This is one of the most difficult questions if you are a business owner and, like most business owners, it is your primary source of income.
You might say, of course it’s your primary source of income .. that’s why I’m in business! But, that is the fallacy that we will be exploring in upcoming posts.
For now, let me tell you about a conversation that I had with a friend over dinner last night:
My friend said that he had a friend who owned a payday lending business – sounds a bit unsavoury to me, but generates mountains of cash for him.
My friend’s point was that this guy would admit that he’s not very smart, but has a very simple system for dealing with the $3 mill. that his business spins off every year:
1. He gives $1 mill. to Uncle Sam
2. He invests $1 mill. (my friend didn’t ask where or how)
3. He spends $1 mill.
But, it’s also wrong …
What would happen if the business had to close down tomorrow (e.g. change in government regulation)?
Unless this guy had managed to save $20 mill. to $40 mill. he wouldn’t be able to keep up a $1 mill. lifestyle (common wisdom says that you should only withdraw 4% from your portfolio every year … I say about half that) …
I believe that it is 10 times HARDER to go backwards in your life (in the event of a financial disaster like if this guy’s business had to close down) than taking a slower run-up in lifestyle in the first place.
This is what I did:
I always drew a minimal salary and tried to live at the median level of the circles that I moved in (for me, this was upper-middle-class college educated professionals).
When my businesses started throwing off more money than that, I invested EVERY penny of the rest, in my case mainly into: (a) reinvesting in the business to expand it, and (b) opening new businesses (3 more), and (c) passive real estate investments.
As I built up equity in (c) – I ignored the ‘value’ of any business until I sold it – I used my ‘divide by 20 – 40 rule’ to decide how much I could spend each year.
Maybe my friend’s friend should have given $1 mill. to Uncle Sam, spent $250k a year to start off with, and invested the rest?
Maybe, after a few years, if financial disaster struck it wouldn’t matter any more what happens to his business …