Business Owners – a special case for diversification
Small business owners frequently focus most of their investment funds, including for their retirement, on their own business. After all, it’s the business they know best. The problem with investing solely in your own business is one of risk, because for every successful business, many more either fail or return only modestly. Diversification is one way to reduce the risk of putting all of your retirement into “one basket”.
Consider this: If you pass the company on to your children, you risk that they won’t be able to run the company profitably enough to fund your retirement. If you sell the company, owners are often asked/required to take a note as partial payment for the sale; so again, you have the risk that the new owners can’t run the business profitably enough to pay you the full purchase price over time. Of course, if you can’t find an all cash buyer, willing to pay you the right amount, when you are ready, you may end up discounting the sale price and receive less than you need to fund your retirement expectations. -- And that is even before we start talking about paying tax on the sale proceeds!!
That’s why financial planners typically counsel business owners to diversify at least some of their investment money. The following are a few suggestions:
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The key is to remain diversified. Your business may ultimately provide all the money you need, but the other investments are there in case that doesn’t happen.
For more information, contact: John Davidson, CPA, CFP® - john@kyleshill.com
Small business owners frequently focus most of their investment funds, including for their retirement, on their own business. After all, it’s the business they know best. The problem with investing solely in your own business is one of risk, because for every successful business, many more either fail or return only modestly. Diversification is one way to reduce the risk of putting all of your retirement into “one basket”.
Consider this: If you pass the company on to your children, you risk that they won’t be able to run the company profitably enough to fund your retirement. If you sell the company, owners are often asked/required to take a note as partial payment for the sale; so again, you have the risk that the new owners can’t run the business profitably enough to pay you the full purchase price over time. Of course, if you can’t find an all cash buyer, willing to pay you the right amount, when you are ready, you may end up discounting the sale price and receive less than you need to fund your retirement expectations. -- And that is even before we start talking about paying tax on the sale proceeds!!
That’s why financial planners typically counsel business owners to diversify at least some of their investment money. The following are a few suggestions:
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- Start with a written investment plan that takes into account your business and will keep your finances steady through rough times.
- Build a cash cushion for your family and your business. Set aside at least three to six months of cash flow (some planners recommend a year or more) in a liquid account, such as a money market fund.
- Resist the temptation to invest only in companies in your industry, or those with whom you do business. If your industry experiences a downturn, both your business and the stocks you’ve invested in could slump at the same time.
- To better diversify, planners commonly recommend balancing off your business investment with a variety of other stocks; large company, non- regional, domestic stocks, as well as international securities and perhaps real estate investment trusts that invest in other regions and industries. This can be a lot of work, so we like to use well managed mutual funds with consistent records of return over the market. Bonds are another important component of a diversified investment portfolio that can provide a level of fixed income, with less risk than all stocks.
- The exact mix of cash, bonds and stock depends on your particular circumstances, age and tolerance for risk, so you will need to re-balance periodically as markets and your personal situation changes.
- Set up the optimal retirement plan increased retirement savings makes you less reliant on sale of the business. Retirement plans i.e. SIMPLE IRA plans, Safe Harbor 401K plans, Profit Sharing plans each have different and benefits and limitations. Meet with a qualified planner to help you find the one that allows you to maximize your own retirement savings, minimize taxes, and provide your desired level of benefit to your employees.
- Use your diversified portfolio - as a receptacle account for harvesting cash flows from your business when they exceed your current lifestyle needs.
The key is to remain diversified. Your business may ultimately provide all the money you need, but the other investments are there in case that doesn’t happen.
For more information, contact: John Davidson, CPA, CFP® - john@kyleshill.com