You ask Ivan:
As a small business owner, I pump most of my earnings back into the company, making it my high-risk investment. What sort of low-risk investments could I make over a period of 5-10 years, just in case things go awry?
Here is my reply
With my years of dealing with small business owners, here it what I believe:
“Low risk” investments are not suitable for most business owners.
First of all, low return investments do not always imply low risk. We are used to seeing high return investments paired with high risk, and low return investments paired with low risk. However, this is not always the case. For example, if you are investing in bonds in a rising interest rate environment, you may be taking greater risks than stock investors, as rising interest rates reduce bond prices.
Secondly, If you are a successful business owner, your business return on investment (ROI) will likely be much better than any paper asset investment you can invest in – you would know “calculated risk” very well, and would be better at managing investment opportunities better than most financial professionals, including myself.
Berkshire Hathaway does not pay a dividend because its chairman and CEO, Warren Buffett, believes it is better to reinvest profits back to his company. Therefore, if your business is prosperous it will be better to invest more funds into it rather than make a low-risk investment outside of your business.
If your business is struggling, diverting cash to external investments can often be a distraction, and you will not be able to stay invested in the long term. Consider what happens during an economic downturn – your existing business woes will be compounded, possibly resulting in you selling your external investment at a steep discount. Therefore, even if your business is struggling, it is better to keep your cash and focus on your business.
You are right that things may go awry, therefore,
The key is not to seek for low-risk investment but to hedge the potential risk.
1. You could hedge your business risks. Consider acquiring insurance for disability income, directors and officers, and health insurance. I go into more detail in my article“Three types of Insurance often overlooked by small business owners”.
2. Instead of focusing on “low-risk investments”, you should work with your adviser to structure your investment to be of “low correlation” with your main business activity. For example, if your business is heavily focused on real estate, you should choose investments which are not affected by the downturn of the real estate market.
3. You could also focus on low-risk strategy than low-risk investment. For example, you can structure a 100% stock portfolio with downside protection or volatility control. You will likely be better off than investing in a simple low-risk product such as bonds.
4. You could have a proper exit plan and a business continuation plan to ensure that business wealth is kept within the family and does not become a burden to you or your family if something unexpected happens.
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