Investing is overrated. Starting a business is a better strategy to get rich. And what it could mean for wealth inequalities between people
Introduction
Disclaimer: I am not an economist or a financial advisor and the information shared here is not financial advice. It is for informational purposes only. If you need any financial advice, please consult with a professional such as a financial advisor.
I think investing is overrated as a means to get rich. Starting a business seems to be a far better strategy to get rich. Let me explain why. If we look at the advantages a business owner(s) has compared to an individual, I think it becomes evident. These advantages a business owner(s) has are due to the support and power that a business could have access to. Examples of support are support from governments, banks or tax specialists. Governments could provide tax breaks and tax specialists could help reduce taxes even more. Banks could provide business loans. Lower taxes and additional funding means that the business has more money to invest in itself and grow. Another advantage is power. Meaning, the control and flexibility that a business owner has in extracting the maximum value out of the business for themselves.
An example of support and its results on a business compared to an investment
Now let’s look at the advantages in support, a business could have compared to an investment. Support a business can get, could be tax breaks from governments, business loans from banks or help from tax specialists. Such support could mean that if you are investing in your own business, it could get a boost in terms of money and support, to help it grow. When your business grows, the person benefiting the most from it is going to be likely you, the business owner. If you are an individual investing in stocks, the support you can get is limited. You may not get tax breaks or access to loans to the extent that a business could be getting.
Consider two scenarios where you put $1000 into investing in stocks compared to using it to start a business.
Imagine the investment in stocks has a gain of 20% per year, which is on the highly optimistic side. After 3 years the investment has grown to $1,728.00. So there is a profit of $728 before expenses. From this you have to pay taxes. Say there is capital gains tax, of around 50%, on half of the profits you made. Suppose this amounts to $180. Say there is also transaction fees of $5. After deducting taxes and transaction fees from $728, your profit becomes $543. So after 3 years you have $1543 to reinvest or use for something else.
Imagine using the same $1000 to start a side business. With that money, suppose you bought equipment, build a product and began selling it. The business slowly caught on and in 8 months you brought in $1000 in sales. Then you made some more sales and at the end of the year you have made a total of $1500. So the business made a profit of $500. Now lets discuss the part where the government and banks help you in growing your business. Suppose the government have a policy where small businesses get a tax break on the first year of business. Meaning there is no tax on the $500. Additionally you applied for a business loan and got approved for $2000 to expand the business. You used that money to buy more equipment and now you can make 3 times more of your products than before. Now with more customers you managed to sell 3 times more as well. At the end of the 2nd years you brought in $4500 from sales. You paid back the business loan along with interest which say worked out to be $2100 and also spent $900 on operating expenses. So your profits for the second year are $1500. Suppose there is a tax benefit for small businesses which reduces taxes on profits to 5%. So the tax on your profit is $75 and in the profit becomes $1425. On the 3rd year of the business you applied for a business loan again and got approved for $5000. You hired a tax specialist for $500 and they advised you to spend money on research and development for your product to reduce operating expenses and taxes. You spent $1000 on research and found a way to reduce operating expenses by 50%. After spending this money you reinvested the remaining profits from 1st and 2nd year combined with the loan which amounts to $5925. With that money you bought more equipment, supplies, started a website to sell online and ran online advertisements. Your sales became 4 times more than before and imagine you brought in $18,000 in sales. You paid back the business loan along with interest which amounted to $5250. In addition to that the business had $1800 in operating expenses. After all the expenses the business have $9450 in profits. Suppose the tax on the profit is around 15% since it qualifies as a small business. Say this works out to be $1450. After taxes the business has $8000 as profits after tax. To maintain the business and bring in the same amount of income, you estimated you need around $2000 and decided to set aside another $2000 as a buffer. So there is $4000 in total invested for the next year in the business. The rest $4000 you paid yourself which has a tax rate of say 30%. So after paying $1200 in taxes you now have $2800 for your personal use or which you can reinvest in the business. So at the end of 3 years, your initial investment of $1000 has paid you $2800 as well as ownership of a business that could potentially generate the same or even more profit for you in the future. From the previous example the investment made you $1543 of which $543 is the profit. With the business the investment made you $2800 in profit, with the initial investment in the business still there along with an addition of $4000 and has the potential to make you even more money.
These examples are to show the possible advantages a business has over an investment when it comes to the support it can get. These were hypothetical but there is a possibility that some of these situations can happen in real life.
An example of power and its results on a business owner compared to an individual
Say you are investing in a stock. Your hope is that it is going to appreciate in value in the future. There is not much you can do to make that happen, unless you are a board member or its CEO for example. Even if you are sure the company is making a bad decision and you have the knowledge to evaluate it, you likely won’t have any control in influencing its decisions. Even if the business that you own the stock for has doubled or tripled its profits, it doesn’t mean the stock is going to double or triple in value. In fact the stock may even decrease in value if the profits made by the business are less than what was expected from the markets. Now suppose you made a profit when you sold your investment. You likely have to pay taxes on the income. After taxes there is less money available to reinvest. So there could be not much control or flexibility for the individual to reinvest the profits back into investments to the extent that a business could be capable of.
A business owner has a lot of control or in other words a lot of responsibilities, in making decisions that can be beneficial for the business. The business owner could find ways to improve the quality of its products or service, run advertisements to bring in more sales, increase the price that is charged or hire somebody who is better at the job than themselves and free up some of their time. These responsibilities comes with some perks. The business owner could pay the employees as little as they can. There may not be any law that says you have to pay your employees a bonus or give them a hike. There might be nothing unfair in that legally speaking because the arrangement with employees could be that they are paid by the hour and get paid the same regardless of whether the business makes a profit or not. This could mean that the business owner can take most of the profits for themselves or reinvest it in the business. The business owner could also have some flexibility in paying themselves from the business in a way that the taxes on their income are reduced. There may also be the flexibility to reinvest the profits back into the business at a higher rate compared to income from employment or investments.
In short, assuming certain policies exist that favor the business or people running businesses, the power that a business owner has in terms of control and flexibility could far outweigh the control and flexibility an individual has.
Probability of success of a business vs an investment
You could be thinking a business maybe a better way to get rich but it is more risky than an investment. When comparing the data about the performance of small businesses to that of professional investors such as mutual funds or hedge funds, this idea doesn’t hold, in my opinion. Data from U.S. Bureau of Labor Statistics indicate that the probability that a business survive 3 year in operation is around 60%. For investing, data from SPIVA Scorecard for actively managed funds indicate that the probability that a professional investor, such as an actively managed mutual fund or a hedge fund, beat the S&P 500 benchmark or the market returns after 3 years in operation is around 20%. It doesn’t mean they don’t make a profit, it means only around 20% of them make more money than what the expansion and contraction of the market would have given them if they invested in an index fund tracking say S&P 500. If this is the statistics for professional investors, who have access to talented people and the ability to analyze markets deeply, then for an individual who has none of that advantages, the probability of success is probably even lower. I couldn’t find such data for individual investors but I saw numbers like 5, 10, 20 or 30 for the percentage of successful individual investors. I am not sure which of these numbers are true. Anyway if we are being highly optimistic and take 20% probability of success for individual investors, it is still less than half of the 60% survival rate of a business after 3 years in operation. 60% is the survival rate of the business which may or may not mean they are making a profit. Anyway from this data I think it is safe to say the probability of success in a business is probably higher than that of an investment. Some of this success may be because of the power and support a business could have access to. Anyway in my opinion, operating a business beats investing by a significant margin.
Note: Please note that I am not qualified in economics or such to interpret the data. I got these ideas from books which I am going to mention at the end. Sources I referenced for success rates are https://www.spglobal.com/spdji/en/research-insights/spiva/ and https://www.commerceinstitute.com/business-failure-rate/. The numbers are approximated and there is a possibility of confirmation bias in choosing the data as well as in its interpretation. The data is used as representing the whole sector but it may not be true. Additionally the links shared are working at the time of publication. If they don’t work please search online for data about businesses from a source like U.S. Bureau of Labor Statistics and for data about professional investors from a source like SPIVA Scorecard for actively managed funds.
My thoughts on what this means for wealth inequalities between people
If businesses are incentivized by the government, banks etc to grow and the people who financially benefit the most from businesses are its owners then I think in a way it means the rich are incentivized to become even more rich. In other words, if governments tax businesses less than an individual and the banks finance the growth of businesses more than that of an individual then I think the likely outcome is that existing businesses are incentivized to grow but an individual trying to start a business is at a disadvantage. The result could be that wealth is concentrated in the hands of people who might be already rich and it likely increases wealth inequalities.
Individuals who want to start a business but don’t have the money or other kinds of support to do so, are getting delayed or missing out on possible opportunities to get rich. To reduce such situations, governments could consult with experts to find policies that help, discuss what works, find ways to test them and implement them. Some examples of policies that I heard about, which I think can be considered are lower taxation for low income households, paid time off, financial education in schools or rent control. If more individuals are able to start businesses and some of them become successful then it could mean that more individuals in total would be able to get rich. It could result in a better distribution of wealth and reduce inequalities between people.
Conclusion
This article was to show the ways in which starting a business is a better strategy to get rich compared to an investment. I am not trying to say starting a business is easy, investing is bad or being an employee is bad. It is possible to lose everything because of a business. It is possible to invest and become rich. It is possible to be an employee all your life and have a financially secure life. What I am trying to say is that being a business owner is likely a better strategy to get rich.
I got these ideas from certain books. These books helped me a lot and could probably help you as well in understanding the pros and cons of a business compared to investments or employment, examples and lessons from successful as well as unsuccessful businesses, understanding the psychology behind financial decision making and in bringing your attention to the value of time. I highly recommend you check out these books. The books are listed below.
Recommended books
- Enrich Your Future: The Keys to Successful Investing by Larry E. Swedroe
- Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not! by Robert T. Kiyosaki
- The $100 Startup: Reinvent the Way You Make a Living, Do What You Love, and Create a New Future by Chris Guillebeau
- The 4-Hour Work Week: Escape the 9-5, Live Anywhere and Join the New Rich by by Timothy Ferriss
- The Psychology of Money: Timeless lessons on wealth, greed, and happiness by Morgan Housel