A look at investing in a turbulent stock market. Here are some suggestions for protecting yourself from a sudden downturn. Also: alternatives to stock investments.
In a turbulent stock market, entrepreneurs must take extra precautions
Not so long ago, the stock market seemed capable of moving in only one direction: up. All that's changed since the global markets started taking some wild swings. If you've felt as though your investments have been on a roller coaster, it's not surprising.
For investors who can afford to ride out the market's storms, those short-term glitches may not matter. After all, the stock market has historically outperformed all other investments. But here's a caveat: if you're the owner of a growing company that has unpredictable cash-flow patterns and sometimes-insatiable capital needs, the risks of a volatile stock market may be more than you can handle right now. What if a cash crunch forced you to sell stock holdings during one of these painful downturns? What if your investments turned out to be worth less than you were counting on? The picture isn't pretty.
Is it time to rethink your personal-investment strategy in light of changing market conditions? To hear many investment advisers tell it, there's little reason to shift gears--regardless of what's going on in the various financial markets--as long as your long-term strategy makes sense. To them, there's no reason not to stay heavily invested in stocks, since they've historically yielded the best long-term investment returns.
Barbara Grogan, the 50-year-old CEO of Western Industrial Contractors Inc., a $10-million contracting business based in Denver, begs to differ. Grogan, whose résumé includes a stint as the chairman of the board of the Denver branch of the Kansas City Federal Reserve Bank, is convinced that it's in every entrepreneur's interest to use caution with his or her investments outside the company. "I've been doing this for more than a year now--moving a little bit away from the stock market to safer investments," she explains. "We're heading into an economic environment that none of us have seen before, so it's in the interests of all of us to be highly diversified."
Another factor to consider is the degree to which entrepreneurs are already exposed to the stock market through their own companies. "Sometimes clients of mine who are entrepreneurs tell me they want to invest in the stock market," notes Jeff J. Saccacio, the West Coast partner in charge of personal financial services in the Los Angeles office of accounting firm Coopers & Lybrand LLP. "But their biggest investment by far is an equity-and-growth component--it's their company." A stock-market downturn could particularly affect you if you have plans to take your company public or sell it soon.
Back to Grogan, who actively manages both her personal investments and her 15-year-old company. Her strategy for shifting investments has a lot to recommend it, in part because she takes a gradual approach that offers substantial downside protection. "My first motivation is always that I've identified an alternative investment offering as an attractive opportunity," she explains. "I might need to sell stock holdings to take advantage of it. Still, I'm not selling stocks because of bad news--which would lock me into taking a loss--but because of future promise elsewhere."
If your shares have sustained a massive paper loss, it probably doesn't make sense to sell unless you have to. When Grogan has made shifts, which have usually involved purchasing real estate or bond investments, she has financed them either through new savings or by selling stocks that have already yielded high profits.
Grogan explains, "I don't want to sell my company, and I don't dream about retiring. But I want to accumulate enough value, through my company and my investments, that I'll have plenty of choices one day."
Economic times like these can be treacherous; often they trick investors into buying or selling at all the wrong times. Instead of responding to every stock-market jitter, concentrate on diversifying your holdings to include other types of complementary investments. Obvious possibilities include bank certificates of deposit, zero-coupon bonds (especially good for college-tuition savings), short- to medium-term government bonds, and top-rated corporate bonds. But do consider some of these off-the-beaten-path strategies as well:
Convertible Bonds. These hybrid investments combine most of the benefits of both stocks and bonds while, best of all, protecting you from some of the risks of today's volatile equity market. Here's why: Convertibles pay income the way regular bonds do; that's their safety feature. But convertibles can also be redeemed for shares of the issuing company's stock. That translates into growth potential. You can purchase convertible bonds individually or through a convertible-bond mutual fund.
REITs. Many people find real estate an attractive diversification away from the stock market. "I'll admit that real estate is prone to the same kinds of highs and lows that stocks are, but I've always done great during downturns because I understand this business and what makes projects profitable," notes Barry Shames, CEO of $15-million Shames Construction Co., in Livermore, Calif. Shames keeps 5% of his noncompany holdings in cash, but most of his other investments are in real estate.
For investors who lack Shames's experience, real estate investment trusts (REITs) may offer an appealing alternative. REITs sell investment shares, which then get traded on exchanges the way stocks do; the funds that REITs raise get invested in real estate properties such as hotels and shopping malls. REITs had a total 1996 market capitalization of about $80 billion, compared with just $10 billion in 1991. They may have more room to keep growing, as industry analysts predict annual returns of 10% to 12% during the next three years.
"Historically speaking," notes Jack Blankinship, a certified financial planner in Del Mar, Calif., "REITs' share prices have tended to have a negative correlation to the stock market." While there's no guarantee that REITs will continue to perform well during stock-market downturns, it's undeniable that influxes from equity-shy investors should help sustain interest in them.
VEBAs. In an investment universe like this one, in which stocks seem too risky, it may be time to start considering vastly different alternatives. What about using this year to purchase a really big life-insurance policy? Or skipping your own bonus and looking for ways that funds could help achieve corporate goals rather than personal ones? What if you could do both?
That's the logic behind a VEBA, which stands, somewhat incomprehensibly, for Voluntary Employees Beneficiary Association. VEBAs offer an opportunity for business owners to earn tax deductions for their companies while socking away extra-special benefits for themselves. Here's how they work: Your company either sets up its own VEBA (too expensive, so forget about it) or joins an existing one that's probably been set up by a large regional bank. Through the VEBA, you buy life insurance for yourself and your employees, as well as other benefits. "You can buy cheap term policies for your employees and a really great cash-value life-insurance policy for yourself," explains David Ford, a financial planner based in Beverly Hills and Newport Beach, Calif. "If your net worth was $10 million and you just went out on your own and bought a $5-million policy from your own savings, there wouldn't be any kind of a tax deduction. But if your company does it through a VEBA, it gets a full deduction." That's an attractive feature.
And although VEBAs won't help you with your short-term investment goals, they can certainly help address your estate-planning needs. However, VEBAs can be tricky, so be sure to consult reputable tax and benefits advisers.
Jill Andresky Fraser is Inc. 's finance editor.
Here's a good antidote to the investment hysteria that sometimes arises in uncertain economic times: Pay Yourself First: A Commonsense Guide to Life Cycle Retirement Investing (John Wiley & Sons, 800-225-5945, 1996, $16.95), by Timothy W. Cunningham and Clay B. Mansfield. In a remarkably readable 272-page guide, these two longtime money managers discuss a wide range of investment strategies and other fascinating topics in chapters such as "The Evil Twins: Emotions and Market Timing." For entrepreneurs eager to make their own investing decisions, this book offers the opportunity to learn a lot quickly.