Having too many eggs in one basket. It’s a problem for a lot of people.
Employees of publicly traded companies are often granted stock as part of their compensation.
From a portfolio management perspective, holding large amounts of stock in the same company that gives you your paycheck can increase risk.
If that business were to have problems, not only could the stock value decrease, but your income could be at jeopardy as well.
Employees who have received stock grants can potentially reduce the risk by selling some of the company’s stock and reinvesting it in other assets. This can help diversify their wealth apart from their source of income.
But what about when you’re the business owner? That situation becomes much more complex.
One strategy that we often encounter is the owner putting everything except living expenses back into the business while they’re growing it and then selling part or all of the business, or taking on a strategic investor to help diversify elsewhere.
Retirement planning is often put on the back burner until the business has grown to a point where the business can be monetized.
The key here is diversification. While it may seem like a good idea, relying solely on your business as your source of wealth can expose you to a lot more risk and volatility than you think.
Whether it’s saving for a rainy day or longer term goals like retirement, if all your wealth is tied in your business, your business dictates your moves.
Creating and regularly adding to a separate investment portfolio can help diversify your assets and if you invest away from areas you are already exposed to in your business, it can be a powerful tool to help smooth volatility across both your business and your life.
For instance, if your business is vulnerable to cyclical changes in the economy, you may want to create an investment portfolio that is defensive against those changes.
There can be a significant advantage to both you and your company in setting up the right kind of retirement plan for your business.
Of course, there are upfront fees and ongoing costs associated with formal retirement plans. However, they also allow you to save in a very tax advantageous manner. Depending on your situation and the plan you choose, we could be talking hundreds of thousands of dollars a year in tax-deferred savings.
A 401(k) and cash balance plan are tools that you can use to save and look forward to a future income stream that you can access without having to sell your business.
They also can be a great way to attract and retain talented employees.
When you’re putting everything into the business with the idea that you’ll eventually fund your retirement by selling all or part of it, you’re essentially making two bets.
First that you’ll be able to sell when you’re ready and not before and second that when you’re ready, the market for your business will be at a good point for an exit.
Having to liquidate early because you are no longer able to run the business, or having to sell when either the business is struggling or the market isn’t right, can limit the amount you realize from a sale.
You only get one chance to sell, and your retirement life will be dependent on that sale.
If you’ve planned for a source of retirement income away from your business, you can have much more flexibility when that time comes.
The bottom line is, even as you’re building your business, it makes sense to think about your personal wealth as a completely different stream of future income. Thinking about diversification across your total asset profile can get you started on a journey to financial independence.
Diversification and asset allocation are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss.
For advice appropriate to your specific situation, please consult a financial professional.
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