In my practice, I often meet with small business owners who have the entire life savings and family fortune tied up to their company. For many of them, their business is the only way out to retirement. With this post, I would like to offer 6 saving & investment practices all business owners should follow.
Having all your eggs in one basket, however, may not be the best way to manage your finances and family fortune. Think about bookstores. If you owned one 20-30 years ago, you probably earned a decent living. Now, bookstores are luxuries even in the major cities like New York and San Francisco. Technology, markets, consumer sentiments, and laws change all the time. And that is why it is vital that you build healthy saving and investment routines to grow your wealth, protect your loved ones and prepare yourself for the years during retirement.
I always advise my clients to start saving early and make it a habit. Saving 10-20 percent of your monthly income will help you build and grow your wealth. For instance, by starting with $20,000 today, with an average stock market return of 6 percent, your investments can potentially accumulate to $115,000 in 30 years or even $205,000 in 40 years.
Saving and investing early in your career can build a buffer to correct for any sidesteps or slip-ups. Starting to build your wealth early will provide the necessary protection against market drops and economic recessions and prepare you for large purchases like a new home, college tuition, a new car or even expanding your business.
Build a Safety Net
Life can often be unpredictable in good and bad ways. Having an emergency fund is the best way to guard your wealth and maintain liquidity for your business. I typically recommend keeping 6 to 12 months of basic living expenses in your savings account.
Even though my firm does not offer insurance, I often advise my clients especially those who are sole bread earners or work in industries prone to accidents to consider getting life and disability insurance. A good insurance will guarantee a protection and supplemental income for yourself and your loved ones in case of unexpected work or life events.
Manage Your Debt
The last eight years of friendly interest environment has brought record levels of debt in almost every single category. Americans now owe more than $8.26 trillion in mortgages, $1.14 trillion in auto loans, and $747 billion in credit cards debt. If you are like me, you probably don’t like owing money to anyone.
That’s great, however, taking loans is an essential part of any enterprise. Expanding your business, building a new facility or buying a competitor will often require external financing. Keeping track of your loans and prioritizing on paying off your high-interest debt can save you and your business a lot of money. It may also boost your credit score.
Set-up a Company Retirement Plan
The US Government provides a variety of options for businesses to create retirement plans for both employees and owners. Some of the most popular ones are employer-sponsored 401k, self-employed 401k, profit-sharing, SIMPLE IRA and SEP IRA.
Having a company retirement plan is an excellent way to save money in the long run. Plan contributions could reduce current taxes and boost your employees’ loyalty and morale.
Of the many alternatives, I am a big supporter of 401(k) plans. Although they are a little more expensive to establish and run, they provide the highest contribution allowance over all other options.
The maximum employee contribution to 401(k) plans for 2017 is $18,000. The employer can match up to $36,000 for a total of $54,000. Individuals over 50 can add a catch-up contribution of $6,000. Also, 401k and other ERISA Plans offer an added benefit. They have the highest protection to creditors.
Even if you already have an up-and-running 401k plan, your job is not done. Have your plan administrator or an independent advisor regularly review your investment options.
I frequently see old 401k plans that have been ignored and forgotten since they were first established. Some of these plans often contain high-fee mutual funds that have consistently underperformed their benchmarks for many consecutive years. I typically recommend replacing some of these funds with low-fee alternatives like index funds and ETFs. Paying low fees will keep more money in your pocket.
Many business owners hold a substantial amount of their wealth locked in their business. By doing so, they expose themselves to what we call a concentrated risk. Any economic, legal and market developments that can adversely impact your industry can also hurt your personal wealth.
The best way to protect yourself is diversification. Investing in uncorrelated assets can decrease the overall risk of your portfolio. A typical diversified portfolio may include large-, mid-, small-cap, and international stocks, real estate, gold, government, and corporate fixed income.
Plan Your Exit
Whether you are planning to transfer your business to the next generation in your family or cash it in, this can have serious tax and legal consequences. Sometimes it pays off to speak to a pro.
Partnering with someone who understands your industry and your particular needs and circumstances, can offer substantial value to your business and build a robust plan to execute your future financial strategy.
The article was previously published in HVACR Business Magazine on March 1, 2017
About the author: Stoyan Panayotov, CFA is a fee-only financial advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to individuals and families.