The Success Problem – 4 Considerations

By Brad Thomason, CPA

 

No, that’s not a typo.  Being successful creates an interesting problem from the financial planning standpoint, namely, “What are you now going to do with all of that money?”  Here are 4 of the big ideas to think about in this topic area:

  1.  Owning a business is generally more risky than having a job (though admittedly that premise has been tested here recently).  So when thinking about overall portfolio risk, a business owner automatically starts out at a higher level than the average investor.  As a result, in order to balance things out within the portfolio, it might be appropriate for the business owner to have financial assets of a generally lower risk profile than what would be seen in a typical portfolio.  This is just sort of a common-sense algebra.  The higher risk from the business really can’t be avoided, so the only option left on the table to bring the overall “number” in where it needs to be is to dial down the risk on the financial assets.  Which will most often be the accumulated winnings from the business activity itself.
  2. As the winnings from the successful business pile up over the years, it is very possible that a point will be reached where the productive capacity of the winnings actually exceeds the productive capacity of thing which generated those winnings in the first place.  Consider the case of a business owner (or professional, or wh0mever) who has the ability to salt away $80K a year after paying for everything else.  Let’s further assume that the savings have accumulated to a sum of $2M.  Is it better to keep pushing the business as hard as possible to keep the $80K addition coming in, or is it better to scale back the business, accept the reduction in revenue, and use the extra time to take a more active role in managing the money?  If the portfolio can generate 9% a year with diligent attention, it will out-produce the business by a margin of $100K ($2m x 9% = $180K; $180K – $80K = $100K).  In future years the margin will only widen as compounding takes effect and the war chest gets ever-bigger.  All of which is summarized in the question, “Where’s the best place to focus time and attention?”
  3. Operating assets, when competently managed, typically earn more than financial assets.  So if a business owner has been used to getting a 20% return on working capital, the prospect of getting 6% – 9% on their portfolio of financial assets may seem like a bad deal.  But the thing to remember is that the financial assets have a completely different risk profile, and are not subject to the kinds of losses that can eat through working capital.  Moreover, even if the WC is still earning the higher rate, if there’s no means for putting the winnings back into WC, then there’s no way to get those dollars the 20% bump anyway.  Viewed in that light, if 20% is not available (and/or not desirable for risk reasons), is it better to deploy the savings in a way that they can earn something, or simply leave them in a corner collecting dust (i.e. have the money languishing in a back account earning essentially nothing, because you are too busy to get around to deciding what to do with it)?  Comparing working capital returns to financial asset returns is not an apples and apples comparison, and really doesn’t provide much by way of meaningful insight.  It’s 2 different tracks, conceptually speaking.   Of course WC can earn more; but that’s not really the point, because it doesn’t address the core question of what to do with the winnings.
  4. Investors who are trying to accumulate a fortune typically behave differently than those who already have what they need and are trying to hang on to it.  Most successful business owners start out in the first camp, and it is the drive to accumulate the fortune (whatever that means in the individual case) that leads to them actually pulling it off.  Trying, after all, makes achieving a good bit easier.  But as a matter of simple mathematics, if they are successful then they will hit a point where they have what they were striving for.  When that happens, if they don’t realize the transition has occurred, they may keep on doing what they always did in their investing life.  Which might have been the right course in times-past, but isn’t the right course anymore.

The basic theme running through all of these is that success drives change.  And in symmetry with that, in order to keep on making good decisions, successful business owners and professionals have to understand that it will be necessary for them to also change their perspective as they transition from a life focused on building, acquiring and growing to one of defending, using and, hopefully, enjoying.

Change of mindset doesn’t come easily, though.  So being consciously aware that it is something that will need to happen is important so you can have time to ease yourself into it as the years go by and the winnings pile ever higher.  But in spite of all that, it is still a pretty good problem to have to have, you know?

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