As a business owner, you often face a very different set of financial risks than your non-business-owning counterparts. When it comes to investing, there are two major considerations you’ll need to remember. First, keep your powder dry. This is an old seaman’s term that I like to use when describing the need to keep enough cash in your personal and business finances to weather life’s storms.
The other consideration is that you likely have heavy concentration risk. In other words, most of your net worth is tied up in your business. For the purposes of this article, let’s assume that you have enough dry powder. Let’s also assume you’re like the majority of business owners and you’re dealing with significant concentration risk. With these things in mind, we want to answer the question, “Why do business owners need to invest differently?”
A Huge Red Flag
Well, if I were to look at a client’s portfolio and see that they have 70% or 80% of their funds invested in a single business, that would raise a huge red flag. That tells me this client is open to an enormous risk should that holding suddenly decrease in value. Yet this is exactly what is happening with business owners all over the world.
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Additionally, business owners are so used to dealing with risk that they often become too comfortable with it. Of course, no two situations are exactly alike, and we all have unique perspectives and biases.
However, knowing that business owners are particularly prone to concentration risk in their daily lives means we must take special care in helping to assemble an investment portfolio that mitigates that risk and enables you to diversify away from your business. This is why you need a trusted adviser who can help keep you grounded.
Now, the basic nuts and bolts of investing will likely remain the same. You still need to know where you’re starting from (your current net worth), risk tolerance and capacity, and where you want to go, financially speaking. That’s probably not going to change.
But each of these important pieces will help your adviser assemble a portfolio that can withstand drawdowns and mitigate risk through diversification, helping you, ultimately, to reach your financial goals.
An Example of How Easily Concentrated Risk Can Happen
However, investing as a business owner is not exactly like investing as the average worker, and it’s vital that your adviser realizes this. A great example of why this is so important comes from someone I met many years ago. This individual was a business owner whose company made widgets for the U.S. military. When they first came to me, they had been working with an adviser who had placed their entire portfolio into defense stocks.
Despite their attempt to diversify and remove their concentration risk, they were even more concentrated. This person was receiving funds through their business via defense contracts while investing in defense equities. After my initial meeting with this individual, I began to understand the importance of entrepreneurs working with advisers who truly understand the specific situations of their business owner clients.
You see, as a business owner, you confront a unique set of characteristics that, from an investment perspective and portfolio construction and design perspective, you and your advisers must be mindful of. For example, your business will typically have fewer constraints on it than you would find in the investment world. Oftentimes, you’re using leverage in your business. You’re involved in the business. These things provide opportunities that are much rarer when investing in stocks.
Primarily, this is because the investment side of things is much more constrained. That’s where strategies such as hedge funds can help.
How Hedge Funds Could Help
Although people often think of hedge funds as asset classes, they’re actually strategies that provide investors with exposure to sources of return. In this regard, they can help to remove some of the normal constraints that come with investing. In many ways, your business is like a miniature private equity fund or hedge fund. So, there are alternative strategies such as these that many business owners might find attractive.
Still, you must remember that the only correct strategy is one that is appropriate for your highly unique circumstances. Then, once you’ve selected the appropriate strategies, you must work with your adviser to determine the best way to combine them to achieve the characteristics you’re seeking. Therefore, investing does indeed look a little different for business owners, and it’s important to work with an adviser who understands this.
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