Many business owners think of their business as their investment portfolio. But having all your assets invested in one company and, therefore, one segment of the market is risky. “Diversifying your personal portfolio is the key to reducing risk,” says Suellen Cramer, Merrill Lynch Vice President and Senior Financial Advisor.
Getting personal
Your first step to diversification is moving your personal investments outside your own industry. It may seem logical to invest in technology stocks if you own a technology company and understand the sector. However, if the technology sector declines – as it did just a few years ago – your entire portfolio may suffer.
The second step involves investing in growth and income investments. The appropriate mix will depend on your personal risk tolerance, how close you are to retirement, and your business’s prospects. Business owners with long-term investment horizons and stable business prospects may choose to put more of their personal portfolio into equities for growth. Those who are closer to retirement or who are uncertain about the future of their business may opt for more fixed-income vehicles on the personal side. Either way, it’s crucial to view your entire portfolio – your business and other investments – for the purposes of asset allocation.
Enhancing liquidity
Investing all of your funds in your business not only exposes you to risk, but it may also leave you with limited liquidity. If you reinvest everything back into the business and have a short-term need for cash, you may have to take a loan against your business to generate the necessary funds.
Money accounts have long been an accepted holding place for liquid assets. In a low-interest-rate environment, however, floating-rate investments may be a better choice. These investments help protect your principal from interest-rate risk while allowing your income to increase as interest rates rise.
Business succession
Business succession planning is vital if you want to maximize your investment in your business and preserve assets for your heirs. Keeping the business in the family is most likely if one or more family members work in the business.
If the family is not involved and you want to sell the business, consider the tax advantages of selling to an employee stock ownership plan (ESOP) instead of an outside purchaser. By reinvesting the proceeds into qualified replacement property (e.g., stocks and bonds that fit specific characteristics), the gain from the sale may be sheltered from taxation. Under current tax law, no tax would be due until the replacement assets are sold. Upon your death, any replacement assets still in place could benefit from a step-up in basis, allowing your heirs to sell the assets with no tax consequences.
Post-business issues
Once you no longer own the business – whether it is sold or remains in the family – you should take a fresh look at your overall asset allocation. Because the business made up a large portion of your overall investment portfolio, you need to replace the business with a well-thought-out mix of investments tailored to meet your new needs.
Although you may look more toward income investments as you age, you will also want to consider growth investments to replace the growth element previously represented by your business. With today’s longer life expectancies (the average 65-year-old can expect to live to almost 85), growth remains important.
Seeing your business as an important piece of your investment portfolio – instead of as your entire portfolio – is essential when you are developing a comprehensive investment plan. By diversifying your investments outside of your business, you can ensure that all the pieces of your portfolio are working together to better help you achieve your financial goals.