In recent blog posts, I’ve pointed out some flaws I see in the Mr. Money Mustache and Bogleheads philosophies for preparing for retirement.
Accordingly, this post talks about a third approach people can use to become financially independent and retire: small business entrepreneurship.
Before I get into the meat of my argument though, I want to talk a bit about both the Mr. Money Mustache and also about the Bogleheads philosophies.
You don’t want to consider some other, more esoteric approach to financial independence and retirement without first appreciating what these other approaches offer.
Mr Money Mustache in a Nutshell
The Mr. Money mustache philosophy, just to summarize, employs frugality to achieve a high savings rate. If you couple that high savings rate with smart, common-sense investing, you create a clear pathway to financial independence and retirement. You may even be able to retire early.
The Mr. Money Mustache plan is good. Sure, as I’ve suggested elsewhere (see here) I see some risks in running the plan. But I agree the plan works. And I will note that some smart, thoughtful people either partially or totally disagree with me about the flaws.
Bogleheads Investment Philosophy in a Nutshell
The Bogleheads investment philosophy relies on passive, tax-efficient, do-it-yourself investing and common-sense asset allocation formulas.
If you or I invest the Bogleheads way with discipline, we get a clear path to financial independence by normal retirement age.
Again, the Bogleheads’ way absolutely makes sense. If you can run the plan, you get someplace good “financially” by the time you’re retirement age.
I also feel like I should point that while the Bogleheads philosophy came into existence after I’d run my own retirement plan, what I did to prepare for retirement was basically what the Bogleheads now promote.
Small Business Entrepreneurship: A Third Route to Financial Independence?
Some folks, however, may have a third route to financial independence: small business entrepreneurship.
In other words, for some people, small business ownership works as an alternative to the Mr. Money Mustache or the Bogleheads formula.
Rather than focus on frugality as a way to fuel savings (a la Mr Money Mustache) or rather than use low-cost do-it-yourself passive investing (a la Bogleheads) as a way to save costs and jack returns, you can use small business entrepreneurship.
No, no, let me be clear. Small business entrepreneurship doesn’t work for everybody. (I’m going to point out the big problems I see with the whole “small business entrepreneurship” thing in a post next week.)
But you know what? Small business ownership may be an option you want to consider if the Mr. Money Mustache or Bogleheads approaches don’t really work for you or your family.
More specifically, I think you can count at least five really compelling reasons to consider small business entrepreneurship as a path to financial independence.
Reason #1: Fast Track to Financial Independence
A first observation: Small business entrepreneurship possibly provides a very fast track to a form of financial independence. But let me get into the details because this financial independence doesn’t work the same way it does with traditional investment strategies.
Let’s start by looking at the two more “traditional” investment strategies mentioned earlier…
The Mr. Money Mustache approach requires you to work a decade, or possibly two, save a high percentage of your income over those years, invest that money in a common sense manner, and then after your work years live off the investment income.
That approach works if you get decent returns and establish a lifestyle of frugality. But 10 or, gulp, 20 years is a long time. And a lifestyle of frugality isn’t going to work for everybody.
The Bogleheads approach? Well, the Bogleheads approach to financial independence requires perhaps 30 or 35 years of disciplined saving and investing over which time you’re presumably going to work in some other regular job, profession or trade.
Again, that approach works if you show discipline in your financial management. No question. Happy to stipulate that.
The small business entrepreneurship timeline looks and works different. You can probably, with a bit of luck and above average discipline, create a viable profitable small business in 3 to 5 years.
Yes, I admit it. Those first three or four or five years may require frugality and discipline and all the other virtuous behaviors and habits required in a Mr. Money Mustache or Bogleheads strategy.
But at the point where you have a successful small business up and running, you probably have financial independence.
Small business entrepreneurship, then, doesn’t amount to a “get rich quick” scheme. It amounts to a “live rich quick.” Or maybe more accurately a “live pretty rich pretty quick” scheme.
Small business entrepreneurship doesn’t mean you retire at some point in the future and then quit some crummy job. It means you create a job or role you enjoy. In a company you own and control. Working with people you really like. Focusing on stuff you find fascinating or fun or important.
If ending up in that role “works” for you, then small business entrepreneurship creates a fast track to financial independence.
Note: Someone who owns their own business probably still needs to someday retire, obviously. And along the way, this person will want to participate in whatever pension plan their small business provides employees. But a large share of the small business entrepreneur’s financial independence may come from owning their own business, enjoying a higher than anticipated income for as long as they want, and then someday selling the business.
Reason #2: Astronomical Returns
Can I next point out something else that many people don’t know about small businesses? Small business investment returns can be astronomical.
Like maybe 10% to 20% better, annually, than the returns that big company stocks offer. So annual real returns of maybe 15% or 25% instead of 5%, for example.
No, no, I get it. Small business investment often forces you to bear far more financial risk. That explains much of the reason your returns are astronomical.
But the point is you can earn those sorts of returns in a small business if you’re willing to work the small business.
Tip: To verify the truthfulness of this “astronomical returns” statement, check out the businesses for sale on a broker database like www.bizbuysell.com. Some of the businesses offered you probably would not want to touch with a ten-foot pole. But others clearly generate high profits. Note that the typical small business sells for a multiple of two-and-a-half-times earnings. That’s like a PE ratio of 2.5. Or an income capitalization rate of 40%. (You would need to take your owner’s salary out of these profits.)
Reason #3: Unparalleled Tax Shelters
Small businesses offer you unparalleled opportunities to shelter your income from taxes. Legally.
Just to make sure you understand this, traditional retirement savings vehicles limit the deduction you can put on a tax return for money you contribute to an IRA, 401(k) or similar account. Typically, you’re talking a few thousand dollars a year.
Further, as a general statement, tax law both obstructs your ability to later withdraw the money and taxes you on the money at ordinary income tax rates.
In comparison, you have essentially no practical limit on what you can invest and deduct in a small business. Further, you can liquidate your investment whenever you want. And finally, you can probably avoid taxes or pay a low capital gains tax rate on the withdrawals.
Further, while you’re running your small business, you can use well-established laws and regulations to sidestep taxes like the Affordable Care Act’s net investment income tax, self-employment taxes, Social Security and Medicare taxes, and state income taxes.
Reason #4: Equal Opportunity Availability
An awkward comment concerning small business entrepreneurship…
The fact is, in some employment or professional categories, you’re supposed to look and act a certain sort of way. You’re also often supposed to fit a particular profile. For some jobs, for example, you’re supposed to have a particular educational credential. For other jobs, you’re supposed to “look” or “be” a certain kind of person.
Some of this disqualification makes sense. Some of it surely is nonsense. Hopefully not much of it is illegal discrimination… but sadly some of it is.
But most of this shouldn’t matter so much with your own small business.
Many great small business opportunities are available regardless of the formal education you have. Or where or how you learned what you know.
Further, small business ownership should mean you’re not limited by traditional (and often illegal) disqualifiers like your ethnicity, faith tradition, age, gender, and so on.
Reason #5: Digital Economy Opportunities
One final quick point. Yes, the digital global economy has often beat up small businesses and workers pretty good over the last couple of decades.
But you know what? The digital global economy is also creating millions of new attractive opportunities for small business people willing to innovate and think outside the box.
You have some gigantic opportunities. You really do.
Two Final Notes about Small Business Entrepreneurship
Let me say this one more time: I don’t think a small business entrepreneurship path works for everybody. In fact, I freely admit, the small business entrepreneurship option works for fewer people, surely, than Mr. Money Mustache’s frugality-fueled FIRE formula or the Bogleheads investment philosophy.
However small business entrepreneurship will work really well for some people.
P.S. Next week I’m going to post my list of the biggest flaws I see with the small business entrepreneurship formula and also the drawbacks one needs to consider before choosing to go the small business entrepreneurship route.
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