Posts Tagged ‘passive income’

The Anatomy of Wealth

Every fortune starts with the first small investment. See how this man turned a small investment into a large fortune with a steady stream of income.

Every fortune starts with the first small investment.

I did something different this holiday season than I ever did before: I took two five-day weekends. This may sound like a minor thing considering the FIRE* community I supposedly belong to**, but to me it was a serious adjustment.

The first long weekend over Christmas didn’t feel like a true long weekend. Every day was filled with family events so I didn’t have to worry about filling lots of dead time.

The New Year’s weekend was the opposite. I had a full five days to do anything I wanted. Sure, I still checked the office email a few times and kept current with social media, but for the most part I stayed the course and enjoyed five days without the obligations of work.

As most people know, it is easy to waste a day or five if necessary. For hyper-productive people this is more of an issue. Can you imagine what Elon Musk, Bill Gates, Warren Buffett or the late Steve Jobs would do with their free time? You guessed it. They do exactly what they do every other day. Either you create value in the world or you don’t. One has a reason to be alive; the other does not. You choose.

The extra days off were delightful, actually. I enjoyed several good books and extra time with Mrs. Accountant and the girls. Still, I was reading the stuff I always read. I was learning and growing. The only difference is I was on my couch versus my office chair.

But this story isn’t about my long holiday weekends; it’s about money; the reason you stopped by this place.

Anyone Have Some Spare Change?

As the holiday came to an end I was sitting on the living room  floor reading a book as Pinky, my cat, pawed underneath the edge of the couch. I put my book down to see what she found. (I was hoping it wasn’t a real mouse (as opposed to the toy mouse we gave her.))

Pinky had her paw underneath the edge of the couch as far as she could reach and kept trying to push further. Whatever she found—or lost—she wanted back badly. I nudged Pinky to the side and lifted the edge of the couch and reached under and found the elusive prize.

A quarter! Pinky’s keen eyesight found a shiny quarter deep under the couch. A guest over the previous weekend must have lost the coin and it finally fell through the cushion to the floor beneath the couch.

To most people this coin is a modest 25 cents. If found in a casino most people would immediately drop the coin into a slot machine with the outside chance of turning the coin into serious cha-ching. Most people would be just as broke as the moment before they found the coin.

Pinky is not a gambler; neither am I. As small a prize as the coin was, Pinky still wanted it. It was shiny. That was it’s value and Pinky knew it.

The Gift that Keeps Giving

Like any cat, Pinky soon gave up her prize when she realized I wasn’t giving it to her. (In my defense, I retrieved the coin she couldn’t get. A smile emoji might go nice here.)

Proud of the prize I stole from Pinky, ah, earned, I should have dropped it into my coin bucket I use for playing cards Friday night. But I didn’t. Something else entirely different crossed my mind.

Why does one man succeed and another fail? It comes down to one simple rule. Follow it and you win; break it and you lose.

Why does one man succeed and another fail? It comes down to one simple rule. Follow it and you win; break it and you lose.

You see, that simple coin is money! Add enough of them together and it becomes a serious nest egg. Even a mere 25¢ has value! If you respect money—which is a store of value—then a simple quarter will be respected as much as a hundred dollar bill. You don’t toss it away in a mindless casino game.

Even Pinky understood the coin has value (as a toy). But it’s worth a heck of lot more than that to me.

The first thought that entered my mind when I saw the coin was how much of a fraction of a share of an index fund will that buy and how much of dividend (an income stream) will it throw off? Pinky, our resident diva, placed a more immediate, hedonistic value on the coin. Pinky’s human (me) was thinking longer term.

Now I know what some of you are thinking. How much income can one simple 25¢ piece actually throw off? Well, by my calculation, the same amount as every other quarter in my portfolio.

Think about that a moment. From this perspective, your entire investment portfolio is made up of a bunch of quarters throwing off an income stream.

This isn’t a hard concept to understand. Your body is made up of a large number of cells. Cells are made up from numerous chemical compounds constructed from atoms. Atoms are made of electrons, protons and neutrons. And the components of atoms consist of a number of elementary (sub-atomic) particles.

All things of size are composed of many parts. Each part alone seems small, but remove the infinitesimally small part and the house of cards starts to crumble. Remove an electron from an atom and the atom is different; responds and reacts different. Helium has two protons. Take one away and the atom is now hydrogen, a very flammable element. One small change does make a difference.

Anatomy of Wealth

What makes one person rich and another poor?

Two people working the same job side by side earning the exact same wage can have radically different financial conditions. One worker can squander her paycheck each week while the other maxes out her retirement plan and saves even more for a rainy day.

The worker spending all her income as it comes in is under a lot of stress. A slow economy is cause for concern. If her hours are reduced, or worse, she is let go, hard times will follow quickly. The worker saving a large percentage of her income feels virtually no stress. A lay-off or reduced hours is nothing more than a reallocation of life-hours. She can always do something else productive with her time. Since she has plenty saved, money will not be a problem.

How much can you turn a 25¢ coin into to? How much of an income stream? If a man and his cat can do it, so can you.

How much can you turn a 25¢ coin into to? How much of an income stream? If a man and his cat can do it, so can you.

So why did one worker save/invest and the other live paycheck to paycheck? It might take a series of questions to get to the bottom line, but I bet the final answer sounds something like this, “I save so I have an income stream when I need it or when I retire.”

The concept is simple in theory; difficult in practice. Everyone knows they need to save and invest for the inevitable day when the money will make life easier. But some see money as a chance to spend and party. So why do some save? What motivates them? Triggers them?

Once the thought entered my head when I saw the quarter Pinky was trying to dig from under the couch it seemed silly. Why was my first thought to invest the newfound wealth for an income stream? And do other people think this way or am I just weird? (Don’t answer that!)

My guess is about the same number of people who have financial wealthy have the thoughts I have about money. Financial wealth is a simple process. Start investing early as much of your income as possible, reinvesting the income stream except in extreme emergencies. Yet, some people can’t do it. If they have it, they spend it.

It comes down to mindset. The ancient Stoics talked about visualization. Well, investing money for an income stream tomorrow requires vivid visualization. I could see the income stream from that quarter the second I saw it. It’s the reason my first thought was to invest it.

People who spend most or all their income can’t see the benefit of saving/investing some of their hard-earned income. “I don’t want to be the richest guy in the cemetery,” they say. “Can’t take it with you.” To which I reply, “You’re right. But I’d like to have some while I’m here!” Perhaps it is time to train your mind to visualize yourself with lots of money and the income stream it provides.

If Pinky can see value in digging a coin from under the couch you can visualize the value and benefits of investing a significant portion of your income.

Warren Buffett is known to keep personal expenses low so he has more to invest. Wealthy people think this way and you need to adopt the financial mindset of the rich if you want less stress and more options in the future.

Every dollar that passes your paw is an opportunity to create an income stream. Even a bank deposit throws off a limited amount of interest. The income stream is vital to your financial health and future.

My grandfather always had a saying that has stuck with me: Never take off the pile. Granddad was an old farm boy living the dream in the backwoods of Nowhere, Wisconsin. He lost the farm in the farm crisis of the early 1980s and then rebuilt his fortune doing nothing more than saving a serious portion of all his income. Most money was only deposited in bank accounts. And he still managed to re-grow his liquid net worth well into the seven figures starting over from an old age. His rule of only consuming the income from an investment had a lot to do with his success.

The corpus of your investments, that original seed money, is sacred. If you never touch the sacred you will always be safe! The income stream keeps growing larger with time. Dividends reinvest to earn more dividends. You don’t need a pension when you have one far safer and personally designed.

 

As for the quarter I commandeered from Pinky? Well, I tossed it into the coin bucket I use for Friday night cards. Seems Vanguard requires a deposit larger than 25¢. Guess I’ll up next month’s auto investment.

 

* FIRE: financial independence/retire early

** Before someone takes these words wrong let me clarify. There is no doubt I’m a member of the FIRE community. I handle tax issues for several key bloggers of the demographic and attend conferences periodically. I say “supposedly” because I don’t feel like a member to the FIRE community. I’ve never been a fan of retirement—I like doing productive activities as long as I’m breathing. As readers may notice, I don’t chum with many members of the community either, instead choosing to keep plugging along in my tax practice. I’m a rural guy who likes his rural life without the bright lights of center stage.

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

PeerSteet is an alternative way to invest in the real estate market without the hassle of management. Investing in mortgages has never been easier. 7-12% historical APRs. Here is my review of PeerStreet.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregations studies work and how to get one yourself.

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Laziness Made Me Rich

Patriotic wind catcher.

BOOM! BOOOOOOOM! SKREEEEEE!

Yeah, we just had July 4th here in the states, so did you. The only difference if you live in a country outside the U.S. is we celebrated our Independence Day. Lots of fireworks were involved.

It’s not a one night affair either. Some cites shoot off fireworks a few days early over the weekend, some do it the night before, many do it on the 4th.

Neighbors have the same philosophy. For a week the crack of thunder (well, it sounds like thunder when I’m trying to sleep) can be heard until the wee hours of the morning. As long as nobody gets hurt I’m okay with it.

I don’t participate in the festivities. Laziness is the problem. Many years ago I had a year or so of insanity and bought some fireworks. Some ointment cleared that insanity right up.

Before you call me a prude, play with me. Fireworks take a lot of work! First you run around finding a place where they sell the stuff, then you crack your wallet wide (bend forward slightly—this is going to hurt) and finally you have to plan the event to shoot them off. Like I said, a lot of work and I’m too lazy for all that. It’s much easier to watch what the neighbors shoot off while I sit around my fire pit watching stars between displays.

It Started a Long Time Ago

My frugal nature has been around a while. When I met Mrs. Accountant we made a pact: no gift giving. Birthdays, anniversaries, holidays and bat mitzvahs (I have daughters) were out. We celebrated all these events, but gift giving wasn’t a part of the process. No struggling to find a gift someone will want; no faux gratitude for another concrete chicken we need to find a place to display in the house.

So we don’t seem like prudes to the community we found a way to feed our laziness. Whenever we need something around the house or take a trip we call that our Christmas/anniversary/birthday gift. The last several years have been easier as this blog requires more travel (and everyone knows how much I love to travel) so we pick a conference I attend and call it the appropriate seasonal gift.

The kids jumped on board early, too. They didn’t care what kids at school did. The Christmas tree (more on that later) was bare Christmas morning. There were never tears. When the kids need something, say a bike, we get them the item and tell them that is their Christmas gift. They get to use their gift when it is more practical. Riding a bike in late December in NE Wisconsin is not happening.

The rest of the family took more work. When my brother bought me a concrete chicken (I have chickens on my farm) for Christmas and followed it up the next year with a plastic chicken it was time for the talk. He took it well. My brother and I don’t give each other gifts anymore. A simple “Happy Birthday!” or “Merry Christmas” suffices. For Christmas we visit and enjoy our company. No breaking up the conversation with ripping gifts open.

My parents are a tougher nut to crack. I don’t get them gifts except for Christmas and the gifts get smaller by the year. The girls, Mrs. Accountant and I still make a haul. How do you tell someone not to do it? If they enjoy gift giving then gift give. I guess it is a way of sharing a sliver of their legacy while they are alive so I am good with it.

The patriotic wind catcher (see picture) is a birthday gift from my mother. I proudly displayed it on my front lawn. My mother knows my attitude for gift giving and dealing with junk around the house. She gave it to me with a reminder it probably will only last the summer so I can throw it out when the snow flies. {Sigh} After all these years my mother still doesn’t understand how much I loathe buying stuff just to throw it away.

Christmas is always the litmus test. There “was” a family tradition of dad picking my brother and me up and heading to the Christmas tree lot the day after Thanksgiving. A decade ago I stepped off the tradition, electing to use a massive fern we call Fronds as our Christmas tree. There are two ferns actually. The tallest one is Fronds, the shorter one his wife. Our Christmas tree is technically up all year round. For the holidays we decorate the guy (and gal) with pretty bows, candy canes and some blue lights donated to us.

For us Christmas is free.

Don’t Call Me Scrooge

At first blush you might call me Scrooge. That is 100% wrong! (Okay, maybe a little bit, but this is my story so I’m telling it my way.)

My kids are not deprived of anything. We still celebrate, only we celebrate what the holiday is really about.

Mother’s Day and Father’s Day gifts do not transfer, but we have a heck of a cookout with plenty of brats, hamburgers and hotdogs. We have great laughs as a family together.

“Merry Christmas!” Concrete chicken?

Christmas Eve the family gathers at my parent’s home for an awesome dinner followed by the Christmas program at church. It is a special night and feels special, too. We talk and laugh; the best gift anyone can receive.

It’s also about the money! Fireworks can easily cost hundreds of dollars. Considering how many some neighbors set off a $500 bill would not cover it. (Yes, I know there are no $500 bills distributed by the Treasury anymore.) Over a decade my savings are at least $5,000, plus all the profits the $5,000 would earn over the decade. Over a lifetime the unspent money with normal index fund gains could buy a small home in some parts of the country.

Christmas gifts are worse! They add up fast. Once the gift giving was traded for quality family time I had only Fronds left to complete the perfect Christmas. Christmas trees run ~$40 in my neck of the woods: some cheaper, a few more expensive.

Then there is the time of putting the darn thing up and taking it down. Vacuuming the needles from the carpet is something the missus doesn’t miss. The cost of additional decorations requires a cash investment too.

Fronds is simple and free. Fronds and his girlfriend (wife?) enjoy dressing up for the season. The limbs on Fronds are weak so only a few bows and lights close to the trunk are allowed. No injuries for the holidays in my home.

Fronds is about 12 feet tall now. Mrs. Accountant received Fronds when he was a two inch twig as a gift from the apartment association back when I had rental properties. Christmas is free in my home, as is the gift from the Son of God, if you are of the faith.

Lazy Bones

So, I am lazy. You’ll get used to it. I’d rather read a book or write than shop for stuff. Even with Amazon I don’t shop unless a loaded gun is pressed tight against my left temple, books excluded, of course. (You can shop Amazon using the link. I have to eat you know.)

4th of July fire pit.

Some people will challenge my laziness claim. I’m always doing something. Call it selective laziness. My interests are catholic (little c). Life has been rewarding for me. There is no time for wasteful things like gifting obligations (giving and receiving).

I’m not a Grinch either. I donate time and money to charities in a larger portion than most. This isn’t bragging. If I say I’m lazy to save money only, it might seem I am shallow. I might be in the shallow end of the pool, but I’m not in the kiddie pool.

Selective laziness is an advantage! When it comes to stupid stuff, be lazy. When it comes to learning, be energetic. Don’t waste your energy on unimportant stuff.

Selective laziness will help you reach your financial goals sooner. Focus on the important.

My net worth is certainly higher due to my laziness. It doesn’t change my lifestyle one iota. Life is good without all the complication.

I have Mrs. Accountant and two wonderful girls. That is gift enough for me.

Passive Income Hoarder

Create massive streams of passive income by aggressively pursuing each passive income opportunity. #money #retirement #earlyretirement 3hoarderWhen it comes to passive income I have an edgy side as the title indicates. Multiple streams of income showing up in your account regardless what you are doing is a powerful force to have on your side. Losing your job is only an issue if your job is the bulk of your income. Business owners know the loss of one client out of hundreds is no more than an annoyance. You can harness the same force in your finances.

Before I list the sources of passive income I have, let me share a short story that happened to me recently. Certain sources of passive income are offered to small groups only. I was fortunate enough in my business to have one of these sources. Mr. Money Mustache, a personal finance blogger named Pete, gave me a plug, including a plug for this new source of passive income. I did not expect a lot. When the numbers were finally tallied I was surprised. The revenue was much higher than I calculated. I shared the info with Pete along with traffic data. He responded with an email saying, “Welcome to the world of passive income.” It started me thinking about all the sources of passive income I have and how passive income cements my finances regardless of the economy or my business.

You can harness the same passive income empire. Below I will outline many of my sources of passive income with a few ideas I don’t use. With a small amount of effort you can build $4,000 of passive income per month; more than enough for a luxurious lifestyle. Keep in mind what I call passive income is different from what the IRS calls passive income. Some of my sources of passive income are classified as earned income for tax purposes. My definition of passive income is something you do today that generates a steady stream of income with almost no effort for those future payments.

A Passive Income List

  • Interest
    • Bank interest: In today’s interest rate environment I do not consider the small amount earned from bank interest consequential.
    • Prosper and Lending Club: P2P lending offers high rates of returns, as much as 12% consistently. Once you open an account you can set up automatic reinvestment of income. A true “set it and forget it” investment. The whole process self sustains. (I’ve stopped recommending Prosper and Lending Club and stopped investing there myself over multiple concerns. As of this update note I use PeerSreet, link listed below.)
  • Dividends: Dividends are easy to get addicted to. You can reinvest your dividends in more shares (easy to do with a dividend reinvestment plan and mutual funds). Reinvested dividends mean you have more shares every quarter. It is like a pay increase four times a year. Index funds are great for reinvesting dividends or living off the income stream. I also receive dividends from my S corporation.
  • Rent income: I no longer own residential rental real estate, but receive $30,000 per year in commercial rental income. Residential rental properties are more forgiving, yet the right commercial property will generate a significant amount more than residential compared to the value of the underlying property. It is common for good commercial real estate to throw off enough rent income every seven years to pay for the property in cash. My property receives enough rent every six year to buy the building, cash.
  • Speaking: Speaking engagements are earning income for tax purposes and is not completely passive in nature. My attitude is anytime I get paid to talk, something I do whether I am paid or not, is free money. I am always amazed when I speak for an hour or two and they hand me a check for several thousand dollars. If you are interested in speaking for profit check local speakers bureaus. Focus on one area you are well versed in. As you can guess, I talk taxes and financial planning a lot.
  • Land contract: Once upon a time I owned well over 100 residential rental properties. Like so many things I do, I burnt out from overdoing it. I still have a land contract. Here is how it works. I bought a repossessed home from Veteran’s Affairs twenty years ago, fixed it up, and sold it for a tidy profit: 10% down, 10% interest, 30 year term, no balloon. They never refinanced and I pray to whatever god will listen that they don’t either. Ten percent is a nice income stream secured by a piece of real estate with only 20% loan to equity at this time.
  • Personal lending: I have been known to lend money to businesses and people I know and trust. The loans are always secured and short-term in nature. Funding the transaction can come from cash flow or I can create a wrap-around loan. Wrap-around loans are where I borrow the money at a cheaper rate than the interest rate I am receiving. The nice thing about the wrap-around is no capital investment is needed; it is all free money.
  • Blogs: I write two flash fiction blogs which bring in about $22,000 per year (don’t tell me you can’t make money writing fiction online), a variety of tax and personal finance writings around the web which brings in small amounts, a content farm I no longer write much for (HubPages; Google: KeithTax) with several thousand in revenue trickling in, and this blog. The Google and Amazon affiliate programs are a monthly source of passive income. Other third party affiliates pay more, but can be seasonal in nature. Blogs are a fast growing segment of my passive income portfolio.

Passive Income I Don’t Use, but Could

  • Airbnb: I could always rent my home when I am away, take in roommates, or remodel a guest house for additional income. I don’t, but I could.
  • Turo: I could always rent my car when not in use on Turo for extra income.

There are many more passive income opportunities if you keep your eyes open. In business and in the blogs there are literally thousands of affiliate programs that offer massive payouts. A small number of sales from these affiliate programs are more than enough to fund a luxuriant lifestyle. If you are like me and can’t help yourself, you can work a part-time or seasonal job, run a bed and breakfast, or start a business. There are so many ways to earn enough to cover your daily living needs for a few hours time per week. You then have plenty of time to follow your bliss or dreams and live the life you want to live.

Why Passive Income is so Important

51VPhON++mLEven if you listen to the news poorly you cannot miss the raging debate on income inequality. Blah! Yes, there is income inequality and it is worse now than 50 years ago. The truth is where the income inequality is coming from. Fifty years ago people saved more and invested their money. A large part of people’s income in the past came from passive income: interest, dividends, capital gains, and rental income mostly. Today people spend every dime they have and invest nothing. Income inequality is explained in large part by the lack of passive income compared to the past. It does not take much to start a passive income machine, but it does take something. The 1% is doing so much better because they kept investing in passive income: primarily dividends and capital gains (also taxed at a lower rate than wages and other earned income). If you want to stick it to the 1%, save and invest. Keep the stock in your portfolio where you get the dividends. Then the rich can’t have those shares and the accompanying dividends; they belong to you.

Passive income is also important to get comfortable with. Your retirement years will be funded in large part by passive income; get used to it. Whether you retire early or work until you can’t, passive income will play a larger role in your life the older you get. Your body will not cash the check your mind demands as the years add up. Since passive income will play such a major role in your later life, why not start early?

Getting Started

511cR5hpdhL._SX322_BO1,204,203,200_For some passive income you will need seed money. Seed money comes from savings: either spend less or earn more to build your war chest. Passive income from blogs requires almost no seed money. Blogs do take time to build a following, however. The nice thing about many blogs is the income keeps coming in after you generate enough content. As I write this blog post, an article I wrote in January 2010 on HubPages, is flying high. I wrote about Tony Robbins back then and Tony is back in the news today so my traffic is out of this world, along with the income; looks like a bonus passive income month for your favorite accountant. It seems there is always something doing well these days with all the content I’ve written over the years.

Passive income opportunities are everywhere in today’s society. The government’s distress at the low labor participation rate could be a renewed lifestyle by the middle class breaking away from low paying jobs to a passive income lifestyle. The world will not end if we all get our share of passive income. Machines and technology will produce more and more goods and services cheaper and cheaper. We really have it made. The labor participation rate was significantly lower in the 1950s and the 50s were considered an economically great time. Let’s go back to the days where we lived within our means, survived fine on one income, enjoyed plenty of passive income, and enjoyed life with family and friends. What an awesome opportunity and way to live our lives.

Be sure to share your favorite passive income source in the comments below and subscribe.

 

 

More Wealth Building Resources

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant for a bonus. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

Life is good when you have plenty of passive income streams. Enjoying an ice cream and no worries is all part of the passive income lifestyle.

Enjoying the good life while the money keeps rolling in.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

A cost segregation study can save $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Amazon is a good way to control costs by comparison shopping. The cost of a product includes travel to the store. When you start a shopping trip to Amazon here it also supports this blog. Thank you very much!

Sell Your Business (or Rental Property) and Get a Raise

IMAG0227The idea of starting a business or owning rental properties builds over a period of time. Slowly you convince yourself you can really pull it off. You talk with family and friends first before speaking with your accountant. Owning a business is a dream you have had from a young age. The work involved is something you enjoy so you are motivated. A business plan is drawn up with the help of an accountant or attorney. With a business plan in hand you visit your banker for funding.

For our example we will use an ice cream shop as our business. Suppliers are lined up, employees hired, equipment purchased and promotion in place. Business is hard, but you deal with problems as they arise. Before you know it years get behind you as your business grows until locals use your business as a landmark (turn left at John’s Ice Cream Shack).

Now the discussion has changed when you visit the accountant. The loans were paid off a long time ago and money is building in the retirement and investment accounts. Only now do you realize you forgot one important part to your plan: the exit strategy.

Buying or starting a business includes plans for funding, promotion and management. Few advisors talk about how it will all end. So much focus is on buying the rental property or running the business that nobody has an idea when the right time is to cash in. Most people assume you run with the business until you get too old or too tired to keep going. Insane!

The Small Business Life Cycle

Business owners with a plan have a high rate of success. We hear about how many businesses fail in the first year, however, most businesses fail due to lack of a plan. Business owners with a plan frequently see their business deteriorate decades down the road as they decide to hang on for “one more year” rather than fail in the early years. I get it. Your business is your baby. Walking away is hard. It is what you do, how you see yourself. What business owners need to understand is that there is a simple way to determine when it is time to cash in and enjoy a simpler life.

In our example we have an ice cream shop owner with no loans or other outstanding debt. Annual sales are steady to slightly increasing at $500,000 and profits of $60,000. Your accountant does some market research and discovers ice cream shops generally sell for about 80% of sales in your area. Should you sell? A better question: If you don’t sell how much are you really making?

We will ignore taxes on the sale because you hired a smart accountant who has you set up with Section 1244 stock as a small business and under current tax law the entire gain is tax free. Another reason we will ignore taxes is because too many variables can change what your tax situation will be.

Because you run such an efficient operation your ice cream shop will sell for a bit more than $500,000, enough to cover selling costs and keep a full half million. Invested in an index fund you can expect a 7% return over the long-term. Under the 4% rule, where you only take 4% out per year, history shows you should never run out. At 7% your $500,000 will generate $35,000 per year; using the 4% rule you will have $20,000 per year with about half coming from dividends. This means if you keep working at your business you are making less than the $60,000 you think you are since you will get $35,000 without working. Are you willing to keep working the business for $25,000 per year since you only make $25,000 more per year by keeping the business over selling and investing the proceeds?

It gets worse. Same example, but you own the building and pay yourself $30,000 per year in rent. If you sell the business and keep the building you have $500,000 generating $35,000 in gains, plus $30,000 in rent income. Sure, you also received $30,000 rent from your own business if you didn’t sell, but are you willing to keep working for only $25,000 more when you could make $65,000 without working? All the money you saved over the years also throws off a massive income stream. Your investment army, supercharged by the business sale, provides you with more income than you spend in a year.

Rental Properties

Income properties are just as bad. Let us assume you have ten rentals you bought years ago without an exit plan. As the years go by you have several million dollars in real estate paid off. The rent income is nice, but the hassle of owning rentals does start to get old. If your rentals are worth $3 million you should clear around $2.65 million and $2 million after-tax. At 7% you will have an income stream of $140,000. Even with the 4% rule you are looking at $80,000, more than enough for anyone to live extremely well.

At what point does running a business make no sense? At some point it is better to sell than continuing the business or keeping the investment properties. Is it about money? Remember, we call working for “money only” a chump’s game around here. Giving up a large part of your life to have more money is beyond insane! Remember, the buyer has certain tax advantages you don’t since you have depreciated so much of the business or investment property.

Before you start a business or buy rental properties you have to ask, “At what point do I plan on selling?” It is harder to sell when your business becomes your baby. A complete plan will help you realize your goals, including when to retire early.

Physician, Heal Thyself

Now I need to make a confession; I am a hypocrite. My accounting business has had no debts for decades. Selling my tax practice and building (or keeping the building for a stream of rental income) is the intelligent move to make. Using the math I outline above it becomes abundantly clear I should sell and move on. The only way to not sell and make the numbers work is to buy additional tax firms. The added tax benefits of expanding the firm would increase my income and skew the math towards retaining ownership . Unfortunately, by running a lean corporation the debts would soon be cleared and I would be in the same boat with only larger numbers. Tax offices sell for between 1 and 1 ½ times revenue. The way my firm is run would indicate closer to a 1.4 times revenue sales price.

So, what reason do I have to keep working? It is not the money, I promise you that. Sure, the money is good, but adding the sale of my business to the investment stack I already have would allow me a lifestyle much higher than I currently live (around $30,000 a year). The real reason I continue is because I love the work; I love the clients and the employees. It is what I do.

In my situation I came to a compromise (or cop out, if you will). I work hard during tax season for three months (something I really love doing) and hardly work the rest of the year. Instead of working harder at the business, I am sharing my 30+ years of experience so other tax pros can improve their skills and have what I have. I can create a better world without working more hours. I love what I do and cannot see myself ever leaving the field completely. My future holds more teaching than anything else.

By the way, I had an exit plan when I went into rentals. When I hit a certain point it was time to sell them all and did. For my accounting office I plan on stepping back completely when my youngest daughter graduates high school in 2 ½ years. In the mean time, I am grooming a group of people to run the business since I will be gone most of the time after that. I will speak for more years and, if you guys are interested, continue writing this blog. Until then I am really working for less money than if I sold the business and went full-retirement. Insane!