The ‘golden rule’ of money

Image Credit: Speedlancer.com

I met with a small group of business owners yesterday to talk about my favourite subject: personal finance.

This is what we discussed …

Most business owners look at the graph (above) and see the difference between Sales and Expenses as Profit.

{if you are an employee, it’s Salary rather than Sales but the same principle applies}

And, it technically is.

But, as an owner of the business, the temptation is to then say “it’s my profit, I can spend it how I want to”.

For a business owner, though, it’s not really Profit, it’s …

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Well, we’ll come back to that, because it’s not anything until you’ve done one important thing:

Before you walk into your business in the morning, you are an owner.

It’s the only time of day that you will get to bask in the glory, so take time out to fully enjoy the feeling over a bowl of bircher muesli and a latte.

But, once you walk in the door you are an employee.

So, pay yourself a salary, like any other employee *

Once, you’ve done that, you’re not an owner, you’re just another expense item to be managed for the ongoing health of the business.

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After you’ve paid all of your Expenses - now, including your own salary - what’s left over is not Profit, to be spent …

… it’s Capital, to be invested!

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Sales - Expenses = Capital

{if you are employed, it’s Income - Expenses = Capital … or Savings, if you prefer}

This Capital is too precious to simply spend or save. It must be invested wisely.

First, invest some of it in your business (& yourself) to help it (& you) grow.

Then, invest most of what’s left outside of your business, so that you can enjoy the fruits of your labour … no matter what happens to your business.

Finally, make sure that there’s a little bit left over, so that you get to enjoy at least some of the fruits of your labour now.

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So, what do you do with this Capital (since you’re not going to spend it)?

In the absence of anything better, it will sit in your bank account, share portfolio, or go into paying off credit cards or mortgage debt.

And, as long as it’s doing these things (or better), your accumulated Capital is increasing your Net Worth.

… Provided you’re also obeying the Golden Rule of Money!

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The Golden Rule

Always be investing at least 75% of your Net Worth.

It’s simple; it’s golden; it’s a rule!

Just remember:

Your own home is not an investment - just think about where you’re going to live (& how you’re going to pay for it) if you sell it?

Your business is not an investment (at least, not until you sell it and the cash is in your bank account) - just think about what happens if the bank calls in your loans; your employees win the lotto; your partner loses it; or, your biggest clients leave?

Your cars; watches; and art are not an investment - just think about how much they might be worth today? How about next year or next decade?

No, these things are all in the 25% of your Net Worth that’s left over, after first obeying the Golden Rule; here’s some guidelines to help:

  • No more than 20% should be equity in your own home/s; this amount may buy you too little home … borrow the rest (if you can afford the repayments from your salary).
  • No more than 2.5% should be equity in your cars; since nice cars are expensive, and borrowing to buy a car isn’t terribly sensible, you may have some tough decisions to make.
  • Finally, no more than the remaining 2.5% should be in the other ‘stuff’ that you own: furniture, electronics, clothes, watches, and art. **

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It’s unlikely that your finances will match these simple guidelines.

Today.

There’s always tomorrow, next month, and next year …

Reevaluate your finances now - then, every year, make adjustments and don’t stop until you are truly investing 75% of your Net Worth.

Oh, and adjust again when you sell your business or win the lottery …

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* By all means, speak to your accountant about salary packaging; just don’t forget this important principle when you do. And, if your biz’ accountant is not too bothered about you leasing cars, etc. … go ahead, knock yourself out.

** Your investments will increase over time; your house may go up in value over time; your cars and stuff will go down in value over time. When you do this calculation again at the end of (every) 12 months, you will find that you have the ‘budget’ to buy lots more stuff and, every so often, new cars as well.