Make the profits from your business work harder for you by creating a sound investment portfolio. Here’s what you need to know.
Building an effective investment portfolio that can navigate the ups and downs of the economy can be challenging to say the least. It’s even more difficult for small-business owners. Most individuals start investing with a specific life event in mind like buying a home or paying for retirement. But for business owners, investing really serves as a tool for managing risk since they tend to have most of their wealth tied up in a single asset – the business.
Why Build a Portfolio?
If you ask a financial advisor why you should have a portfolio of investments, instead of a single investment, the answer will typically be “diversification.” Every type of asset that you may own—stocks, bonds, equipment, entire companies—will see its price fluctuate over time. This fluctuation in price is known as volatility. The more volatile the price, the riskier it is to own that asset because when it comes time to sell you don’t know whether the market price will generate a gain or a loss for you. By having different types of assets in your portfolio with prices that respond differently to market conditions, you mitigate the risk of everything you own going down in value at once. This won’t necessarily make you more money, but it will help minimize the risk of losses which is lesson number one in investing—don’t lose money. It is also possible to have two goals at once—to minimize losses and maximize returns within the realm of the possible.
How to Start?
As a business owner, your first step is to get a handle on your current financial condition by asking yourself:
- What is my business worth? If I had to sell tomorrow, what would I be able to walk away with?
- What other assets do I have outside of the business?
- What are my current and future cash needs?
Next, you should honestly assess your level of risk tolerance. This is important because it will define which investment opportunities are appropriate for you and the level of returns you can realistically expect given the level of risk you are willing to take. In theory, a higher risk should provide higher returns and conversely a lower risk should provide lower returns. This isn’t always the case. Risky assets are risky for a reason and attempts to make high returns by taking on too much risk usually isn’t a good idea.
When determining the riskiness of a particular stock, bond or commodity, you aren’t flying blind. There is almost an unlimited amount of historical data which provides insight into how each asset has performed in the past. While this doesn’t guarantee that you’ll know how they’ll perform in the future it is a good indicator of what you can expect.
Choosing Your Assets
When evaluating potential assets for investment like stocks, bonds, mutual funds, exchange-traded funds, commodities, hedge funds or even other businesses, there are two key questions you need to keep in mind:
