We regularly spar with our clients about what to do with surplus resources. These are resources in the company (or private) that are already certain that they are probably no longer needed for business operations in the near future. Everyone has their own ideas about this, often I hear entrepreneurs say in full conviction that paying off the commercial mortgage is always a good solution. Often because they have learned this from home or have heard of it from their accountant.
I never really have a ready reply to that, because the best solution for surplus funds actually depends on the long-term financial strategy.
In our role as the entrepreneur’s most important financial advisor, we naturally always look for the best ratio between return and risk.
Paying off a loan is a particularly risk-free allocation of surplus funds. There is no risk of bankruptcy, the amount repaid does not change in value and – theoretically approached if the collateral, interest and repayment capacity and bank lending willingness do not change – you can also withdraw the money in the same way, as the bank has was willing to lend, why not now ?.
Of course, risk-free is always nice, but it does not have to be a good financial strategy.
The best investment
After all, the financial strategy determines which (pension) investment fits best in the current situation and which, among other things, depends on when the money is needed and the purpose of the funds.
For young entrepreneurs in particular, the best investment may be to make a different choice than paying off the mortgage.
A calculation example:
A 40-year-old entrepreneur intended to retire at the age of 70. He now has some surplus resources that he wants to use for that purpose. An offensive investment profile may be appropriate for this (it naturally remains situation-dependent).
History shows that returns can be achieved of at least 5% or more.
Suppose this entrepreneur pays 3.5% interest at the bank and rounded off 50% income tax, in BOX 3 he has to pay 1% tax on all his assets.
If he repays an additional € 100,000, he will save € 3,500 in interest per year, which after payment of income tax amounts to € 1,750 in net return. Spread over 30 future years, the return is therefore € 52,500.
However, should this entrepreneur choose to rent out real estate or build up an investment portfolio with an asset manager where a 5% return is achieved, then the return will be € 5,000 per year, after deduction of 1% BOX 3 tax, € 4,000. Spread over 30 years, an amount of € 120,000. A net return of more than double.
Risk versus return
In the very simplified example of this above, someone earns 2 average annual salaries by running a risk. This entrepreneur must run the risk that he loses his investment (or part thereof). That chance is statistically very small, but not excluded.