I mean, he might know the price of his rent, and maybe his car loan, if he has a car loan. But how much was his cellphone bill? Eating out? Groceries?
He don’t know.
***
BACKWARDS-LOOKING ECONOMIC WILDNESS
So let’s say the guy made $2000 last month, spent $2000, and only knows for sure that he spent $600 on rent… and really has no clue where the rest of the money went.
That person’s backwards-looking economic wildness for last month would be 1400/2000 = 70%.
That’s pretty drastically bad.
It's like if someone gets totally drunk, eat a bunch of kebabs, takes an expensive taxi, and then isn’t sure sure where their money went on Monday besides knowing vaguely that a hangover is present.
A lot of people have only a vague idea of where their money went after the fact.
A person who keeps precise accounts and knows exactly where their money went last month would have a backwards-looking economic wildness of… 0%. Not wild at all. They know exactly where all their money went.
Good, right?
Well, yes, but that’s less than half the battle.
***
FORWARDS-LOOKING ECONOMIC WILDNESS
So, next month, where’s your money going to go?
I bet you could brainstorm on paper.
Your hapless idiot cousin/acquaintance/whomever [*] will probably pay the rent ($600) and might estimate that he’ll spend $300 on food (he’ll be wrong; it’ll actually be $900), but the rest? He don’t know.
[*] (I don’t actually dislike the guy. I wish he’d get his act together and succeed.)
So, if he doesn’t save his pay at all, he’s already going to be at least 55% wild next month. He doesn’t know where 55% of his money is going.
Well, that’s easy enough to understand. Most of us won’t make the same errors.
Heck, let’s say you’ve got no savings – $0 – but are otherwise more responsible. You make $2000 and you’ve budgeted $1800 of it, and your budgets are actually good. You’ll use $200 however you please.
If so, you’d have accounted and budgeted in advance for $1800 out of the $2000 you were going to spend, and you’d only be planning to be 10% economically wild next month.
That’s pretty good, yeah? Knowing where 90% of your spending is going is pretty reasonable, right?
But, wait a minute…
… what’s the thing that breaks people who have no spare cash?
Oh yeah, emergency expenses.
So your car breaks down and you’re forced to pay $600 to get it repaired.
Now you spent $2400… and had only planned for $1800.
Your “economic wildness” relative to budget thus went up to 600/2400 = 25%.
Or, 2.5x higher than you’d planned for.
That one random expense might just put you in the debt spiral.
If you fail to make plans to pay off the debt, it’ll start generating interest, and the downward spiral starts.
***
COMPANIES, TOO
You know, these days I don’t do consulting any more – I’ve got my writing, I’ve got my nonprofit work, and I’ve got my new company, Ultraworking – but I used to consult for a lot of growing companies, primarily in high tech and finance, that were growing and scaling.
I’ll just say empirically – you’d be shocked at how little the median company knows about (1) where its money went last month and (2) where its money will go next month, and (3) all sorts of relevant facts and figures you’d think they should know.
I have a variety of entrepreneurial friends and acquaintances. Some of them freelance, and live very boom and bust – and many of them don’t plan for their income very well, don’t plan how much to spend, and don’t plan their spending at all.
Their economic wildness is high.
Their companies and their professions often fail them, or at least, they get into periods of high stress fairly often.
Actually, I find myself having less and less of these friends every year.
The smart people grow out of it; the people who don’t grow out of it become increasingly irascible and stagnant.
***
CURRENT ECONOMIC WILDNESS, I
Quick –
*How much money is in your checking account?
*How much is in your savings account?
*How much do you have in unpaid taxes?
*How much have you invested in tax-advantaged accounts this year?
*How much more will you invest this year?
*If you have debt, when’s it going to be paid off and retired?
*What did you spend less month?
*What are you spending this month?
*What are you spending next month?
Don’t know?
Isn’t that a little concerning?
***
CURRENT ECONOMIC WILDNESS, II
Yes, I think most people don’t know the current state of their affairs. The more accurately you could know those answers – either off the top of your head, or by quickly checking a spreadsheet or app that you periodically look at – the lower your economic wildness.
Before Luca de Pacioli and modern accounting, basically every business had a much higher degree of economic wildness than the well-run companies do now.
A baker making bread might have a reasonably good idea if he’s turning a profit on each loaf, but without accounting, he neglects things like how fast his oven is wearing out and needs to be replaced, the cost per day of staying in business (including property taxes, etc), might fail to adequately build reserves to pay off taxes if they’re not due immediately, and so on.
That sociology journal we quoted earlier, they explained this about accounting –
“For [pioneering sociologist Max] Weber, “rational capital accounting” involves “the valuation and certification of opportunities for profit and of the success of profit-making activity by means of a valuation of the total assets (goods and money) of the enterprise at the beginning of the profit-making venture, and the comparison of this with a similar valuation of the assets still present and newly acquired, at the end of the process””
Yeah, that quote hurts my head too. But it’s important.
Accounting is one way to reduce wildness – it lets you value things right now, and track value changes over time, and so you can know if you’re actually profiting or not.
And in fact, the closer your are to “the edge” – the less savings you have and the more you live paycheck to paycheck – the greater the chance that missing a single detail will sink you.
If someone budgets and lives on 10% of their pay and banks 90%, even underestimating their expenses by half won’t sink them. The people that are most desperately struggling – the people who have the least reserves and buffer – are the ones who most need to minimize economic wildness.
And I think this is true up and down the spectrum. I think it’s true for individuals, families, companies, institutions, cities, countries; from the micro up to the macro.
While it’s obviously unfair and not perfectly informative to compare somewhere like Britain to a much younger country like Indonesia, among “apples to apples” countries like the Czech Republic and Slovakia, I contend the “less economically wild” country will more reliably get wealthy. That is, I think China has been less economically wild than Russia over the last 25 years, and that’s one of the biggest contributing factors for China’s rise vis-a-vis Russia.
***
TEMPORAL CONTROL AND WILDNESS
We’re in the midst of our explorations into “Temporal Control,” using our skills and abilities to manage time, space, and resources towards success.
Two chapters ago, we covered a “Unit of Account” – then, last chapter we covered a warning against getting obsessed with measurements and neglecting something important.
The same could be said here, of accounting.
Accounting is very valuable, but it’s not the on
ly thing that matters – a city with a wonderful culture and lots of advantages like San Francisco can get away with more wildness than a crummier city.
Likewise, doing and keeping accounts takes work, and there’s always opportunity cost on work. I don’t know his accounts, but Kanye West seems to have a high degree of economic wildness – at least from his public statements – and perhaps it makes sense for him.
And yet, here we are, examining how to navigate time and space effectively.
That sociology paper is really hit-and-miss; it says some nearly nonsensical things, but also has some gems –
“Weber: … from a purely technical point of view, money is the most ‘perfect’ means of economic calculation. That is, it is formally the most rational means of orienting economic activity.”
“Accounting makes it possible for capitalists to evaluate rationally the consequences of their past decisions.”
I mean, isn’t that marvelous? And incredibly powerful?
“Accounting makes it possible for capitalists to evaluate rationally the consequences of their past decisions” – wow.
It’s true, too.
Now, I’m not here to worship the market; that’s really not the point. There’s some businesses that I think are terrible for mankind and which I think no one should buy what they sell. In particular, I think companies that make their profits nearly entirely from obese people selling bad foodstuffs that make them obese, I think these companies are morbidly awful, and the sooner they’re out of business, the better.
And despite that, acknowledging that “accounting makes it possible to evaluate rationally the consequences of past decisions” is still a statement that’s poignant and true… and maybe even beautiful.
Yes, I do think it’s beautiful. The math is so pure and elegant, and the ability to understand what happened last year, in business, from a sheet of figures in a ledger… this is remarkable. It also didn’t exist until five centuries ago.
We went 200,000 years without money as a species, and didn’t get all that far.
After money was created, we still went another 1,200 years before being able to fully numericize the entirety of our affairs. During that time, we couldn't really know the exact extent to which a business – or freelancer, or wage earner – was profiting or losing in a given year.
Really, it’s a toss-up for me if Gutenberg’s printing press or Pacioli’s double-entry accounting was more valuable for human development. Literacy is probably more important than complete accountancy for our species, and yet, there were good books before Gutenberg’s press, but genuinely complex and technical businesses would have been impossible to create without accounting.
I believe it would have been outright impossible to create combustion engines and personal computers and all that wonderful stuff without accounting. And I think the Internet has now begun to obsolete books created by printing-press… so maybe I’ve just talked myself into thinking that double-entry accounting is more important than the printing press.
That digression aside, when I read, “Accounting makes it possible for capitalists to evaluate rationally the consequences of their past decisions” – we should start thinking of all the aspects of life where one can’t rationally evaluate the consequence of past decisions with the same rigor, and think through the practical applications.
***
OBVIOUS IMPLICATION: LOWER YOUR ECONOMIC WILDNESS [*]
[*] (Unless you have a damn good reason for not doing so. Which, if you're not Kanye West, you probably don’t.)
You lower your economic wildness by,
1.Knowing more accurately how much money and monetary valuable things you have currently on-hand,
2.Knowing more accurately where your money went in the past,
3.Knowing more accurately where your money will go in the future.
Now, wildness = 0% is both probably impossible and not worth aiming for.
Some industries are naturally more economically wild. Those industries tend to be more dangerous to operate in. Some professions tend to be more economically wild. Some countries tend to be more economically wild. And so on.
But you can lower your economic wildness.
The original theory of health insurance was that everyone has a relatively low risk of any given health disaster, but it would absolutely sink both your finances and life if you got one. If you have a 1 in 100 chance of a $20,000 expense (or die if you can’t pay it), then it can make a whole lot of sense to buy $200 of insurance.
In that case, you convert the variance and risk of a very large degree of economic wildness hitting you into a fixed known small cost.
Having a huge amount of savings is sometimes called “self-insuring” – you can keep all your things maintained, but if something breaks, you just buy a new one. Thus, if you have $100,000 of savings and no fancy possessions, it probably doesn’t make sense to buy renter’s insurance. But if you have some expensive technical equipment or tools, no savings, and live in a high-crime neighborhood, that $20 per month lowers the chance of needing to outlay a huge amount of cash.
Backwards-looking economic wildness can get reduced to basically zero by just tracking your income and expenses. You don’t even have to do it forever; doing it for 1-3 months gives you a much better picture of what you genuinely spend. It’s shocking to me that more people don’t do it. It doesn’t even take long.
Likewise, doing a current accounting of your cash accounts and possessions (and the wear-and-tear on them, especially if you own a house or car) – well, this isn’t so hard to do, and more people should do it.
Forgive me if this sounds stupidly obvious, but I do think life is easier if you know how much money you have.
As for forwards-looking accounting, well, that is genuinely harder, given the lack of reliable crystal balls.
And yet, there’s dozens of good methods that, even halfway-implemented, can go quite a ways.
I personally use YouNeedABudget v3 for my finances.
But any personal finance app, including just tracking your spending on a spreadsheet daily, works just fine.
I read these sites somewhat regularly:
http://www.mrmoneymustache.com/
http://earlyretirementextreme.com/
https://www.reddit.com/r/personalfinance/
Then, this guide by Ramit Sethi on Tim Ferriss's site is still quite relevant – setting up your accounts so your “landing account” gets pre-diverted to investments before withdrawing or paying cards off from it can make immense sense. Schwab Investor Checking is still the best checking account, though you’d probably want to use a credit union like Alliant over Capital One these days.
If you’re in business, sooner or later you should learn accounting. Maybe you’d do well to learn it on a e-learning site, but I think it’s the perfect college course to take: it lends itself perfectly to university format. If you’re an undergraduate, I think accounting is a no-brainer course to take. If not, your local community college probably has it very affordably. It really does benefit from practice and being graded by the instructor, as opposed to self-grading.
***
LESS OBVIOUS IMPLICATION: THE INVISIBLE LINES
Now here is the more difficult implication; more difficult basically by definition.
For 200,000 years, humans didn’t have quality money.
For 1,200 years after quality money, we didn’t have modern accounting.
What else are we missing?
I’ll quote that remarkable line again –
“Accounting makes it possible for capitalists to evaluate rationally the consequences of their past decisions.”
You can gain a lot of Temporal Control by reducing your wildness and getting an accurate accounting of your finances.
And you should do that, yes.
But over and beyond that, how do you develop a more rigorous and rational thinking? This is what we really want; accounting is just one particular sub-skill of numeracy, rationali
ty, measurement, and diligence.
Greg Nance shared a very good post on mental models with me recently –
https://medium.com/@yegg/mental-models-i-find-repeatedly-useful-936f1cc405d#.i2aj2ajkj
Gabriel Weinberg, the author, is a terrific thinker and his old archives are worth reading, too.
Whilst on the topic, you should probably also read “The Intelligent Investor” by Benjamin Graham if you want to understanding investing, and “One Up On Wall Street” by Peter Lynch if you want to hone investing skills more while understanding the handcuffs that public money-managing institutions face (a big part of why the Efficient Market Hypothesis is wrong).
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