Finance is all about trade-offs. If you buy a new couch, you’re forgoing the opportunity to put that money into your savings account. If you decline to work an extra shift so you can spend time with your family, the extra money you could have made is the trade-off for the quality time that you experienced. The decisions we make in trade-offs determine both our short-term and long-term well being.
One of the most formidable trade-offs associated with owning your own business is the subsequent lack of corporate financial power. You trade in a steady salary and in many cases a retirement plan for the freedom of being your own boss and controlling your own career. But does this have to be a one-or-the-other, black and white scenario? Contrary to what many believe, there are actually ways to dip into that gray area and work towards the financial stability of the “company man,” all while still enjoying the freedom of an entrepreneur. These 5 wealth-building tips for business owners could help you do just that.
1. Live within your means. I know—duh! However, this seemingly uninteresting piece of advice is by far the most important of these five tips. As a financial planner, I can assure you that debt is an anchor to building long term wealth. You may to have a mortgage, and a rule of thumb for the general public is to spend no more than 20% of your gross monthly income on your mortgage payment. But business owners should consider being even more conservative on this estimate—15% of your net monthly income may provide a better balance. Then you have auto-payments, a mortal enemy to wealth building. Instead of getting a new car once yours is paid off, consider continuing to drive it, and use the money that would go to a car payment to work towards building wealth. In short, if you are a business owner, you should consider keeping mortgage payments under 15% of your NET monthly income, and drive your car until it falls apart.
2. Trick yourself into saving and start early. As a business owner, you probably won’t have the privilege of enjoying a 401k match, pension plan, or stock options. Saving is a mindset, and it takes a little discipline to be good at it. Above all else, you must maintain a healthy balance in a personal savings account. You likely take more risk than the average corporate employee, so it’s very important to keep extra money for a rainy day. Next, ensure that you have ample savings in a business account. Once these two protective measures are met, you can work towards building your long-term net worth. Retirement saving should be as mandatory and routine as paying the electric bill, and it should start in the same year you open your business. If you want to take a risk in your business, go for it—but you should only consider doing so after you meet this very important step each month. Let’s say you save $250 each month. Earning 7% for 30 years, you would accumulate just shy of $305,000. To throw fuel on the fire, if you increased your savings every year by 3% (the historical annual rate of inflation), your thirty year result would be roughly $400,000. On the other hand, if you waited just five years to begin saving, the end result would only be roughly $250,000 after twenty five years—a 38% difference. Use the snowball effect to your advantage, and capitalize on the potential benefit of compounding interest. Most small-business retirement plans can be automated, allowing you to potentially retire with a chunk of change without ever even feeling it. Oh, and did I mention there are potential tax breaks in this area? Talk to a financial advisor, and he or she will work with your CPA. Start saving as soon as possible and do it regularly and automatically if possible.
3. Stay ahead of inflation. “When I was your age, I could feed a family of four for $4.50.” It’s something we’ve heard our parents and grandparents say numerous times, and if you’re old enough, you may have experienced this yourself. Years ago, a family of four could go out to eat for a lot less, but people also made a lot less too. Generally speaking, salaries and the cost of goods increase at about 3% each year. It’s normal; it’s been happening since economics was a thing. In most cases it’s nothing to worry about, unless you have too much cash on the sidelines, which can dramatically reduce your purchasing power over an extended period of time. There is a very delicate balance between “too much” and “just enough,” and that amount varies for each person and their unique individual life goals. Don’t let the inflation work against you. Put excess cash to work.
4. Consider owning your real estate. In a low interest rate environment, it is often advantageous to elect longer-term loans. Long-term rates today are a fraction of what short-term rates were just a few years ago. We are in a unique borrowing environment. If you rent your building, consider borrowing some money and buying your space. In many cases, physical property is the main bulk of valuation when it comes time to sell a business. By not owning your space, you are missing out on having the potential to build valuable equity. In many cases, I would expect a loan payment on property to only be marginally higher than the cost of renting. Remember, your landlord isn’t likely to lose money if you stay in business, so consider being your own landlord.
5. Don’t overestimate your brand. Selling a business can be rather difficult, and business schools across the country teach a litany of ways to value a business in question. Many include placing a value on future earnings. In financial planning meetings, business owners often tell me that their business is their retirement plan. Sometimes that works, but other times it is a fatal mistake. There is value in a brand and intellectual property, but don’t underestimate your value to the business. If your sales revenue is largely tied to your relationships and connections, after you bow out your business loses its most valuable asset. In other words, your business is probably worth more with you at the helm, so don’t lean on it to provide you with wealth. Consider it a supplement to what you’re doing independently, and use other methods to work towards building your wealth. Don’t rely on your business to handle all of the heavy lifting.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All illustrations are hypothetical examples and are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing. Investing involves risk including the loss of principle. No strategy assures success or protects against loss.