An entrepreneur friend of mine who runs a wealth management business has all his personal investments in cash, in order to balance out the correlation to stock market of his startup. The awareness for diversification is good, though his money can be doing much more.
“Think of your money as your partner,” sage advice from Professor Charles Lee of Stanford Graduate school of Business, “your portfolio is supposed to work hard as you work hard.”
Even if your startup does not directly buy stocks, its risk exposure is most likely akin to an illiquid high-risk stock. As an entrepreneur, you can design your investment portfolio to mitigate this risk exposure while have it work hard for you on three purposes:
- Stay liquid – have at least 9 months of “personal runway”
- Subsidize income – invest in tax-exempt bond strategies
- Meet future goals – start a SEP IRA or individual 401(k)
Manage Your 401(k) Today — Start by Getting Your Free Analysis >>
Liquidity = Sanity: Your “Personal Runway”
Liquidity is the single most important investment consideration for entrepreneurs.
In plain English, liquidity simply means having enough money to support your lifestyle.
Liquidity allows you to stay sane and focused, as you are now able to separate business decisions from personal financial needs. Exhausting your personal income and reserve in your business can put undue stress on your relationships.
If you raise funding, you should have a salary, as your time and expertise has a market value. You can take a sizable pay cut to work on the startup for the potential upside in the equity, but this cut shouldn’t be 100%.
Besides meeting expenses each month, regardless of the funding structure of your startup, it’s a good idea to hold additional “rainy day funds” beyond what you would have otherwise. When you are an employee, you might be fine with 3-6 months of savings in the bank. As an entrepreneur, however, you should have at about twice that as your “personal runway”.
Learn How to Invest Confidently — Download This Free App >>
The rainy day funds should ideally be in liquid securities with limited downside, for example, in short-term bond ETFs and not your buddy’s film project. In case of an emergency, you don’t have to sell other assets at a potential loss or take on high interest.
Subsidize Income in a Tax-Efficient Manner
If needed, you can subsidize your income with higher-yielding bond funds. One option is tax-exempt state municipal bond ETFs, if your state is fiscally sound. Another option is to blend it with U.S. treasury, investment-grade corporate bond strategies, and other income-oriented assets like MLPs, REITs, or rental properties.
If you don’t need more income, diversify with strategies such as low-duration bonds and alternative strategies that have limited correlation with stocks. Unless your income is in a low tax bracket, avoid taxable dividend or high yield bond strategies in brokerage accounts as they can move you to a higher bracket.
You May Not Need to Put Future Goals on Hold
In the short-term, you are dedicating your human capital to create value in your business.
For the long term, your money as your partner should continue to work toward your future goals.
If the startup you are a part of does not offer retirement plans yet, to the extent you are able to put money away, set up an SEP IRA or Individual 401(k), which can reduce your taxes too. Here you can hold stocks and reinvest the income of high yield, real estate investment trusts (REITs) and dividend strategies, to achieve tax-deferred long-term growth and not be too worried about short-term volatility.
See How Your 401k Stacks up in Minutes — Start by Getting Your Free Analysis >>
Tips for Putting Everything Together
Be aware of the hidden correlation among your business, stocks, and physical assets. If you own significant equity in a technology company and a home in the Bay Area, then you might not want all of your trading and retirement accounts to be in tech stocks. Similarly, if you develop real estate and already have investment properties, then diversify with stocks from other sectors rather than fixed income or REITs.
As an entrepreneur you may barely have time to eat or sleep. Don’t lose time or money on volatile stocks just because you don’t have time to follow them. Limit the number of securities in your “play pot” that requires your frequent attention.
“Great entrepreneurs contain risk; they don’t seek it” – The Agile Startup. In our holistic framework that identifies the unique risk exposure of each household, the most concentrated risk for an entrepreneur is the startup itself.
Overall, as the risks in a startup are already tricky, entrepreneurs should clearly understand the purpose of each of their investments, hold them in the appropriate account types and get rid of the ones whose purpose aren’t clear. Contain risk and stay liquid in your investment portfolios so you can focus on building a successful business.
This article was originally posted by Min Zhang on moneyinc.com