The Milk and Muscle Theory

Megan is a good friend of mine with a nagging headache.

We recently caught up for lunch when she asked what I thought was the ‘best super fund’…and I immediately started talking about ‘paddocks and cows’.

That’s when I got the “WHAT?!”, response!

Anyway, I said there is no ‘best super fund’. It’s a myth.

Instead, I suggested super is just a tax effective ‘paddock’ and the only difference is what you put in that paddock.

And when Megan asked what she should put in this so-called paddock, I simply said, ‘cows’.

To prove I wasn’t playing her, I explained the ‘Milk and Muscle Theory’.

The Milk and Muscle Theory is a very simple idea I put together about two years ago for a webinar. Its purpose was to explain the two ways people invest.

As the name suggests, the theory is analogous with Dairy Cattle (milk) and Beef Cattle (muscle).

This is how I explained it to Megan.

Beef Cattle: suppose you’re a beef farmer. Your model for making money is to buy young calves at a low price (say $200 each) and grow them into much bigger cattle to sell at a higher price (say $1,000 each). The difference is the profit which becomes your income.

But the problem for a beef producer is he’s always up against the vagaries of the markets and the weather (e.g. floods, drought), all of which he has no control over. Therefore, his method of generating an income is riddled with uncertainty.

This is exactly how most people invest. They invest like beef farmers. They hope to buy low and sell high and rely on the profits to create wealth, especially in retirement.

The problem with investing like a beef farmer is it relies on buying the right investment at the right time and then selling it at the right time to maximise your sale price (profit).

“Ok, so whats the alternative?” Megan asks

Dairy Cattle: suppose you’re a dairy farmer instead. Your model for making money is to maintain a herd of dairy cows that get milked twice a day, 365 days a year. The constant milk flow becomes your constant cashflow.

Simply put, when a dairy farmer wakes up on January 1 every year, he knows within close proximity how much milk his cows will produce and therefore what his income will be for the year.

This is the investment approach we subscribe to at Suncow. We recommend clients build an asset base that generates good consistent cashflow, regardless of the markets. It delivers greater certainty.

“So there really is a method behind your madness. But how does this apply to my super?” she asks

It’s very simple.

 

Super Cows
Investing like a dairy farmer inside super is very powerful.

Here’s why.

Suppose you have a herd of dairy cows, and all you do is sell the milk to buy more dairy cows. Your herd gets bigger which means it produces more milk enabling you to buy even more cows. And then it grows again which means more milk, more cows, more income…and on it goes.

If you keep repeating the process by reinvesting the milk to buy more cows, you begin to compound the size of your herd.

And that’s all you need to do with your super. Buy the right cows and keep reinvesting the income every year so you can buy more cows. Just keep growing your herd until it’s time to retire and then live off the income.

BTW…do NOT sell your cows to fund your retirement. Less cows, less milk, less income.

And don’t worry about how much your herd (portfolio) is worth, just concentrate on how much milk (income) it produces.

If you do this, you will never have to rely on the markets to grow your super, nor will you be affected when the markets go down.

Megan interrupts. “If that’s all you need to do, why don’t most people do it?”

“Emotion. When the markets go up people get greedy and then their ego takes over, they start buying and selling. And when the markets drops, fear takes over”

Megan liked the sound of this but she still thinks she needs some beef cattle in her super to make it make it grow faster.

The Great Irony…
Investors are attracted to beef cattle because they love to watch their investments appreciate in value. It makes them feel wealthy and they think its the only way to make money. E.g. when an investment goes from $10 to $20. Negative gearers go though the same thing.

However, the irony is this. Eventually dairy cows become more valuable than beef cows because of their production capacity.

It’s the difference between the goose and the golden egg. The beef farmer just wants to breed a big fat goose that he can sell (and then start over again). The dairy farmer prefers to look after the goose and live off the golden eggs. Make sense?

Beef farmers buy and sell, dairy farmers buy and hold.

But What About When The Market Drops?
Megan asks one of the most commonly asked questions of all…

“If the market falls, won’t my income drop as well?”

Simple answer. No.

Imagine this. You see a cow standing in a paddock happily grazing, making milk. And the next day, the market for cows falls through the floor. Do you think she’s going to eat less and produce less milk just because she’s worth less? Of course not.

If the market drops, she’ll still eat and produce the same amount of milk regardless of how much she’s worth.

It’s the same with the stock market. If the market crashes, do you think people will stop buying groceries, disconnect their gas and power, close all their bank accounts and cancel their phone accounts. Of course not.

The tail doesn’t wag the dog.

The only way to plan for retirement is to build an asset base that spins off plenty of cash without relying on the markets going up.

That’s why investors freak out when the markets drop. They’ve got the wrong strategy in place.

They’re investing like beef farmers instead of dairy farmers.

Too much muscle, not enough milk.

Have a great weekend!

Adam