Tuesday, June 29, 2010

Get rich quick(er) with your own business

Growing up, my idea about investments was very simple: you buy stocks, hope they go up, and that’s about it. Depending on the source, stocks were said to offer 7-9% return after adjusting for inflation, and that sounded pretty good to me compared to anything else I knew. Of course at this pace I would never get really rich by owning stocks, but that wasn’t my aim either (especially as I figured I’ll be making tons of money by working hard and becoming a CEO of a major corporation in any case before I turn 40!)

As my ideas about saving and investments were rather rudimentary, I didn’t keep any real stats on my success and therefore don’t even know for sure if I my stocks were returning that 7-9% or not (how sad!). I did start keeping track a bit more systematically since the mid of 1997, but still only followed up the total value of my investments. Due to this, I can only say how quickly (or slowly) my net worth went up, but cannot tell which part of this was the return on my previous investments and which part was new savings. The new savings were typically quite little, though, and knowing that my net worth went up by average 11% a year in 1997 – 2004, the returns on existing investments seem to have been around that 7-9%.

Having all my investments in stocks, the ride was pretty wild. In 1997-2000 my net worth went up 18 – 39% each year which felt great! Then came the dot.com bust and my net worth took a dive: -17% in 2001 and another -5% in 2002. I still remember how sickening it really felt. In 2003 – 2004 I got back to 12 – 14% annual net worth growth, but I think much of this was due to the dive of 2001 – 2002: having gone through those stomach churning two year, I was now saving much more than before. Even if it still wasn’t much, it was enough to have a visible impact on my net worth of about $220,000 of that time (including the $100,000-or-so equity tied up in my own house). I was very happy about this and the increase in my net worth, but having to save more money just to see it return by average 7-9% a year did not feel that exciting.

When I started planning my real-estate business in 2004 – see more of these plans in the previous two postings on this blog – something really struck me. Based on the data I gathered and calculations I made, it seemed that the returns on equity I would get from my real estate business would be way to high to be correct. All my calculations seemed to point to returns of 20 – 40%, depending on the assumptions and scenarios. I was wondering if I was somehow making a huge mistake somewhere, as 20% average returns – these were with my most pessimistic and conservative assumptions and scenarios – seemed way to low. Therefore I checked and re-did my data and figures again and again, but the results did not seem to change. Quite the opposite, the more I worked on the figures, the more convinced I became that my math was correct and the opportunity was just simply huge – much bigger than I had every expected.

In order to be sure, I started checking a bit what type of returns on equity small businesses could offer. I soon found out that while the spectrum of returns was really wide, well-managed small businesses could often and easily return 20-40% on equity. I was appalled! How come no-one had ever told me this before (or how come I hadn’t been listening if anyone every actually had mentioned that to me)?

This may help you understand why I was so hot in getting started in 2004. I was a bit anxious, though, as I still found it a hard to believe that those kind of returns would actually materialize. Fast forward to the mid of 2005 – and now I just couldn’t believe that it was really happening! What I was seeing was exactly the kind of figures I had estimated in my scenarios. In 2005 the ROE I calculated for my real-estate business ended up around 40% and again the same in 2006. This didn’t even reflect the real estate boom, as I didn’t use actual market appreciation to calculate the ROE’s (instead I used long-time average appreciation figures, knowing that what’s going up will come down).

This experience has continued – even through these past couple of years of real estate bust – so you can understand that I am a huge advocate of people setting up their own businesses. Funny enough, while my own experience was a catalyst to this, my real enthusiasm comes from what I since learned from others. Ever since I started, I’ve been on search for data on the profitability and characteristics of start-ups and small businesses. What I have found is that while every business situation, start-up, and entrepreneur is different from each other, people who understand their businesses well, are enthusiastic about them and therefore work hard to make them successful, tend to get very high returns on equity in their businesses.

This is why I am so convinced that your own business can easily be also your best investment. If you set up your own shop in a field that you understand very well, there is a high chance that you can make it very successful and get those higher double-digit returns you could only dream about in the past. I’m not saying this is easy, and yes it sure is quite a bit of work, but again it’s really worth it. Few experiences can beat the satisfaction – or returns -you can get out of this!

Tuesday, June 15, 2010

Saving for the sunny day

In the spring of 2004 I was a man with plan. I had a purpose, I had a destination, and I was in a rush to get there. I figured I’d just need to buy some real estate – my first property – and then the rest would follow pretty much automatically!

I was spending tons of time trying to understand what kind of property exactly I should be buying and how to get the money to buy it. Pretty soon I concluded I’d need to be buying a multi-unit apartment building. While there were several reasons for this, the main one was the profitability: in my part of the world, managing a multi-unit property offered much better returns than what was available from individual houses or condos. I was glad I had figured this out, but it also gave me a real headache. This kind of properties required a much higher initial investment than houses or condos, and I didn’t have enough savings to get a reasonably priced mortgage to finance my purchase. In my area banks wouldn’t deal out a mortgage for the full purchase price of a property without adding a hefty premium to the interest rate. With the premiums they were asking, it would have made little sense to invest at all. I simply had no way around it: I was in an urgent need to save much more money to get my real estate business going.

I had never been a big spender, in my own opinion, and certainly didn’t feel there were many expenses I could have skipped or postponed in order to save more money. Yet, as I was dying to buy some real estate, I figured I’d have to find something. So I set about analyzing my income and expenses, in order to find some money to save.

First, I carefully detailed my – and my wife’s – sources of income. As for most people, this was a relatively simple and quickly done. Two salaries, and that was about it. Sure there were a few other minor pockets of income contributing to my household’s budget: a few hundred a month from a very minority interest in a family business, some regular dividends from the shares I owned, some occasional bonuses from my employer, and so forth. Yet the amount these things contributed seemed small and felt therefore almost negligible.

On the expense side, the story was more complex. First of all, it took a while to even understand where my money really went, on a monthly or annual basis. Tracking this down wasn’t difficult, but it sure was time-consuming. I found a few good hints and templates on the web and used them to come up with a comprehensive list of expense categories plus an exact or estimated amount for the monthly or annual spend in each category. I then compared the total spend to my bank account records, and as the two seemed to matching pretty closely, I decided my analysis was accurate enough for my purposes.

I had never before done proper budgeting in a holistic way, but still thought I had a pretty good idea of my income and expenses. While the results of my analyses mostly proved this correct, there were also some real surprises there. First, the total of my average monthly spend was a fair bit higher than I had thought. There were some items where I spent much more than I had expected. This had been masked by the fact that also my average income was higher than I had thought. In brief, I had never properly factored in the bonuses and other similar “extras”, and accordingly had also failed to notice where some (or much) of this money had gone.

With this, I saw that while my expenses were mostly reasonable, I was really spending away for traveling and vacations, and it had only gotten worse over the past few years. While I was far from being prepared to give up my traveling – I really enjoy seeing and experiencing new places near and far – I sure was ready to scale it back. In a similar way, I noticed some of my other favorite pastimes – mostly sports – were eating up a disproportionate part of my income. Again, I felt I could cut back in these without losing the essence of the pleasure I got out of them. With these and a few other smaller pockets of extra spend, I found much more money than I had ever expected. This felt fantastic!

So, having found all this “new money”, I only had one more challenge left, but this was the kind of one that could really stop my efforts unless properly addressed. If I wanted to save more money – or really proceed with any other parts of my plan either – my wife would have to be part of the picture. The problem was I wasn’t sure she would be really buy into my plans, especially to the the need-to-save-more-now part. Luckily, I felt she would agree – maybe a bit reluctantly, but still – if I just laid out the whole plan to her. So one evening I took the steps to explain to her what I had in my mind and where she’d need to help me out. As expected, she wasn’t excited about the need to save more, but agreed to give it a shot. However, more surprisingly, she had a lot of questions about my real estate business plan and really wondered if I these plans were realistic at all.

So, good news: my main stakeholder had signed up for the plan to considerably increase the level of our monthly savings! The bad news: while she subscribed to the purpose of my plan, she wasn’t convinced at all that my assumptions hadn’t been overly optimistic. After some discussion, I just decided to get going with the first part of the plan and not worry about the second part just yet, but tackle it a bit later, even if still very soon.

I made the necessary changes to my spending patterns and worked with my wife to tackle the parts that required her contribution. Actually, this turned out to be easier than expected, as our purpose was so clear and motivation strong. Also, the rewards came in very quickly: in just a few months’ time, our bank accounts started to show behavior and balances that had been rarely seen before, and this sure gave a further great boost for our motivation. Our feeling was that now – for the first time ever – we really had grip of our finances. While we didn’t really have a lot accumulated let, it felt it would be just a matter of time that this would dramatically change.

So far so good: the savings were now accumulating and my ability to get started with the real estate business seemed ascertained. However, my assumptions and knowledge concerning the planned business itself had been questioned, and to be honest I knew my wife had a point there. I had never owned any real estate other than our own house and certainly had no experience in putting together successful real estate deals, managing tenants, or doing many of the other things that this new business would require.

Starting a new business is always risky, especially if it’s the kind of one you’ve never managed before. However, I quickly found out there are many ways to mitigate this situation, and while you cannot take away all the risk, you sure can reduce it and make it manageable. My firm belief is now that owning a business is one of the best and least risky ways to make the journey to your first million, despite the challenges and requirements it brings. More than that, I am convinced it’s actually a necessity, an essential component for the vehicle you’ll need for your journey.

In my next posting in a few weeks from now I will explain why I think you too should set up your own shop. I will also discuss how to do this without having to quit your current job, and how to pull off starting your own business without a risk of killing yourself – or at least your finances – in the process.

Meanwhile, if you’ve read my first three postings – including this one just now – but haven’t done anything yet to get started on your journey, I’d say: GET STARTED NOW, DUDE! (Please note that in my vocabulary “dude” is a unisex word.) The goal is worthwhile, the journey isn’t that hard, your chances of success are high, and the results are rewarding. That’s why today is a better time to start than any other. Get a grasp of your finances now, start seriously saving for the sunny day (will also take away your need to save ever again for the rainy day!) and read the next posting to get going with your next steps too!