alcaraz shares more advice on how to achieve financial freedom more quickly.

Peter Alcaraz read law and economics at Durham University and spent 24 years advising small and mid-sized companies on mergers, acquisitions, IPO's and fund raisings, first as a lawyer and for the last 20 years in corporate finance. At the age of 46 after reaching 'O' he left city life to write, study, travel and spend more time with his wife and two daughters. His first book, The Wealth Game - an ordinary person's companion was published in 2016 and has become a staple amongst wealth managers, business schools and private individuals wishing to develop their personal finance skills. 

• How you can achieve financial freedom more quickly
  
• How to calculate your real net worth

• How to calculate your total future needs and retire early
  
• How to keep a firm grip on cash flow and preserve your wealth
  

Surplus cash is the game currency. The more cash you generate the greater the wealth you can build.

Surplus cash = after-tax earnings from labour + after-tax earnings from assets− spending of any kind except that relating to investment in net worth.

Earning from your own labour requires skill, commercial nous, hard work, opportunity, and a degree of luck, particularly around timing. It helps for at least some of your career to be the right person in the right firm in the right industry in the right economic cycle, but no one can be sure to align all these stars.

To earn cash from your assets, you need to have productive assets and the disposition and energy to make them pay. This source of money is a powerful stimulant that can grow exponentially and ultimately dwarf and replace your earnings from labour.

First, it's time to face spending. This is the most controllable element of the equation, yet probably the most overlooked. It's as simple as this: spend less to generate more surplus cash, and spend more to reduce surplus cash.

Get it right, and you enjoy the double benefit of more cash and net worth as well as less need, allowing you to reach O quickly. Get it wrong, and you face the double whammy of less cash and net worth trying to service greater need. Your net-worth-to-needs gap can be deep into negative territory and O no more than a fantasy.

A Small Idea

Siu Lim Taois the first form of the ancient martial art Wing Chun and can be loosely translated as "way of the little idea" or "little idea form." It is composed of three sections of movements that can be learned easily but that are foundational to the entire system. Mastering them doesn't mean that you will be good at Wing Chun, but to be good, you need to master them.

In Buddhism, four observations called 'noble truths' underpin the practical cure for human suffering. Deceptively simple and quick to recite, two and a half thousand years of analysis, development, and discussion begins and ends with them.

A third example of small idea and large effect is that of satyagraha.In 1906, where no word existed in Gujarati to accurately describe his principle, Gandhi set up a competition in the newspaper Indian Opinion.

What emerged were two Gujarati words that Gandhi tailored through their Sanskrit equivalents, satya (truth embodying love) and agrahara (firmness), into a new one meaning "holding to what's right," a kind of obstinate virtue. Although he had been living this principle since childhood and was inspired by a Gujarati poem extolling good action against evil, the New Testament's Sermon on the Mount, the Bhagavad Gita, and Tolstoy's antireligion polemic, The Kingdom of God Is within You,this was the first time he was able to simply articulate it and communicate the idea widely.

The principle of practicing nonviolent action in a good cause galvanized a divided nation and led to India winning back its independence.

If you take up any simple but profound idea of this sort, you will find that, over time, it changes the way you think and behave.

Naturally you will test the notion, and if it doesn't stack up, drop it, but if it is genuine and you are open-minded, it will stick.

In order to live the idea, all manner of rules, protocols, and practices naturally arise to facilitate it. Some may have already been constructed by others and are there to be learned and obeyed, like helpful road signs; others spring up organically when circumstances require them.

As you adopt and internalize these and discover your own personal methods, they build into an entire pattern of conscious and subconscious behaviour, impossible to fully articulate or comprehend at the outset, but impregnable and capable of very significant force.

Conversely, if an idea is not taken up, its associated rules, protocols, and practices seem empty and meaningless. You may follow it, but without zeal and passion. It will be easy to drop.

This is a common problem for people trying to economize. They approach the task by creating or following someone else’s micro-prescriptions for saving cash at every opportunity and end up becoming dispirited.

Think about this. Your small idea may be a goal or a cause or just a musing, it may be personal or connected to something external, or it may be specific or general. Which will you adopt?

Begin by imagining, as clearly and vividly as possible, the benefits you can experience by reaching Oand claiming the prize, such as freedom, space, tranquillity, and time.

Next, reflect on the obstacles that could impede this goal, again as starkly as you can—for example, boredom, restlessness, fatigue, limited opportunities in your town, the wrong skills, distractions at home, and so on. Take time out to dwell on this for a moment or two.

The first part is good old-fashioned visualization, peddled as a "get rich" or "success" technique for as long as I can remember. Adding the second element is the clever part, as it does away with the fantasy that wonderful results come effortlessly or that they are somehow deserved, not earned. It reminds us that we have to make success happen through our own careful planning, sound actions, and determination.

Studies show that those who practice mental contrasting around an objective they are confident they can achieve - as opposed to one that they doubt is possible - will have the following characteristics:

• They are better prepared to overcome obstacles, because they will already be primed to act in the face of any given obstacle. Mental contrasting increases the association between future possibilities and challenging realities. Even words that represent challenges will automatically invoke words that represent inspiring possibilities.
• They are more motivated to overcome these obstacles by appreciating that challenging realities represent obstacles to future possibilities.
• They embrace all the information needed to proceed with any given action. In contrast, those who enjoy only positive fantasies tend to neglect vital information; in particular, they feel motivated to overlook complications and other insights they perceive as undesirable impediments to their progress. In a form of selective exposure bias, they shift their attention to the benefits of the pursuit and deliberately disregard alternatives or foreseeable difficulties. Rash or ill-considered actions result, increasing the likelihood of failure or setbacks.

I don't remember trying to visualize financial independence in my early twenties, but I always assumed it would happen at some point. This confidence was not inspired by a view of where my nascent career was heading, which remained a mystery, but rather through an awareness that I could manage my needs as necessary.

It became clear to me that wasting what little surplus cash I did have was a major obstacle to achieving financial self-sufficiency. I must have considered other obstacles, like losing interest in work, being in the wrong firm, failing to progress, or getting distracted by something or someone, and found ways to overcome these. But the standout small idea relating to spending was and still is this: don't waste money.

From this rather general idea came a specific maxim: Spending on consumables and depreciators is an obstacle to reaching O.

At every point, at every turn, and in every given situation, this notion guided my behaviour. As long as O still mattered to me and it never stopped mattering, positive behaviours sprang up to overcome this obstacle. Whether I found what I wanted at a lower cost or for nothing, chose an alternative, or dropped the desire completely, there was always a route around the problem. I didn’t need specific rules for this or that spending—it all fell into the same basket.

Spending hard-earned money on consumables and depreciators was such a blindingly obvious obstacle that no further consideration of the subject was needed. There was no agonizing about the rights or wrongs of a purchase; it was clear-cut. Unsurprisingly, this simple approach became second nature and made life easier. It became so normal that I never felt as though I was denying myself anything of importance. To deny myself the chance to reach O quickly— now that would have felt like an intolerable sacrifice.

Others around me certainly had difficulty with my approach at times, but I remained quietly resolute, certain that it was the right thing to do.

Where are you on this? Reflect on yourself and what matters to you. Be realistic.

From your small idea springs a range of others that, together, will form a personal style of spending behaviour that is unique to you and, as such, fits easily.

An opportunity for creativity arises. Ask yourself, "What spending style do I want and why, and what are my underlying values?" Clearly the objective is to develop a package that lowers spending to increase surplus cash flow, but even within this remit, the options and nuances are considerable. There is far more here than simply being a 'spender' or a 'saver'. Your style and values can be clever, discerning, eco minded, compassionate, highbrow, lowbrow—in fact, they can be anything you want, as long as they’re fit for your purpose. The point here is that they are considered and designed. You set them.

Here are some suggestions, versatile but also classic and timeless:

• Simplicity - This might be stark minimalism or extreme selectiveness
• Purity - A return to nature and the natural way. Roll back technology, resist labour- and time-saving gadgets, shortcuts, processed and mass-market factory products, and return to basics. Wholesome and simple.
• Utility - Everything should be functional, fit for a purpose only, and not over designed or overly specified or unnecessary. This one sits well with simplicity, and both apply widely to potentially high-spending areas, such as home, food, clothes, possessions, relationships, work, leisure, and travel.
• Economy - Use only what is necessary and avoid waste.
• Efficiency - Don't overengineer or overcomplicate. Find the quickest, most effective line between you and your goal, and quietly follow it. Distill actions to create the maximum effect from the least expenditure of time, energy, and money. Don't zigzag around and make a lot of noise.
• More for less - A simple motto that reaches far. Allied to efficiency and economy, it means more benefit for less cost. The output may be material things or intangibles; the input may be time, effort, raw materials, or money. Just think about the power and potential of this. Is there anywhere it can't be applied?
• Creativity and resourcefulness - Let necessity be the 'mother of invention', only manufacture the necessity as well. Why deny yourself this proven and valuable spur? The simple solution is to behave as if you are poor, whether you are or not, and apply lateral thinking, innovation, agility, and brazen opportunism to meet every need. Only when you have exhausted all options do you fork out cash for it, assuming you haven’t lost your appetite by now. Once developed, these qualities deliver colour, brightness and levity to all corners and push many needs to one side.
• Good things come to those who wait - Whoever first said this was spot-on. It has served me well, and recent scientific studies bear it out. Humans, it appears, have an unusual ability to defer gratification: "I'll resist this instant gratification for months or even years if it means a better return in the future." Apparently, it stems from the fact that we prefer larger rewards to smaller ones, and the more vividly we imagine the future gain, the more likely we are to wait for it.

Walter Mischel's recent book, The Marshmallow Test: Understanding Self-Control and How to Master It, revisits his seminal 1960s experiments.

What happened to the hundreds of six-year-olds who were invited to take a marshmallow from a pile or to wait fifteen minutes and take two?

The Columbia professor discovered that the 25% of children who deferred their pleasure have performed better academically and socially than the instant-gratification majority.

They have also been more successful in their careers and relationships and less prone to obesity, over-drinking, or drug problems. Mischel's work shows that people with good self-discipline and emotional control tend to have more success, leading to greater confidence and a sense of being able to overcome whatever obstacles and negative outcomes are thrown at them. You should look at it.

Internalizing one or more of these or other such notions as part of your personal ethos and style provides the intermediate structures necessary to bridge the space between where you are right now and O, some way into the future. The whole exercise is entirely positive, and it works in practice.

And it all stems from a small idea.

So far, I've outlined the wealth game and discussed, net worth, needs and cash. But what's the plan? Read the next edition to find out...

Peter Alcaraz is a freelance contributor and not a direct employee of interactive investor.