If you have an entrepreneurial mindset and the spirit of innovation, you can find yourself in a confusing spot when it comes to managing your personal finances.
Basically, you are fed two contradicting types of advice:
1-You are told you should play it safe with low-risk retirement investments.
2-You are told that entrepreneurship is risk, and that you should reinvest money into your business for growth.
How do you reconcile these two seemingly contradictory pieces of advice? The truth is that both pieces of advice have a role to play in an entrepreneur’s portfolio.
Most entrepreneurs would benefit from putting some cash away to create a long-term safety net. But if that was all anyone ever did, we would live in a world without innovation. If you have a quality business, you owe it to yourself to give that business a chance to succeed. As an entrepreneur, your biggest wealth creation won’t come from small deposits you make into a 401(k) that compound over 25 years – your wealth creation vehicle is your business.
So how can you come up with a balanced plan for managing your personal finances that reconciles this paradox? How do you make sure you’re investing enough into your entrepreneurial projects to maximize your chances of success, while also ensuring you have a net to catch you if you crash and burn?
Here is a simple 5-step plan.
1. Make sure you have an emergency fund.
This is your very first priority, and should be even if you are not an entrepreneur. But it’s especially important as an entrepreneur.
There are times in your life when things are going to go horribly awry. You might abruptly lose your day job and be on the dole for a few months (worse, if you are self-employed, you will not even be able to claim unemployment insurance). You could have an unexpected medical expense. You may need to repair your vehicle after a wreck.
An emergency fund is all about making sure you have a buffer for these unexpected expenses. How much of a buffer do you need? That is going to vary from person to person, but for employees the conventional advice is that it is wise to have enough money set aside that you could survive without a job for at least 3-6 months.
As an entrepreneur, your emergency fund is also your runway. If you have the cash flow, you might even want to consider building a runway of 12-24 months. If an employee loses their job, they start getting paid as soon as they get another job. If your business fails, you either have to get a job or you have to rely on your runway to help you get your next business off the ground. 3-6 months is almost never going to be enough to do this.
2. Have some general savings/liquid cash.
Next, you should make sure you have some actual cash around for everyday life expenses—paying your bills, buying supplies, and so on. You can keep this money in a checking and/or savings account.
Basically, you do not want all of your money tied up in retirement accounts. Employees can contribute to retirement accounts aggressively, but as an entrepreneur your opportunity cost for having cash tied up is much higher – if your business needs an extra cash infusion or an opportunity comes up, you don’t want to have to sell-off long-term investments.
3. Consider additional funds for occasional expenses (necessary and unnecessary ones).
Next, create various “funds” which you are going to use for different types of recurring expenses.
One common example is a “fun fund.” This is a small pile of money which you have set aside specifically for unnecessary expenses. Use this if you just have to have that new video game or you need a weekend away.
What is the point in doing it this way? It helps to keep you disciplined, and stops your unnecessary purchases from spilling over into vital finances. If you never made fun purchases, you might drive yourself crazy, but at least this way you are keeping them contained.
You can also set up additional funds for other more important purchases. I talked about having an emergency fund before. You may also want to have a fund for routine costs which are unavoidable, but still are not “everyday” types of expenses. Some examples might be tune-ups and vehicle registration fees, tax preparation fees, and so on.
The reason to do this is more psychological. If you subtract the money in these funds from your budget each time you run it, you will think of it as money that has already been spent. Then when those annoying bills do come due, they will not feel as painful to pay, and you will be better prepared for them.
4. Add a percentage to a “safe” retirement investment.
Next, you should have some kind of traditional investment that you are contributing to. Most entrepreneurs dislike traditional retirement investments because of the relatively low return on capital and lack of control, but not every dollar of your net worth should be put towards high risk, high rewards investments (which is essentially what a startup is).
There are 2 ways you can go about this. If you do have some interest in learning investing basics (e.g. portfolio rebalancing, asset allocation), a good way to start would be to invest with an online brokerage like Motif Investing which has no minimum deposit and low trade commissions. Motif combines the convenience and simplicity of a robo-advisor with the level of customization and control you would expect from a traditional brokerage. However if you want bare bones DIY investing with minimal fees, you can also go straight to Vanguard and build a simple ETF portfolio.
If you really want to keep things simple and not have to think about it at all, you can go with a robo advisor or a Vanguard Target Date retirement fund. The idea here is that they’ll handle asset allocation and rebalancing for you at a low cost so you don’t have to think about it and focus all of your mental bandwidth on your business.
5. The rest goes straight to your entrepreneurial fund.
You have now laid the groundwork for a reasonably safe and viable financial future – or as much as one you can carve out for yourself as an upstart entrepreneur! Whatever is left of your income each month can go straight to funding your entrepreneurial ventures. Whether it is a little or a lot, you now have something you can work with to innovate and pursue a more dramatic growth curve in your finances.
You can of course tweak this system as you need to in order to fit your personal financial needs. The right solution is always one which is customized to your life situation. But by following these basic steps, you are creating a balance between risk and conservation with your finances. This will give you the best shot at success, no matter what happens.
