Startup Q&A #16: Investing for Entrepreneurs - When and How to Start

Hey everybody. Matthew Paulson here. Today we are going to start a three part series about investing for entrepreneurs. Over the next few episodes, we're going to discuss what your investing priorities should be, whether or not you should get a financial advisor, what kind of account you should have, what you should invest in, and when you should start investing. Let's do this. This is officially episode 16 of Startup Q and A, the online video show that helps startup founders, entrepreneurs and small business owners grow their businesses faster and achieve their dreams of financial freedom. So whether you're just getting started or if you have 100 employees, this is the show that will give you actionable ideas and advice that you can implement in your business. So we are going to do a couple of special episodes on investing. We're going to do the first one this week. So really these episodes are designed to answer the question, once your business starts to make money, you're going to need to put it somewhere. So the question is where do you put it? When do you put it there, what kind of accounts you have? These episodes are going to attempt to answer that question. We're going to talk about what types of investments are right for entrepreneurs, where you should keep your money, whether or not you should hire a financial advisor, when you should stop investing in your business and begin investing in, say, your retirement accounts, and just a bunch of other important topics like that. Again, this is another series. So these aren't questions that have been asked by actual entrepreneurs, but these are the questions that I get over and over and over again about investing. So we're going to have kind of a three part series about investing and then we're going to go back to some more normal Q and A for a little while, I think. So hopefully this content will be helpful to you guys. But before we kind of dive into the tip of the week, I wanted to provide just kind of a brief overview of this strategy that I'm following to achieve financial freedom and really what the whole message behind this show is. So personally, I think the best way to build wealth and achieve financial freedom and live the lifestyle that you really want to live is to start a small business, a startup, an online business, something like that, that generates cash flow for you and then you take the cash flow out of that business and then you invest it into income generating investments. So real estate, municipal bonds, dividend stocks, and then eventually you'll have so much in investments that you'll be able to live off the income from those income generating investments and, and you won't need the money from your day job anymore or your business anymore. So then you, at that point, you are free to do pretty much whatever you want the rest of your life. Because when you have investments that create income to live off of, you know, you don't need money from anywhere else. So you can choose not to work. You can choose to work, but only on things you care about. And it's really kind of what I've been doing in my own life and what I kind of teach others to do. Build a business, make some money with the business, take the money from your business, put in income generating investments and take that. Eventually you'll get to the point where you can live off that income. Now I personally am not quite there yet. My wife and I, we've been working on kind of financial freedom train since we've gotten married. We're debt free. We've got quite a bit in investments, but we also have some pretty high, not excessive living expenses. Expenses. But we don't live like we make $50,000 a year either. I think we're currently at about $120,000 in investment income that we get per year. And that kind of covers about half of what we live on. And yes, we live on a quarter million dollars a year, but we can afford to do that. We have a nice house, we have new cars, we like to travel, we like to buy stuff for our kids. And all that stuff kind of adds up. We like to go out to eat and my wife likes to shop. It's totally okay. And that stuff adds up. I could retire today and live on a more normal lifestyle, but I'm 31 and I don't want to retire today. I'm too young to do that really. My immediate financial goal is to get to the point where I'm generating about a quarter million dollars per year in investment income. Eventually I can just live off that. And if I want to sell MarketBeat at that point, I can do that. Or if I just want to stop working on it or stop working on anything, then I have the total financial freedom to do that at that point. Really the idea is start a business. Hopefully that business makes money. It will pay for your living expenses. You put the extra into income generating investments. You keep doing that for maybe a decade or two, and then eventually you'll be able to live off that investment income. It will certainly happen a lot faster for some people than others. That's just the nature of the game. Some people have more success in business than others, and that's just how it is. But I do think this is a strategy that works for everyone. This isn't a strategy that requires taking a lot of risk with your investments, but there definitely is some risk on the entrepreneurship side. Maybe I'm not explaining this all that well, but hopefully over the next few episodes you'll get the idea. But you have a business, that business makes money. The extra profit you have goes into investments. And those investments will eventually make you enough money where you don't need the money from the business or your job anymore. It's a really simple plan, so hopefully I'm communicating it well right now. Let's move on to the tip of the week. So before we dive into the questions, I wanted to share an investing tip that will help you kind of see whether or not you're investment strategy. Your 401k plan, your IRA is following kind of standard best practices for your retirement accounts. And this is a tool that will go in. It will log into your, say, your Vanguard account or your TD Ameritrade account. It'll review all of your different investment accounts and tell you whether or not you're kind of following standard best practices. It'll tell you if you're paying too much in investment fees. A lot of just it will identify a lot of common mistakes that people are making with their investments. This tool is called personalcapital.com the way it works, you log in, you sign up for an account. They will try to pitch you their financial advising services. I don't recommend those, but their tools and their research tools are free. So just use those and maybe ignore the call to sign up for their financial advisor service. But what it does, it will log into all of your accounts. It'll say, okay, you've got these investments. Maybe you have some duplicate kind of investments. Maybe your asset allocation is inappropriate for your age. Maybe you're paying for some really expensive mutual funds and you don't realize what fees you're paying. It's really kind of a 401 IRA retirement account investment account checkup tool. And it's just been really helpful for me in just kind of analyzing am I doing kind of what I'm supposed to be doing and are the strategies that I'm using, how do they compare with a standard mix of stocks and bonds over time? Personal capital. It's a really cool website service. Go check it out. PersonalCapital.com Again, just make sure to use the free tools. They want to charge 55 basis points per year for their financial advisory service. Probably don't need that. There are probably better ways to get financial advice than that. So just ignore those calls, but definitely check out the tools that are there. So yeah, personalcapital.com that is the tip of the week. Let's dive into the questions. So every week we take a few questions that are either made up by me or submitted through Facebook or our website and we try to answer them about startups and investing. So if you have a question you would like to have answered in a future episode of Startup Q and A, go to the domain Startup Q and A Co that will take you to my website and under the Startup Q and A show menu there is a link there to submit a question and you're certainly welcome to do that. I also periodically post on Facebook ask if anybody else has questions. So if you happen to be Facebook friends with me or you like my Facebook page, facebook.com MatthewPolfsonpage Watch out for one of those posts and that would be a great chance for you to ask your question for this show. So the first question this week is when should I stop investing in my business and start investing in my retirement accounts? First, there are two general criteria that I like to use when considering to take money out of your business and put it into a brokerage account. First, when are you out of great opportunities to reinvest money in your business? Generally speaking, you get a lot higher returns by reinvesting money in your business because you just have opportunities to put money into your business that people generally don't have in investment accounts. So if you've got some kind of advertising you can do that will get you two or three times your money back over a couple years, you're definitely going to want to do that because let's say you can triple your money back in two years. That's the equivalent of like 150% ROI on your money a year. And with the stock market, you're maybe getting 8, 10, 12% if you're lucky. So anything like that in your business, where there's a pretty good shot of you investing money in equipment or advertising and getting maybe double or triple your money back over the course of a few years, you go ahead and do that because it's a no brainer in terms of the ROI compared to investing in your retirement accounts. Of course there's risk with that, but there's also risk with investing. There's a chance that any advertising you do won't work or that a piece of equipment won't generate the savings that you forecast. But you just kind of have to calculate those risks as best you can so definitely do those types of things first. If there's a pretty good chance you're going to double, you're going to get your money back in a year or two and make money after that, go ahead and do those types of things definitely first. So really, you know, you should start thinking about taking money out of your business and putting it in your kind of personal retirement investment accounts when you've kind of run out of those opportunities. So that's kind of the first criteria that I use. This kind of leads into the, you know, second, I guess, second question, which is kind of finishes the first question. But the second question for this show is, where should my personal finances be before I start investing? And this is kind of the other criteria that I recommend that you consider before investing, and that is really to have your personal debt outside of your mortgage paid off. So I think that if you have credit card debt, you have other kind of high interest, you know, a personal loan, loan for a piece of furniture, a loan on a car, anything that's kind of a higher interest rate, maybe above 5%. So you should really knock that stuff out before you invest in your retirement accounts. And the reason for that is when you're in debt, you are effectively paying somebody else a fixed interest rate. And by paying that off, you're effectively not paying a fixed interest rate. So if I'm paying 15% APY on a credit card and then I'm paying that debt off, I'm not doing that anymore. So I'm effectively getting a 15% guaranteed rate of return on my money. And you're just not going to find that from an investment. So always go ahead and do those things first. And really, it's the same question Dave Ramsey likes to use the question, if you should borrow when you're in debt or if you should invest when you're in debt. Should you invest if you're in debt is kind of the same as would I borrow money to go invest money? And of course, usually the answer is no. It's just the same kind of thing in reverse. You probably wouldn't go to the bank, take out a loan to put money in your Roth ira. So the fact that you're investing to not pay off your personal loan is really the same kind of thing. I definitely agree with Dave Ramsey on that kind of stuff, where if you got a lot of debt, you probably want to clean that stuff up first before you start thinking about retirement accounts. If you can get a guaranteed rate of return by not paying interest on a loan, Anymore, that's going to be a better deal than any kind of investment that you get. The only really guaranteed investment you can put money in is U.S. treasury bonds. And they pay about a 2% yield on those, maybe if you hold them for five or 10 years. I'd rather get the 10 or 15% guaranteed rate of return by paying off a credit card or any other kind of debt than what you can get in the market. If you're at the point where you've run out of those reinvestment opportunities in your business and you paid off your personal debt outside of your mortgage, really that's kind of when I think you're about to. You're ready to start investing in your retirement accounts and those kind of things. If you do those things, you're really in a good spot and at that point you can start stacking away money from maybe the more distant future. Alright, the next question is what investment priority should an entrepreneur have? So at this point I'm going to assume that you have maxed out the opportunities to reinvest money in your business and you've paid off all your consumer debt, except for maybe your mortgage. So the first thing that pretty much everybody should do, entrepreneur and non entrepreneur alike, is to max out their Roth ira. Now a Roth IRA is a special type of retirement account where you can invest in stocks, bonds, municipal bonds, mutual funds, real estate through real estate investment trust. Any kind of standard investment that you would buy at a brokerage account, you can do inside of a Roth ira. And what's cool about a Roth IRA is that any dividends you receive from the Roth ira, any capital gains, so the difference, if your stock price goes up, you sell it. Normally you have to pay a tax on a difference inside the Roth ira, you don't have to do that. So all the earnings from your investments in your Roth IRA are tax free. And really it is the single best deal out there in terms of investment account vehicles. There's no annuity, there's no fancy retirement account other than this that is really equally of, you know, it's equally as good other than, you know, 401k in a Roth 401k, same kind of thing there. So if you're single, you can stick away $5,500 a year. If you're married, you can do $11,000 as a married couple. Really. And then inside that we'll talk about some standard investments that you can buy. You might see opportunities to invest in like real estate and gold and ira. Don't do that. We'll talk about what types of investments to put in your retirement account a little bit later. But I recommend doing a Roth IRA through Vanguard or TD Ameritrade, maybe Fidelity. Any of the big brokers will be halfway decent. Vanguard's my personal favorite. But there's nothing wrong with some of the others as well. Now let's say that you're an entrepreneur, you're making good money. The Roth IRAs, they have an income limit. So let's say you're making more than $150,000 per year. You think, am I just out of luck? Can I not do a Roth IRA because I make too much money? It turns out there is a cool tax loophole that allows wealthy individuals to do a Roth IRA just the same that a normal person would. So if you are above the income limit for a Roth ira, you can do what is referred to as a backdoor Roth ira. Do some research on this. But really the way it works is you make a contribution to a non deductible IRA and then you immediately convert it into a Roth ira. And any half decent financial advisor can do that for you. You can do it yourself if you're really complicated and you want to figure it out yourself. This is the one account where I paid a financial advisor to do it for me. I know a good guy named Jesse Haller. He set it up for me because I didn't want to do it wrong and end up paying a lot of taxes because I screwed it up. So I had him set it up for me. He does all the transfers. It works really well. But if you are above that income limit, you can still do a Roth ira. If you're willing to do a few maneuvers to move money around and maybe get the help of a financial advisor. Don't let the fact that you make too much money stop you from doing a Roth ira. So let's assume that you've maxed out that Roth ira. You know, what do you do next? There are several different types of retirement vehicles that are available to entrepreneurs. There are simplified employee pension plans, SEPs. If you don't have any employees, there's an individual 401 plan. That's what I used to have. If you have employees, you can start a regular old 401 plan. That's what we have now. There's also like a simple Iraq. There's quite a few different choices that are out there. It kind of ranges from kind of simple to complex. I think the simplified employee pension plan is probably on the simple side. And then the real 401k plan is more on a complicated side, with the individual 401 and the simple IRA being somewhere in between. So each of these have different cost contribution limits, fees associated with them. But what worked out well for me, and I guess my situation was, was until I had employees, I did an individual 401 through Vanguard. So you can set aside the standard $18,000 401k contribution limit every year, and then on top of that, you can do an employer match from up to a fourth of your salary. And together those contributions can make up a total of $55,000. So that is a lot of money that you can stick away for retirement each year. And that is worked out. That's a big limit, well above what you can do with a Roth ira. So that is a great option. It is a little bit of paperwork. To do an individual 401, you have to file a special tax return, just more like a tax reporting form, I think, in June or July called like a 5500. It's a little bit of work, but not huge. And you only have to do it if you have more than, I think, a quarter million dollars in there. Don't quote me on that. I'm not an accountant or a tax person, but I know there is an extra form you have to file for the individual 401k. Then if you have employees, you can have the same kind of limits if you do a regular 401k plan. There is some more complexity with that. Once I hired Rebecca and Stevie to set up their regular 401 plan was quite a bit of work. We did it through a company called Ascensus. They work with Vanguard. And my financial advisor got involved and he helped set it all up. There's a lot of different parties, a lot of different moving pieces. We had meetings on the phone every Wednesday or Tuesday for like two months to set the thing up. But now that it's all set up, there's not a ton of paperwork involved. And now my employees get a cool 401k plan as well, and they get some benefits. I think my cost to run the plan are about $3,000 per year, but it is well worth it for the money that I can set aside. And both my employees can set aside. To set up a regular old 401 plan is really not that hard of a thing to do. You definitely can do it. You may also have an option for a Roth 401K, that's a really good choice, too. And a Roth 401K, if you set up will allow you to set aside money, you know, after tax, which I think is usually a better deal than a pre tax option that most 401ks are. So I should probably take a second to explain that. But a regular 401k, you get a tax deduction on the money up front, but then you pay taxes on the money when you take it out in retirement account. Retirement with the Roth 401K, you don't get the deduction up front, but then the income and the dividends that you receive from that Roth 401 throughout your life is usually a better deal. So if you have a Roth 401 option, you maybe take advantage of that over the normal 401 option. So at this point you have about, I'm going to assume you're married about $66,000 of retire or I guess tax advantaged investing that you can do per year. And there's one more thing you can do on top of these things and that is to open a health savings account. If you have an HSA eligible health plan, my family does, you can stick away $6,500 per year into an HSA and you can spend that, you get a tax deduction up front. Then when you spend that money on healthcare expenses, it's tax free. And then any growth on your account while the money's just kind of sitting there waiting to be spent on health expenses, that growth is tax free. So some people have referred to the HSA as being triple tax free because you get the deduction up front when you spend it, it's tax free and the growth is tax free. So that's really cool. I haven't been actually using my HSA to pay for medical expenses, just kind of letting the account build up and you know, if we ever have something huge, I guess I can, you know, use that account to pay for, you know, a big medical expense. But right now we're just kind of letting money grow in there. And I assume that when I'm old I can spend it, you know, on medical expenses. Alright, so you know, those are kind of the three kind of first steps that I recommend for investing, you know, the IRA, the 401K and the HSA. This is what I can refer to as the taxed advantage investing Triad. Between these three accounts you get, you know, $11,000 with a Roth IRA if you're married, $55,000 with 401K and then another $6,500 from the health savings account. So that money really adds up. It's more than $70,000 a year that you can set aside in retirement accounts on a tax advantage basis. Really, it's just a good deal. These are really the best deals there are in terms of saving for retirement. There's nobody that has an annuity or any kind of complicated investment accounts that are going to do a better job than these three things. And the reason is just taxes. If you have money in a retirement account or a regular brokerage account, any capital gains are going to be taxed at 15 or 20%. And then if you're in that top tax bracket, like many successful entrepreneurs are, you're going to have to pay an extra 3.8% in the net investment income tax, which pays for the Affordable Care Act. So, you know, if I have money in a brokerage account and I pay capital gains on it, that's 23.8%. If it's in, you know, my Roth IRA, it's 0%. So these, you know, these accounts, they were set up by the government to encourage people to save for retirement, to save for, you know, health expenses. They are just a really good deal. Everybody should do them before you think about doing pretty much anything else. So go ahead. Those are your first three steps. When you're ready to start investing, do your IRA, set up a 401k or SEP, and then maybe do an HSA if you have the right kind of plan for it. This is kind of the end of part one, I guess, probably a three part series on investing for entrepreneurship. So those are the questions. Check back next week for part two of this show. So if you want to learn more about investing, check out the book that I wrote on dividend investing. It's called Automatic Income. It's a book about investing in dividend stocks. You can just get it@automaticincomebook.com the Kindle copy is like $4. So not a huge investment. But if you want to learn about investing, that might be a half decent place to start. If you want to grab that book, it's Automatic Income book. So if you'd like to subscribe to Startup Q and A and get next Monday's show delivered to you automatically, go to the domain startupqa Co and there are links to subscribe there via Facebook, RSS, YouTube, iTunes and Stitcher. You can also follow me personally on facebook@facebook.com MatthewPaulsenPage Add me as a friend on Facebook. That's just facebook.com MatthewPaulsen I will only accept you if we have one mutual friend or more. So find a mutual friend to add before you add me. If you want to do that, you can follow me on Twitter. My user ID is MatthewDP. 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