Small business owners, by design, assume significant financial risk by putting their time, energy and money into ventures with relatively small chances of success. While their business is likely a large percentage of their financial portfolios, because of the inherent risk in entrepreneurship, small business owners should diversify their holdings by also investing in bonds, mutual funds and other relatively stable financial instruments.
Your ideal portfolio will vary depending on factors such as age, income, retirement needs and more, but here’s a general guide to diversification for entrepreneurs.
For all individuals, regardless of profession, it is recommended that you budget your finances within the following spending plan structure:
- Housing: 35%
- Other living expenses (e.g. leisure activities, travel, entertainment, clothing, etc.): 25%
- Debt: 15%
- Transportation: 15%
- Savings: 10%
This allocation plan can help anyone ensure that their money is being funneled into the optimal channels for success, but for small business owners, diversification can be a bit trickier.
Diversification for Business Owners
Small business owners need to pay particular attention to how they allocate their investments.
Entrepreneurs tend to be risk takers; this is evident in their career choices. However, since their business is already a risky endeavor, it is important that entrepreneurs keep the rest of their investment profile at a low-risk state. It should also be noted that entrepreneurs should spend more of their time focused on business operations rather than investment strategies. As such, entrepreneurs should make financial selections that require minimal management while also providing long-term rewards.
While it’s not always feasible, entrepreneurs should not place all of his or her funds into the business. The inherent risk of entrepreneurship could derail the savings of a small business owner, but by diversifying, an entrepreneur can mitigate that risk.
In terms of the small business owner’s pie chart, aside from investments into the business, it is recommended to invest with the following in mind:
- Bonds approximately 40 to 50%
- Stocks for the remainder
Specifically, the New York Times states that business owners should be sure to keep six to 12 months’ expenses in cash, then invest a percentage equal to one’s age in bonds. For example, if the business owner is 45, then 45% should head to bonds.
Delving deeper into the stock slice, ING recommends the following division:
- Stable value fund: 66%
- Large cap value: 16.6%
- Large cap growth: 16.6%
A stable value fund, which includes company retirement plans and IRAs, provides steady, predictable returns with low risk. “Large cap value” refers to value stocks that are undervalued by the overall market. Similarly, “large cap growth” refers to securities with predicted high growth and high value (i.e. high price ratios with low dividend yields); these securities often include exchange-traded funds (ETFs) and other stocks with high growth potential. The fact that these funds are invested in “large cap” companies means the stocks are well-establish and relatively risk-averse compared to lower-cap securities.
Tips for Entrepreneurs
Here are some additional words of wisdom that small business owners should consider when making investment decisions:
- Increase the amount you put aside for savings each month. Since savings rates have dramatically decreased since the 1980s and 90s, it is important to put more money into savings, rather than waiting for the percentage of return to rise.
- Be aware of taxes and fees associated with investment funds that may lower your returns.
- Be mindful of the long-term process. With investing, you should focus on long-term gains rather than short-term fluctuations.
A diversified portfolio will allow you to properly prepare for your retirement years while giving you the time and peace of mind to focus on running your business. While your future may hinge on the success of your business, it’s always a good idea to hedge your risk with some relatively stable financial investments.