Why You Shouldn't Invest Like Your Brother-In-Law
BY Elle Kaplan
Entrepreneurs have different risk profiles than everyone else -- and that's especially true when it comes to investing.
As an entrepreneur, your brain is hardwired to take risks. To start your own business is to defy logic: You step out of the stability and security of a corporate environment, complete with established accounts, office support, an HR team, and many other resources, to take on the responsibility of wearing all of these hats, all at once. This is not for the faint-hearted, and requires you to take a huge amount of risk.
It also affects how you should be investing, both in the short and the long term. And most entrepreneurs fail to take into account the very unstable nature of their work when looking at their asset allocation. Even though they think they’re looking at their asset allocation holistically, they’re only looking at their bank and brokerage accounts. And they should be looking equally closely at their source of income.
Think of it this way: Even if your business is stable and seems to be growing nicely, on a very real level, you never quite know what’s going to happen next. Being an entrepreneur is analogous to owning a concentrated position in one stock - an inherently risky move.
Contrast your situation to that of a tenured professor, who has long-term job security that’s as stable as they come. Or a government employee, who has a guaranteed future income stream in the form of pension. These jobs are analogous to bonds, the “sleep easy asset class,” because they have an embedded income stream of stability, and thus carry far less career risk.
Someone with a great deal of job and income security can afford to take on greater investment risk. Entrepreneurs may want to offset some of their risk - especially in the early years of launching a company-- by placing their assets in less volatile holdings, such as fixed income.
Why? If both your entrepreneurial endeavors and your portfolio tilt toward risk, overall, you’re unbalanced. The ideal asset allocation should incorporate a holistic perspective of you as an individual--your career included. In planning your portfolio, you should always seek balance: A healthy portfolio is a well-diversified portfolio. When your very job is concentrated risk, this must factor into your overall investment strategy.
You also want to make sure you don’t double down on risk by investing in your own industry. I know a mortgage trader who invested in real estate and mortgage bonds, and leveraged his personal wealth into buying a home-;just before the bubble burst. This trader was hit hard in terms of his career, his assets, and his portfolio, all at the same time. For entrepreneurs who already invest in higher-risk asset classes, this all-too-common practice unbalances your portfolio even further. Having your holdings and your career centered in one area increases your exposure to concentrated risk.
Familiarity doesn’t give you an edge in selecting more profitable stocks-;one often winds up with too much concentrated risk and no real reward. Across your asset allocation--portfolio and career--you should always shoot for a balanced distribution of risk. Ask yourself, are you a stock or a bond? And invest with that in mind.