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.
Additional Small Business Posts You Might Find Useful
Your Real Odds of Succeeding in a Small Business
Seven Reasons for Starting Your Own Small Business
Six Common Formulas for Small Business Success
They say that most small businesses fail. So you can spend 3-5 years living frugally and working hard, and you are more likely to end up with nothing to show for it.
Lots of good reasons exist for not taking on the role of small business owner. But conventional wisdom about failure rates, in my opinion, isn’t one of them.
Lots can be said about failure rates, but four big issues I think we need to consider:
1. Failure rates vary tremendously by industry. Here’s a link to one article that provides some neat charts and data:
http://review.chicagobooth.edu/entrepreneurship/2017/article/surprising-numbers-behind-start-survival-rates
And then the thing to note is that other researchers have found an even wider range of failure rates and success rates.
2. The definition used for failure may not be the same thing as saying the entrepreneur ends up with nothing to show for it. Someone who makes, say, $200K a year for five years and then stops counts as a failure. But maybe that’s not a failure.
3. An entrepreneur isn’t limited to a single attempt. He or she can “go to bat” two or three times… if one wants to use that 50% failure rate, that suggests the chance that at least one attempt will succeed is very high.
4. Unlike passive investments, the entrepreneur has tremendous control over many of the variables that determine success.
P.S. Some of these issues are expanded on in this other blog post:
https://evergreensmallbusiness.com/your-real-odds-for-business-start-up-success/
Failure rates matter, I agree,
But seems to me we need to look at lots of other factors too as noted above.
Also, it seems to me like the issue of failure rates applies to all sorts of pursuits and also to other routes to financial independence.
E..g., any high probability professional or vocational option is probably pretty low reward. And won’t many high reward professions and vocations maybe have high failure rates? (I remember telling my dad, a physician, that it didn’t make sense for me to follow in his footsteps and go to medical school because in those years, the odds of getting in were so low… His argument then was, “yeah, you can’t think that way… you can be in the 30% or whatever that gets accepted.”)
Also, while I totally believe in the Bogleheads investment philosophy’s potential, looked at through one lens, that seems like something nearly everybody fails at (because it’s so darn hard to be a disciplined saver.
But all the said, I do agree that failure rates matter.
Steve,
Great write-up (as usual). I hope this isn’t too far off topic, but have you previously written about how you started your CPA firm? I’m familiar with your background as an author/publisher, but was unclear if you had worked at a small CPA firm initially or just went on your own from the beginning.
Hello Chicago,
I’ve got a lot of posts here for CPAs (obviously). But we don’t have much autobiographical stuff up. To answer your question, though, the only “other” CPA firm I worked at was Arthur Andersen… and then twice I’ve started a firm… (one in the 80s and once around 2000)…
It is hard to bootstrap any business of course. Even professional service firms.
Steve
Just found your blog today while doing a search on a financial topic I was interested in.
Then I saw this post and for the most part was thinking, “Yes, yes, yes!” as I was reading it.
Putting aside the fact that I don’t think this is an either/or decision (i.e., one can run a small business AND still use the Bogleheads method of investing assets), the power of having your own small business is not mentioned enough in financial retirement circles.. Frequently on blogs that mention “save, save, save” I also point out “or earn, earn, earn”.
Owning my own business (started 3 years ago) has been a financial windfall that I never could have imagined when I was just a normal “wage slave” of corporate America.
P.S. Your reason #3 is not to be underestimated.