When is taking Pay Cut a Good Thing?
When is taking a pay cut a good thing? Individuals who have been downsized often face the prospect of either taking a pay cut or becoming an independent businessman. Ryan has an excellent post about Franchise Due Diligence at his blog about a little understood feature of this decision, The Opportunity Loss
I’ve written several times that investing your $150,000 nest-egg in the public markets is an underappreciated alternative to applying it towards a franchise. This article cites a study by Vanguard’s founder John Bogle regarding a 25-year study of a diversified portfolio return that on average has yielded 9.5% annual return.What would you hope your franchise is worth in 10 years? Does $372,000 sound good for a selling price? That is the approximately growth of your $150,000 investment in the market compounded at 9.5% annually for 10 years. The decision to invest in and hire yourself to manage a franchise is a personal balancing test of many factors - lifestyle, family needs, risk tolerance, job satisfaction, financial goals, etc.
Ryan is pointing out that when you buy a franchise with $150,000 and taking a manager's salary of $X, you are also turning down the chance to invest the $150,000 for the term of the franchise agreement and taking a job with a salary of $Y.
He has done a very good job of quantifying what that might mean - $150,000 invested in a diversified portfolio will likely produce a return of $372,000 after ten years. How many franchise resales show this type of growth? (You can find some of this information from the UFOC.)
Here is an example. A person may decided purchase a franchise because they have been downsized, from salary of $65,000. Because they cannot find a suitable job at $65,000, the only jobs being in the $35,000 - $40,000 range, they automatically assume that a franchise purchase must be a good thing -even when they know nothing about $X -what they will be making as the operator of the franchise.
The valuable point Ryan is making is that you really do need to know both $X and the historical chances that your franchise investment will beat 9.5% compounded and taking a job at a lesser salary range.
