Three pillars of financial success

By David McEwen

Monday 11th February 2002

I recently came across an interesting article by US businessman Mike Duffey that extolled the virtues of network or multi-level marketing. While these have been abused over the years, and are sometimes just disguised pyramid schemes, there are others that are spectacularly successful with good products and increasingly wealthy network members.

But this is not a story about network marketing. What struck me about Duffey's article was that many of the principles that spell success in network marketing can be applied to investing generally.

Duffey talks about the "three pillars" of success, which he lists as:
- residual income
- leverage
- geometric growth

Network marketers achieve success by persuading others to purchase their company's products and encouraging their customers to on sell products to people they know. When such sales are made, a percentage of the income goes up the chain of suppliers.

This enables some people with large networks to make money without having to do any work, if they want to. This is known as residual income because it comes in regardless of the earner's efforts.

This principle also is a pillar of success for investors. When capital is accumulated then invested, income or profits go the owners without them having to do any further work. A person can only do so much work. After that, they need to get their money working for them.

The second pillar is leverage. Network marketers gain leverage by persuading others to do the selling for them. One person can only achieve so much. A hundred or a thousand people working for the same goals can do so much more.

Where investment is concerned, leverage can come from borrowings. The most common use of leverage is taking out a mortgage on a property. If income (from rental) and capital gain each year is greater than the cost of borrowing, then investors can bolster the returns on their original investment.

Let's look at someone who takes out a $180,000 mortgage at 7% on a $200,00 house. A year later the house is worth 10% more. After paying interest on the mortgage, the investor would be left with a 37% gain on their $20,000 investment.

The third pillar is geometric growth. Network marketers achieve this by encouraging those who buy their products to find other customers. If a marketer has six buyers and each of those people start supplying six customers - the marketer can enjoy an income stream from an extra 36 buyers, making 42 instead of six. If the 36 new customers each start selling to six friends and relatives, the marketer can tap into another 216 customers, bringing the total to 258. This is the same principle as pyramid schemes but, because it involves the purchase of products rather than simply the passing money up the chain, good networking schemes don't fall over under their own weight.

For investors, the nearest equivalent to geometric growth is compound returns. If someone starts with $10,000 and gets a 10% return on it, they end up with $11,000. That is hardly something to write home about. However, if they start with $10,000 and get a 10% return every year for 30 years, they would end up with nearly $175,000. Now that's good news.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz.

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