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Whether you own a shop or work on Wall Street, part of being successful in the ’90s depends on knowing what to do with your money.
Part of being a successful business person in the 1990s — whether you own a collision repair shop or work on Wall Street — is to know what to do with your money. If you own a business, much of your profits will go back into the business. But not all. Smart business people (and business owners) also invest a certain amount of their money externally.
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Many different ways are available to put your money to work for you and your shop. We’ll take a look at eight of these ways, broken down into external and internal options, and we’ll explore the basics of each, as well as the pros and cons. What will work best for you will depend on your profit level, your priorities, the life cycle of your shop and your future financial needs.
External Investment Options
1. Certificates of deposit (CDs) and money market accounts — One easily accessed home for your excess profits is the bank. You already have a bank checking account and can readily transfer funds internally within the bank to a CD or money market account. A CD typically pays a higher rate but requires you to leave the funds in for a specified period of time that can range from 30 days to five years or more. The money market account is more liquid in that you can access the funds on a daily basis (with some limitations on monthly withdrawals).
The risk level associated with a CD or money market account is low, which is the primary advantage of these investment options. Both accounts are insured up to $100,000 by the Federal Deposit Insurance Corporation (FDIC). Even if your balance is higher than $100,000, there’s little risk of losing the principal as long as you stick with a well-established financial institution.
The disadvantage of CDs and money market accounts is the relatively low return. While some stock funds have been returning upward of 30 percent per annum in recent years, existing yields on CDs and money market accounts run in the 5 to 6 percent range, depending on the institution.
If your risk tolerance is low and you don’t need to access the funds, a CD is a good investment option. A money market account might be considered by the shop owner who likes to keep an emergency fund on hand or who knows of a specific short-term need for the excess funds.
2. Bank sweep accounts — Also known as automatic investment plans, these accounts automatically sweep collected demand deposit account (DDA) funds that exceed your target balance to eliminate service charges into overnight investments, such as master notes and repurchase agreements. The rates paid by banks on these investment options are currently 7 percent or higher.
There are two primary advantages to bank sweep accounts for your excess income. First, the rates paid are higher than those on CDs and money market accounts. Second, a bank sweep account enhances the overall cash management of your body shop. The exact amount of excess funds are automatically swept from your checking account to the master note or repurchase agreement every night. This saves you a lot of time and effort and maximizes the amount of money earning interest.
On the other hand, master notes and repurchase agreements aren’t guaranteed by the FDIC for any amount, so the risk is higher. And the rates earned have been lower than the yields available on Wall Street in the 1990s.
A bank sweep account is a good option for most shops with excess profits. It’s recommended that you set up a sweep account if you consistently have un-used funds in your checking account. However, if the funds swept on a daily basis consistently are $100,000 or more, then you may want to consider another investment alternative in addition to the sweep account.
3. Bonds — There are many different types of bonds. The most common are government bonds, high-grade corporate bonds and lower-grade corporate bonds (also known as "junk" bonds). Bonds are created by a government agency or a private company to raise money, and a bond is issued for a specified period of time with a specified yield, driven by market conditions and the term of the bond. As an investor, you can buy a single bond or you can buy into a pool of bonds (similar to a stock mutual fund).
The risk level generally is the lowest for federal government bonds. Bonds also are issued by state governments and local municipalities. The risk taken on state and local bonds varies in much the same way as the risk taken on corporate bonds. Bond-rating agencies issue ratings for state and local governments and on corporate bonds based on the financial stability of the municipality or corporation. The lower the rating, the higher the yield and the higher the risk.
Federal government bonds (also known as treasury bonds) are a good investment option for a shop owner with a low risk tolerance. Current yields run in the 5 percent to 6 percent range. If you plan to venture into the world of state and local-municipality instruments or corporate bonds, it’s advisable to find a trustworthy investment advisor. While these yields can be quite attractive, the word "bond" doesn’t mean "no risk." Just ask investors who were holding Orange County, Calif., bonds a couple of years ago when the municipality went bankrupt.
The advantages and disadvantages of bonds depend on the type. However, most bonds offer relatively low risk with yields in line with bank investment instruments, but lower than those available on Wall Street.
4. Marketable securities — Also known as stocks, these instruments represent publicly traded securities readily marketable to investors. Your body shop can invest in stocks either by purchasing them individually or by buying mutual funds. If you’ve paid attention to the various stock indices — Dow Jones Industrial average, S&P 500, NASDAQ, etc. — then you know the stock market has been a good place to invest money in the 1990s. It hasn’t been uncommon for investors to realize returns of 25 percent per year or better over the past three or four years. And during this century, stock returns have averaged about 10 percent per year when dividends are also taken into account.
Of course, the stock market isn’t without risk. You put your principal at risk when you invest in the stock market more so than in any of the other investment options previously discussed. If you don’t have the stomach for watching the value of your investments fluctuate, then avoid the stock market.
Another rule of thumb is not to invest money in the stock market that you can’t afford to lose. If you’ve got some excess income that you plan to spend on a new spraybooth in four months, it’d be ill advised to risk that money in the stock market.
Internal Investment Options
5. Purchase assets — One excellent use of excess profits is for the purchase of fixed assets, such as a spraybooth or alignment machine, or to purchase inventory for your shop. If your business is already profitable and growing, what better place to invest your excess profits than in your own shop?
The key advantage of using excess cash to purchase assets is that you avoid the use of additional debt. This results in the dual benefit of buying an asset that will yield additional income, while foregoing the payment of interest expense (anywhere from 7 to 18 percent).
While there aren’t really any disadvantages to using excess income to purchase assets, there are a couple of caveats to avoid. First, don’t buy equipment just for the sake of buying it. Make sure the equipment will pay for itself in additional business. Second, don’t commit funds to purchase equipment and other fixed assets that will be needed for other uses. For example, if your busy season is coming up and you’ll be paying for a big paint order in a month, you might run out of funds before the payment is due.
6. Pay down debt — Another good internal use of excess profit is to pay down debt. The rate you pay to borrow money might run anywhere from 7 to 18 percent. If you have excess profit that’s not needed for any other internal use, it probably makes more sense to pay down or pay off debt rather than invest the funds externally. There’s no risk associated with paying off debt early, and you’ll be hard pressed to find any investment that will yield more than the rate you’re paying on the debt.
Although there aren’t any real disadvantages in paying off debt early, there are timing issues to consider. If you anticipate other financing needs in the near future — an expansion of your shop or a major equipment purchase — then you might want to save the funds for this use. Also, if you have a low rate on your existing debt and anticipate additional near-term borrowings, then you might want to keep the debt in place and reduce or eliminate the need to borrow funds for the upcoming project or asset purchase.
7. Employee benefits — Investing excess profits in your employees by enhancing your employee benefits might be the best possible use of these funds. If you consider your employees a key reason your shop has been successful, an attractive employee benefit plan will help ensure low turnover rates. You might want to consider improving your major medical coverage or offering a new ancillary coverage, such as a dental or vision plan. You also could pay a higher percentage of the premiums, thereby lowering the out-of-pocket expenses of the employees.
On a similar note, you could begin or enhance your incentive pay system. Many shop owners have seen turnover rates drop dramatically by offering an employee bonus plan tied to performance. These plans often pay for themselves in the form of increased productivity and the resulting higher income levels. Other employee benefit options include qualified retirement plans such as 401(K) and pension plans.
8. Executive benefits — If you have a few key senior-level employees who are vital to the success of your body shop, then you might want to consider some executive benefit options. In most cases, a non-qualified retirement plan will be the most effective and efficient tool to keep these key employees on board and reward them for their excellent performance. In fact, non-qualified retirement plans are often referred to as executive compensation plans because they’re usually offered only to the owner or the senior management team of a business.
While there are a number of different non-qualified plans that can be undertaken, there are three that are the most common for small businesses. The first, an executive bonus plan, is common for a new or emerging small business. The business pays a tax-deductible bonus that’s used to pay life insurance premiums, deducts the bonus as a normal business expense and reports it as "other compensation" on the employee’s W-2. The employee owns the policy and reports the bonus as taxable income.
The second executive option is collateral assignment split dollar insurance and is more typical for maturing small businesses. The company pays all or part of the premium for a key employee’s life insurance policy. A portion of the death benefit and policy cash values (equal to the premium paid by the employer) is assigned to the business. The employee pays income tax on the cost of the policy’s current economic benefit, which is usually minimal. At a future date, usually triggered by the retirement of the employee, he or she uses cash values to repay the premiums the company paid with the policy and its benefits reverting solely to the employee.
A third executive benefit option is voluntary deferred compensation. This benefit delays payment of a portion of a highly paid employee’s income (and taxes) until retirement, when his income level presumably will be lower. It also provides funds in case of early retirement or disability.
It should be noted that a reputable insurance agent or trust officer should be consulted for additional advice on non-qualified retirement plans, as this discussion is intended to provide only a very basic overview.
Putting Your Money to Work for You
Before writing out checks, check with a financial advisor well-versed in the investment areas you’re interested in. You need to be sure you’re doing the right thing before forking your money over to someone or before making an expensive purchase.
Once you’ve looked into your options and talked them over with an expert, you can — after years of working hard for your money — put your money to work for you.
Writer J. Tol Broome Jr. is a financial expert who’s been in the lending business for 15 years. He’s also a contributing editor to BodyShop Business.