Double Dose of 7million7years! Please check out my FIRST EVER Guest Post … it’s at BripBlap, a blog that should be on your DAILY READING list: http://www.bripblap.com/2008/guest-post-education-a-curse-or-a-cushion/
In a few weeks, I was planning an ‘expose’ of a book that I read , but just came across a related post by an innovative thinker who calls himself Gryffindor (presumably, named after one of the Hogwarts Houses in Harry Potter) so I can’t resist but to weigh in now …
And, I’m going in boots and all!
First, here is what Gryffindor had to say – which I actually like because it is innovative and a little controversial:
So if an investor has 2 million at the age of 55, what does the conventional wisdom say? He could invest it and with a safe withdrawal rate of 4% count on $80,000 a year. 2 million of savings – with that all you get is a 80k a year. No wonder most people are depressed about retirement.
Now what if the investor takes a million of his nest egg and buys [a] business? She gets $200k of cash flow a year that is growing at 3% to match inflation. She can also reinvest the additional earnings from the other $1 million. She also gets some additional tax benefits of owning the business and can have some productive part-time hobby / business and not just spend her time on the golf course. It sounds all good to me.
And, here is part of my response that I posted on his blog post:
This is such an important topic that I am going to post a response on my blog [which you are now reading!] … I would really like to set up some debate on this because it is a very useful – but, potentially highly dangerous – retirement strategy that really needs to be well thought through before anybody implements.
Rightly or wrongly, some people just see me as a guy who ‘got lucky lucky in business’ (AJC: most of my $7m7y Net Worth actually came from investments … my leter/additional Net Worth came from selling some businesses), so it might seem natural when I say that Gyffindor actually appears to be onto something that is one of the central ideas in a recent book called Get Rich, Stay Rich, Pass It On.
The principle is that rich people keep their money for generations ONLY if they split their assets roughly one-third in a business, one-third in paper (stocks, bonds, mutual funds, etc.) and one-third in real-estate (incl. their own home):
Then, you might be surprised when I say that this is “the most dangerous idea in retirement planning that I have read”!?
What the book is recommending, that I find so damn dangerous for retirees, is this:
The authors of Get Rich, Stay Rich, Pass It On suggest that you need to invest, and keep invested forever, 25% – 35% of your Total Household Assets into ‘continually innovative enterprise/s’:
What we mean here by a continually innovative enterprise is one that either offers a product or service that breaks new ground or changes a traditional product or service so much that it becomes virtually new.
Now, that is something that you do before you retire so that you can retire rich … you take risks, you innovate, then you sit back and reap the profits (or sell) …
… it is not something that you get into in order to preserve wealth, which is exactly what the authors suggest:
At the lowest level of personal involvement, you might invest in a limited partnership, private equity plan, or venture capital program in which the actual management of the enterprise – possibly even the choice of the enterprise to invest in – is beyond your reach and outside your control.
Put simply: this recommendation is crazy …
… in my opinion, it unfortunately totally discredits an otherwise fine book written by authors who are respected consultants who assess the wealth habits of America’s mega-rich for the financial planing industry.
to me it seems that they are confusing the Making Money 201 wealth-building practices that rely partially on risk-taking strategies that may include a business – or, at least look a lot like a business (e.g. rehabbing/flipping real-estate; trading stocks/options etc.) …
… with the Making Money 301 wealth-preserving (i.e. retirement) practices that move you away from risk towards passive income!
So, is there a place for owning a business in a wealth-preservation strategy?
I think that I speak with some authority on this: I have owned, operated, and successfully sold a number of businesses across a number of countries, many of which I owned at the same time!
I was an active owner in some and am still a passive owner in others …
Now that I am retired before 50, I am giving one part of a business away to my partner, converting another part into a ‘licence annuity’ that I will keep, and I am also keeping one other operating business as a semi-passive entity.
This last one is interesting, as it appears to support the thesis in Gryffindor’s post and the book that I mentioned:
This business is still in another country … it’s a finance company that turns over $40,000,000 per year with a only staff of 4 and nets me a cool $250k per year with about an hour’s work a month from me … I control it (through various legal entities) 100%!
Even so, here is the fundamental truth:
There’s no such thing as a PASSIVE business – as long as you own a business, you:
1. Will lose sleep every so often until it is sold or closes down, and
2. You will NEVER be truly retired.
As long as you can accept this level of semi-retirement worry and activity (which may actually HELP to keep you young!) then the Gyffindor Strategy could work for you, BUT:
i) I could accept owning in retirement: Big Name Franchises; Self-storage facilities; Mobile-home parks; Car-Washes; Your own well-established business that you are now ‘winding back on’.
ii) I would be a lot more concerned about: auto-repair and other skill-based businesses OR ‘vanity businesses’ – you know, the types that celebrities like to own (e.g. restaurants, bars, etc.).
iii) You would need to set out to have the business/es that you select run without you from the very beginning.
If you like the idea of owning a business in ‘retirement’, here’s a hint:
This strategy could hold a lot more attraction for you if you can also own the real-estate that the business operates from!
A. It assures the rental stream,
B. It assures at least some capital growth,
C. It hedges your bets against business failure (particularly if you plow excess cash generated by the business into the mortgage),
D. It provides a partial exit stream i.e. sell or give the business to management or a buyer under the condition of a long-favorable lease with upward-only ratchet clauses (rents increase at least with inflation).
A final thought:
I mentioned that I will continue to own at least one business now that I am fully retired:
– I founded this business and have owned it since 1991 … it has successfully run without my direct involvement for more than 5 years.
– I tried to sell it anyway, but it was only worth 3 times annual Net Profit before Tax … for that I will keep it for three years and take my chances!
– If I do happen to find a buyer who will pay me 5 or 6 times annual Net Profit before Tax, I will sell it.
– I do not count this business’s income towards my retirement portfolio’s ‘safe withdrawal rate’ because anything can happen with a business at any time … rather, I use the profit to build my portfolio’s total value, and spend the passive income from that.
If I do eventually sell it, THEN I will increase my portfolio’s withdrawal rate because I will have converted the business into a passive investment (cash, stocks, or real-estate).
Phew! This is one of my longest posts … so, now it’s your turn to comment!