Before I begin this post, I wanted to thank all of the people who submitted responses to last week’s request for my blog survey. The survey has 14 (mostly multiple choice) questions, and I received quite a few responses, enough that I will compile the results and I will provide an update of all of the answers in next week’s post. If you haven’t submitted a response, then it isn’t too late … I would really appreciate your input, and it shouldn’t take more than 5 minutes. You can find the survey here.
And now, back to regular programming …
For those who have been reading my posts long enough, and especially those who have read my book, The Kickass Entrepreneur’s Guide to Investing, you will know that I’m not a big fan of an entrepreneur working with an investment advisor.
Yes, my bias is based on my negative experience of having spoken and worked with quite a few advisors over the years, and in late January of this year, I fired my advisor. I fired this particular advisor because I just didn’t feel she was asking the right questions (it was a fairly short-lived relationship anyway).
In the last 40 years of investing, I’ve worked with maybe four advisors, one of whom I am still working with, so it’s not like I have a long list of advisors that I’ve thrown to the curb, BUT over the last twenty or so years, I’ve had dozens and dozens of conversations with different advisors who have cold-called me to discuss their philosophy and to pursue me as a potential client.
The conversation invariably starts with me asking how their investment philosophy is any different from all of the other advisors out there.
For the most part, all of the advisors have a similar philosophy. They each have their unique blend of stocks and bonds that they recommend, but rarely, if ever, do they view the wealth that an entrepreneur already has tied in their business as part of the overall asset allocation strategy.
The holy grail of an asset allocation strategy has uncorrelated assets that have been optimized for tax, across multiple currencies, that can produce a steady stream of annuity income, with enough cash set aside for the entrepreneur so they can take advantage of opportunities as they arise.
When I mention this to an advisor, they look at me like I’m from another planet.
The advisor makes money on assets they invest. It isn’t in their interest to look at your portfolio holistically, including any existing real estate—or your business for that matter—and suggest that maybe you should hold extra cash because you have too much invested in equities already. And yes, your business should be included as part of your overall mix.
I also suggest that if you live below your means (think of the book The Millionaire Next Door), maximize your business’s growth and profits, reinvest those profits back into your business and your own investment real estate portfolio, it is very possible to grow your wealth into the millions, and even tens of millions, of dollars.
The average employee salary in North America is around $60,000 a year. If you manage to save $10,000 a year and invest all of your proceeds into the stock market at a 9% compounded year-over-year return, after 30 years, you’ll have $1.36 million dollars, which is definitely a decent amount.
If you have loftier ambitions that reach into the multiple millions, or tens of millions, then you have two levers that you can adjust:
- Invest more
- Produce a better return
Enter the Entrepreneur
As an entrepreneur, you can grow your wealth as you grow your business’s profits and improve your returns, but there’s also an extra lever you have at your disposal … the value of the business itself.
As an employee, no matter how well you do at your job, unless your company offers some sort of equity arrangement, you might improve your salary and position in the business, but you’re not building wealth that can be sold.
An entrepreneur not only has the advantage of growing profits and leveraging additional team members to expand the business, but the business itself has value. In some cases, the business has tremendous value that can make the entrepreneur an instant multi-millionaire.
Let’s say you start an elevator repair business a few years after college. You start with $30,000, and you manage to grow the business from a fledgling start-up with one employee, you, to a 20-person operation doing $5 million in revenues and $500,000 in profits by year 20. (That’s no small feat, by the way, so congratulations if you’ve managed to get there.)
The average service business that has a large percentage of recurring revenues will have a valuation anywhere from 4 to 6 × EBITDA (earnings before interest, taxes, depreciation, and amortization), so the $500,000 in profits will value the business anywhere from $2 to $3 million. Let’s round this number at $2,500,000.
Enter Asset Allocation and Diversification
My recommended asset allocation portfolio looks something like this:
1/3 real estate
1/3 equity (business value)
1/3 cash (fixed income, bonds)
In the above example, since the entrepreneur has so much equity in the business, I’m going to suggest that they shouldn’t invest additional dollars into the stock market. Any extra cash should be invested:
– Back into the business to grow the business
– In investment real estate
– As cash on hand (fixed income investments, bonds)
Investment Real Estate
If this entrepreneur managed to put aside $300,000 as a 30% down payment toward a $1 million apartment building, it is possible that after 10 years, the building can be worth $2 million. I’m not going to explain in great detail in this blog post how you can turn $1 million of real estate into $2 million, but I do explain that here and in much greater detail in my book, here.
After 10 years, the building’s $700,000 mortgage will now be approximately $400,000, so the initial $300,000 investment will now be worth $1,600,000 ($2 million − $400,000 mortgage = $1,600,000).
Assuming the entrepreneur has been diligent with putting cash aside into the third bucket, it is possible that by the 20th year, the entrepreneur is able to live off the salary provided from the business and invest the bulk of the business’s $500,000 profits into the cash bucket.
Keep in mind, I did explain that the business grew to $500,000 in profits by the 20th year, so economic fluctuations aside, the business would have conceivably produced $480,000 in profits in year 19, perhaps $470,000 in year 18, $450,000 in year 17, and so on.
Again, if the business owner manages to live off the salary provided by the business and manages to invest the business’s profits into 1. real estate, 2. the business itself (for growth and acquisitions), and 3. cash, then it is very possible that by the 20th year, this business owner has a wealth formula that looks something like this:
Business Value = $2,500,000
Real Estate = $1,600,000
Cash = $2,500,000 (conservative assuming the profits as discussed above)
This business owner started the business with $30,000. By year 20, the entrepreneur has $6,600,000 in assets (net worth), not including their primary residence and other assets. This equates to a 31% compounded year-on-year return. This business owner managed to turn $30,000 into $6,600,000 in 20 years.
Point 1: Building a business isn’t easy.
Point 2: Building a profitable business is even more difficult.
Point 3: Being disciplined, living below your means, despite all of the temptations to buy all the fancy toys that come with large profits, is most challenging.
If you want to build wealth, you need to focus first on point 3. LIVE BELOW YOUR MEANS. This one is the most challenging because it requires consistent discipline.
Then, focus on point 2 and build profitability into your business. It isn’t acceptable to forgo profits, year after year. Your business should make at least 10% profit (as a percentage of revenue).
Then, last, focus on growing your business’s revenue.
Building wealth isn’t easy. It is definitely possible though.
A quick reminder, once again, that if you can spare 5-minutes, I would appreciate your feedback on my blog survey. You can find that here.
In this post, I mentioned a book, which happens to be one of my favorite business books of all time, The Millionaire Next Door. You can get more info on that book here.
If you found this post interesting, you might like this one I wrote a few months ago: My Response to an 18-Year-Old Who Wants to Become a Millionaire by the Time He’s 30
To your success,