It turns out the instincts that make one a good entrepreneur can also make one a bad investor.
Lewis Schiff is a consultant with the Advanced Planning Group. He writes a blog for Inc.com that emphasizes two points: 1) entrepreneurs who take lots of risk with their businesses should minimize the risks they take with their investments, and 2) because business owners simply don't have enough time to manage their investments properly, they should pick simple and easy to use strategies.
It's conventional wisdom that entrepreneurs make lousy investors. Why is that?
Entrepreneurs have a great tolerance for risk. It's one of the factors that differentiates them from those who take a more corporate route. That risk tolerance can lead them to a risk rush, and they may put themselves into situations where the risk is greater than the reward.
But at least entrepreneurs understand business. Doesn't that count for something?
Entrepreneurs own businesses, but the process of building a well-crafted portfolio that's meant to reach certain benchmarks a couple of decades hence is a different exercise. We need to focus on things like diversification, tax efficiency, and the drag of volatility in the short term on our long-term goals.
It's true that the smartest entrepreneurs have both a long-term and a short-term vision for their businesses, but the short-term vision commonly trumps the long-term. In investing, it's the reverse. We have to learn strategies and coping skills to mostly ignore the short term in order to maximize the long term.
What are the most common mistakes entrepreneurs make?
First is time commitment. Entrepreneurs are notoriously busy people. Picking stocks, the most common way people invest in the public markets, is time-consuming work. It takes research and analysis to make a choice and then you have to stay in touch with your investment choices every day. Even if you pick mostly mutual funds, you'll want to keep tabs on how the manager is doing and how well the fund is keeping to its benchmarks. All of this takes time -- time that most entrepreneurs don't have.
Second is knowledge. I'm not talking about being smart, but about having good intelligence about the companies and sectors you invest in. Most of the time, professional stock market analysts spend all day talking to the companies they follow as well as those company's vendors, customers, and competitors. The average entrepreneur does have some unique insight if the sector they invest in is related to their business but they may not have the whole picture. When you rely on information that is already in the public domain -- such as news reports -- you are making decisions based on data that the analysts had long ago. You're always behind the eight ball.
Where would you put $10,000 right now?
My answer to that question is always the same: into a diversified, low-cost, tax-efficient, passively invested set of global mutual funds. To learn more about what that means, you can read my blog, The Only Guide to Investing an Entrepreneur Will Ever Need, but we're talking about index funds. It's the strategy we recommend for entrepreneurs.
What's especially significant about that question of where to put money today is that you should always have your money invested in a place where you'd put it if it were new money in your hands today. If some aspect of your business was operating poorly, would you just leave it alone and wait for fresh funds to come along before you started something new? Most of us know we should eliminate our underperforming investments and use our resources toward investments that we think are good bets. The same is true with your portfolio. If you've got bad holdings in your portfolio, sell them. Put your resources into strategies that work and get rid of your laggards.
What entrepreneur is going to put his or her money into an index fund? If they were willing to just be average -- to just do what the market does -- they wouldn't be entrepreneurs, would they?
There are so many good reasons to use index funds for achieving long-term investing goals. First and foremost: achieving the same returns as the market is quite a feat! Most professional investors fail to do that every year. There are two reasons for this. The most daunting is that it's extremely difficult. Second, fees and taxes eat up profits a lot faster in actively traded portfolios so you're usually in the red right from the beginning.
Simply put, I have invested in index funds for 10 years and my returns beat 9 out of 10 investors' returns. Can you say the same thing?
Given the volatility of the stock market lately, should entrepreneurs with growing companies invest in stocks rather than putting that money into their own businesses?
Benjamin Franklin famously said "a penny saved is a penny earned." What that means is you haven't really earned any money until you've saved it. By putting some of your earnings into a diversified stock market investment, you've effectively taken that money off the table. You've pulled it out of the volatility cycle of your business and put it into the cycle of another business. Now, you've constructed a portfolio whereby a bad period in your business won't be correlated to your stock investments. By the same token, a downturn in the stock market won't be correlated to your own business. You're experiencing the kind of diversification that leads to better long term returns and fewer sleepless nights.
You recently wrote a book, The Middle Class Millionaire, which suggests that entrepreneurs -- because of the way they accumulate and spend their wealth -- are changing the very nature of this country. Can you explain?
Middle-class millionaires are the "working wealthy." They have middle-class values but wealth-building skills that put them into the top 10 percent of America. Those skills are being applied to create a better way of life for those extremely busy families. The end result is a whole new economy driven by the demands of a well heeled, time-starved demographic. Not only are we seeing some fundamental changes in core areas of daily life, such as medicine, education, and home ownership, we're also seeing the blossoming of a whole new entrepreneurial economy, based on serving the needs of America's self-made wealth.
Can you give us an example of the kinds of changes you're talking about?
Some of the most profound changes are occurring in the service segment of the economy as the affluent middle-class seeks more help and assistance living their lives. One middle-class millionaire referred to it as "360 Degrees of Support." In the book we profile the rise of concierge healthcare, home generator systems, and new real estate businesses that are making home-buying more efficient.
So what's the thinking behind The Only Guide To Investing an Entrepreneur Will Ever Need?
In a nutshell, "time." Valuing the entrepreneur's time is behind everything we'll address in The Only Guide to Investing an Entrepreneur Will Ever Need. Business owners are busy people. They need simple, effective solutions to their challenges. Retirement portfolios need to be created. Cash flow produced by successful businesses needs to be maximized. Diversification outside of the primary businesses needs to be achieved. Long-term financial goals need to be reached. All of these take time to investigate, prepare, implement, and track. Making those decisions efficiently, so you can accomplish all of your goals in less time with fewer headaches is the goal.
If your investing strategy is mostly about putting your money into index funds, why do you need a blog? What are you going to tell me next week -- put some more money in your index fund?
The strategy behind The Only Guide to Investing an Entrepreneur Will Ever Need may be simple, but it's not unsophisticated. There are many ways to customize the strategy to your needs, including: your time horizon, your risk tolerance, your cash flow, and your tax status or family situation.
Further, once you decide to look under the hood of your financial life, you may see that there's more than just a change of oil required. A full financial plan -- the kind that will truly help you sleep at night -- is one that addresses your long term future, your short term goals, and even the unexpected.
For example, thinking out a financial plan for a sole proprietorship is different from the plan you'd put together if you're in a partnership or are employed in a larger company. Perhaps you are in a family business and have succession issues? Perhaps you're looking at a sale of your company down the road. For each of us, the answers to these questions will help guide the way we apply The Only Guide to Investing an Entrepreneur Will Ever Need.
On the blog, I'll be leveraging some of the best minds in finance to answer your questions, think outside the box for ways to address challenges, and design creative solutions that allow you to maximize your opportunity as successful entrepreneurs and build wealth.