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!