Should You Invest in Your Business - Or Diversify Away?
Most entrepreneurs prefer to bet on themselves, knowing they have what it takes to navigate challenges, solve problems, and deal with risk along the path to building a successful business.
If you own your own business, you probably want to devote your energy and resources -- including both time and money -- to growing that company. And when you start something of your own from scratch, you need to do this at the beginning to get your business off the ground.
Continuing to invest in your business as you grow and evolve might sound like the best way to go because that’s something you control… but if you fail to diversify and consider other aspects of your financial plan, you could miss opportunities, leave money on the table, or take on more risk than necessary.
Diversifying your investments -- and not simply pouring everything you have into your business -- is something every entrepreneur needs to consider. Here’s why.
When You Only Invest in Your Business, You Miss Out on Other Tax Planning Opportunities
One of the biggest reasons to invest elsewhere is for the tax benefits. Money you pour into your company only does so much to reduce your tax burden. If you also invest into retirement vehicles for yourself or your employees, you can reduce that tax obligation even further.
You can fund IRAs, 401(k)s, or defined contribution retirement plans in order to defer the taxes you’ll pay. This is usually the easiest way to diversify your investments (instead of letting everything you have flow straight back into business coiffers).
If you have employees, setting up these plans can help them do the same on their personal incomes -- which might help retain more of your talent if they appreciate these benefits.
Diversify Your Future Nest Egg
In the process of funneling some of your revenues into these plans, you also build a more diversified nest egg for your future self.
Your business may very well provide you with income well into the future, either by continuing to operate after you retire or by providing you a valuable asset to sell when you’re ready to move on to the next phase of your life.
But there’s no guarantee. Therefore, there’s not much sense in putting all your eggs into one basket. You need a safety net or something to fall back on if things fall apart.
By diverting some of your funds into IRAs or 401(k)s, you give yourself another avenue through which to grow wealth so you can fund your lifestyle in the future -- regardless of what may or may not happen with your business in years to come.
Whether It’s Within a Portfolio or Across All the Different Assets You Own, Diversification Helps Manage Risk and Volatility
Investing in accounts like IRAs and 401(k)s can help you mitigate future risks by giving your retirement years multiple funding sources. Investing in the market through other, non-retirement investment accounts can help mitigate present risks, too.
That might sound strange if you’re the kind of entrepreneur who believes your business is far safer than the market. But again, the future is unpredictable and unknowable -- and diversifying where you invest provides a hedge against things going wrong.
The key here is to ensure your portfolio is set up with the right investment allocation for you and your business. It should take your situation into consideration, and that includes evaluating the type of business you have and what that means for investments outside of that business.
For example, a real estate developer may not need the usually-recommended basket of stocks and bonds if their real estate holdings are correlated to bonds.
In other words, if the business behaves like a particular asset class and they tend to go up and down together, the entrepreneur’s investment portfolio should reflect that.
For our real estate developer, they might have more equities than fixed income to reflect the fact that their business tends to behave in certain ways.
On the other hand, you could have a business owner with a fast-growing business that’s promising but volatile. Investing in mostly equities in their investment portfolio might not make much sense because they’re already taking on a lot of risk with the business itself.
That doesn’t mean that the business owner shouldn’t invest elsewhere. It means their portfolio in the market should account for their other investments, including the business.
What to Keep in Mind When Considering If You Should Invest in Your Business, or Start Diversifying Instead
Ultimately, you want to seek to strike a smart balance between investing in your business and diversifying your wealth and potential income streams.
What that balance looks like will vary from entrepreneur to entrepreneur -- but almost every business owner could benefit from investing in a variety of locations instead of exclusively into the business.
If you’re not sure what the right move for you looks like, keep an eye out for signs that you might be over-invested into your business.
When you see slow growth or low returns, that might be the nudge you need to diversify and invest in the market as well. Or if there are major tax savings opportunities that you’re currently leaving on the table, it might be time to take advantage so you can keep more money in your pocket.
Another sign it might be time to further diversify is if the cash flow the business generates meets its needs and then some. Instead of continuing to reinvest extra, consider allocating that money to other investment vehicles.
When you create a dynamic and comprehensive financial plan, these opportunities and challenges are easier to spot. You likely have more needs and goals than just “grow the business,” and your investments should reflect that.