Putting all the Money in Business

BARRY: Next one you have on here. On Chad’s list, number six: putting all money into the business and not planning outside of the business. It’s not bolded, but it’s a good one.

CHAD: It almost could be bolded. And I do get fired up about this, because it’s the most common response from every single business owner as to why they’re not saving for retirement. And it’s a good response in that the rate of return that they’re getting on their money in the business is more than they’re getting in the market. Or could get in the market. And they are absolutely correct most times in that assumption.

Your business is your most valuable asset while you’re running your business. But one day you’re going to be out of that business. And the problem is that if you’re not planning for retirement in other areas outside of that, what happens if you can’t sell your business? If there’s not a market to sell your business? How do you extrapolate the value from it? What happens if there’s not someone inside the business to turn the business over to and pay you out in installments that way?

We talked about unknowns. We don’t know what that’s going to be. And what if you’re in an illiquid business? What if most of your money is in real estate or something like that? There’s no way of extrapolating the value. Well, if you’re not putting money away into other retirement accounts, you may end up with nothing.

BARRY: I want to expand on that. What you’re mentioning is both exit planning as well as succession planning. Not having an exit or not preparing for one, and not having a succession plan or a key person to take over for your family or a family member to take over. That’s all true. You’re reinvesting in your business thinking it’ll keep growing and hopefully that materializes to something better at some point, but that’s a risk.

CHAD: The only thing is that the money you’re getting from your business, while in linear year-after-year fashion it may be higher, it doesn’t compound the same way retirement planning does, where your money grows on itself every year. You’re getting your money out of the business, but it won’t be compounding in the same sense that it would in traditional planning.

BARRY: And that’s because in business you’re getting a return on equity, you’re not getting a return on money compounded, right?

CHAD: Right.

BARRY: Wasn’t it Warren Buffett — or Freud or Newton or one of these wise people — who said compound interest is the eighth wonder of the world?

CHAD: I always give an example– As you know, I do a lot of financial education to people in graduate programs. And I always talk about the value of compounding money. I always ask: “If you started with a dollar and it doubled every day for a month, how much do you think would be there at the end of the year? And people always yell out, “$1,000! $2,000!” And when I tell them it’s over a million dollars, they’re like, “What are you talking about?” And I say, “Yeah. A dollar is two dollars. Two dollars doubles, four. Four doubles eight. But when you get to those 25th, 26th, 27th days, with $100,000 becoming 200,000. Two hundred thousand becoming 400,000. And I know it’s an extreme example, but it drives home the point of what compounding does do your money when you just let it sit there and do the work for you.

BARRY: Yeah, that’s a really good example. Two things, actually, because that’s a bias. In one of my books I’m gonna share with you another day, it’s called a bias when you can’t wrap your head around something intuitively, that that can possibly be a million dollars in 30 days, but when you put it on paper and look at the data it’s facts. It’s black and white.

And the second thing is, when I was in school, in law school, in my estate and tax planning classes that I took, they did the same kind of analysis, but it wasn’t in terms of doubling money. It was a question on the board: would you rather have this or this in subject to the different taxes. And of course everyone picked the one that on its face looked like your beneficiaries would have more. But in reality with the taxes and with planning the taxes, it was actually a different option. And it was a way to reinforce that there are these taxes to think about.

CHAD: I’ll give you a similar example also. Because when you ask people what’s a good return on your money you might get in the market, they’ll say 8 percent. And that’s a good return. But I’ll ask them: “What taxes are you paying on that money? What fees are associated with that account? And what risks are you exposing yourself to to get that 8 percent?

Because there are plenty of planning strategies out there with less risk where you can get a 4 or 5 percent return but there’s less risk, no taxes, no fees. At the end of the day, that’s the same return as the 8 percent your were getting in the market. But people don’t think about that net number. The 8 percent is what you’re telling your buddy at the bar when you’re having a beer. And they don’t say, “What did you actually keep of that 8 percent?”

BARRY: Isn’t that the age-old saying in business? “It isn’t what you make, it’s what you keep.”

CHAD: Right.

BARRY: I see that a lot.