As a business owner, one of the major challenges you face is figuring out how to spend, save and invest the money you take out of your company.
Will you pay down debt? Will you buy a house? Will you save for retirement? How can you minimize taxes? How will you invest your savings?
Yet those decisions are all secondary to one of the most important decisions you face (which also happens to be one of the hardest). How will you live? Your lifestyle choices have a huge impact on your ability to reach financial independence and live with the lowest stress possible.
Every person living through an increase in their personal income faces the risk of falling into lifestyle creep– gradual (or not so gradual) increases in your cost of living that lead you to become accustomed to a more lavish lifestyle.
During my 25 year career advising business owners about their personal finances, I have seen dozens of situations where my clients ended up saddled with debt and struggling to achieve financial independence. Lifestyle creep and less-than-ideal decisions about their spending took over their lives.
But I haven’t just seen it professionally. I have lived it personally.
Early on in my career, my wife and I bought a BIG house that led to mortgage payments and additional costs (like furnishing five bedrooms and managing property taxes and utilities) that were a huge source of stress for nearly a decade. At the same time, I got a case of FOMO (fear of missing out) and spent significant amounts of money trying to keep up with the Joneses. I got into a luxury vehicle (or two), we started going on expensive vacations, and we frequented popular restaurants in the city.
The result? A decade of stress in my life and marriage, as well as a significant delay in my ability to achieve financial independence.
It doesn’t have to be that way. When your business starts to generate serious cash flow, you have choices.
Here are 5 major financial mistakes and lifestyle creeps for you to avoid that will help you keep your stress down and help you arrive at financial independence sooner.
Mistake #1 – Assume a BIG mortgage
Your company finally takes off, the cash flow is coming in and there is every indication you can count on a steady – and substantial – personal income for the foreseeable future. So you start looking for a house in that neighbourhood you have always admired and buy one that’s much larger than you need. Your bank happily approves a large mortgage and you happily accept it – after all, interest rates are low and you are confident that this is only the beginning for your business.
Let’s say you are making $250,000 from your business and decide to buy a $1.5M house in a nice area of Toronto. You could end up with monthly principle and interest payments of $5,335[1]. Once you add in monthly expenses like property tax and utilities, you will have a monthly bill over $6,000, which is half of your monthly disposable income.
What if you did this instead? Buy a $750,000 condo or home that is only 3X your income. With your down payment of $375,000, you only need a mortgage of $375,000, which would give you payments of $1,778 per month. After additional costs, your monthly housing expenses will be around $2,500.
The lower payments give you a cushion in the event your business goes through a tough period. They also give you less stress and more flexibility. And you are now on the fast train to financial independence.
Take this one seriously. It was THE major financial mistake I made in the early years of my business.
Mistake #2 – Purchase an expensive vehicle
I love cars. What’s not to love? There is nothing quite like the experience of a luxury vehicle – especially a new one. When you drive off the lot, you feel like you are on top of the world. You have also played right into the car company’s hand.
Having been through the process of buying or leasing a luxury vehicle more than once (yes, I learned these lessons the hard way), I can tell you that there is a way to drive something you enjoy while hanging on to more of your money.
Let’s say you went out right now and bought yourself a high-end SUV for almost $100,000. If you drop down $17,500 on delivery, you will be left with monthly payments of $1,082 for 96 months. Add that to the ongoing expenses of your BIG house and you are well over $7,000 per month.
Instead of a new car, buy a good second hand car. If you spend $30,000 and pay it off over four years, your payments will be $677 per month.[2] Now you are driving something you enjoy while knowing that you are really moving toward financial independence.
There is a significant mental shift required to change how you think about cars. But it’s really worth it. In any book, article or blog that gives advice about how to achieve financial independence, you will find that not buying a new or expensive car is one of the top recommendations.
Mistake #3 – Not preparing for an emergency
We have all been there. Things are going well and we assume that the good times will just keep on rolling. That’s natural. It’s also not how life works. Things happen. Downturns come. Businesses falter. Personal emergencies arise. Unexpected expenses crop up.
Yet again, this is a lesson I learned the hard way. When I started making solid money from my business, I didn’t see the need to build up an emergency reserve because I assumed my business would continue to grow. Besides, I had already committed myself to other major expenditures and setting aside money for a reserve fund would have been a challenge.
Guess what happened? A massive recession and a huge spike in interest rates. How’s that for a hard lesson in “prepare for the worst and hope for the best?”
The new economic climate wasn’t just a problem for my personal finances; it also presented major challenges for my business. Low economic growth and high interest rates are disastrous for a financial planner and investment advisor.
Clients were losing their jobs and could not invest because they needed their savings for basic expenses. And those still working who did have some extra money were buying guaranteed investments that had yields of +10% interest. No one needs a financial planner and investment advisor to help them buy a GIC or Canada Savings Bonds.
My emergency came in the form of a two-year recession that was a 40% hit to my savings and a 50% hit to my business’ revenue.
What’s the emergency that is coming in your life?
Take the time to think about potential risks and set yourself up with the funds you need to weather those storms. You will be glad you did.
Mistake #4 – Not budgeting properly for the birth of children
Ask any parent and they will say they had no idea what they were getting into. Parenting is one of the most challenging and complex roles a person can take on yet there is no manual, no training and very little you can do to prepare. Good thing it is so wonderful and rewarding!
One of the ways that becoming a parent can catch you off guard is how much it costs. Kids are expensive. Period. The costs start on day one and they continue long after your children go to college or university.
When they are young, you are faced with the costs of food, diapers, day care, clothing and all kinds of baby-related equipment. But you are also faced with days off work when the kids are sick and the ongoing additional strain of being a working parent. It all takes a toll.
If you are thinking about having children – or have a young family – consider how you can scale back on your lifestyle to set aside money for the kids. Those costs aren’t going anywhere, so reduce stress by having the funds you need to cover them.
Mistake #5 – Hanging out with the rich kids
I can’t speak for all business owners, but my intuition and experience tell me that the following statement is true: there is a direct correlation between ego and cash flow.
In my case, as the cash flow increased, so did my ego and my need to “improve” my friends. I started looking for rich kids to play with. And though I was completely unaware of it at the time, the shift in who I hung out with led me to start living a much more lavish lifestyle.
I know some wonderful people who also happen to have lots of money. But spending a lot of time with them got me into spending much more money. I was often swept up in the euphoria of being in the fast lane and gladly paid for expensive dinners, hockey games or elaborate weekend getaways.
Don’t let your ego get the upper hand. Stay humble, focus on your objectives. That way you can give yourself the financial freedom to be in control of how you live – now and in the future.
That’s it.
My advice? When your business is doing well, give yourself a conservative increase in spending (because you deserve it!) and direct all additional income to your financial independence pool.
Today, when my business produces extra cash flow, I increase my spending by 10% of the extra cash flow and invest the balance. It’s a great formula that allows me to live large and be cautious!
Be smart. Take the extra income and build wealth. Your future self will thank you.
Does thinking about never retiring resonate with you? What did I miss? Send me a note and let’s start the conversation.
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Read more by Dri Financial Group
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- 7 tips for a successful partnership with your wealth advisor
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[1] At this rate of personal income (according to neuvco.ca), your net annual income in Ontario will be $149,718 or $12,476 per month. Let’s also assume you make a $375k down payment so your mortgage is $1,125,000 and you opt for a 5-year-fixed rate mortgage at 3%, amortized over 25 years.
[2] Assumptions: the first car is a Tesla model S 75D purchased from the Tesla Canada website. The second car is a 2018 Honda accord sport, financed at 4% and bought from autotrader.ca.
source https://richarddri.ca/5-financial-mistakes-that-business-owners-should-avoid/
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