Investing Advice for the Small-Business Owner
Source: The New York Times
To succeed at running a business takes confidence. You make decisions in a hurry, often with imperfect information. That’s life in the real world.
But the skills that serve so well in nurturing a family business or start-up may not serve when it comes to investing the money you take off the table, where you’re up against other people who spend all day, every day, thinking about stocks and bonds. A friend of mine is a genius at turning $2 million houses into $4 million houses, but he let his banker put his profits into auction-rate securities just before that market froze. Now he can’t get his cash to capitalize on today’s great housing deals.
Another friend runs a successful equipment rental chain. He used a margin account to raise cash for some personal expenses, preferring to borrow at low rates and keep his investments in place. But when stocks dived last winter he had to bolt from a lunch to meet a margin call — not a welcome distraction when he was working around the clock to save his business.
Sure, some small-business people are great investors. But be honest: if you devote 60, 80 or 100 hours a week to your business, do you really have time to read 100 prospectuses to find 10 good stocks? Many financial experts say that despite their business acumen, business owners tend to be fish out of water as investors, quick to fall prey to overconfidence and a sweet line from a self-serving adviser (or a brother-in-law).
If any of this rings true, this guide and a regular blog feature called The Owner’s Money are for you. Their underlying principle: You take plenty of risk in your business; as an investor, you should keep it simple, spread your eggs among many baskets, keep fees and taxes low and tilt the odds in your favor with indexed mutual funds and exchange traded funds.
At the same time, I understand the entrepreneurial mentality. Entrepreneurs tend to be thrill-seekers. They like to test themselves. They like to take chances. For those who want to devote some play money to more aggressive ideas … well, I’ll talk about that, too. That will be fun.
But the smart investor will commit only a sliver of assets to that kind of gamble, certainly no more than 10 percent. For the rest of your money, you should construct a supersimple portfolio, one that requires little maintenance. You could do far worse than to simply split your funds among the following (I explain how to allocate below):
For stocks, the Vanguard Total Stock Market Index Fund (VTSMX). It is an index fund designed to mirror the performance of the entire United States stock market.
For bonds, the Vanguard Total Bond Market Index Fund (VBMFX). This, too, is an indexer, designed to track the entire market of investment-grade bonds in the United States.
For cash, the Vanguard GNMA Fund (VFIIX). This fund invests in mortgage-backed securities guaranteed by the federal government. It is relatively safe and has been yielding upward of 4 percent.
Other fund companies, like Fidelity and Charles Schwab, offer similar funds that are perfectly good. I’ve suggested Vanguard because it specializes in index funds and because, while most fund firms are for-profit operations run for the benefit of shareholders, Vanguard is owned by the people who invest in its products. Vanguard keeps expenses to the bare minimum.
In most years, index funds, intended to mirror the market’s performance, tend to do better than actively managed funds that constantly scramble for the next hot holding. The average active manager cannot beat the market, and trying to do so, he racks up costs that chew away at returns.
The model portfolio above is aimed at conforming to what I consider nine proven principles for keeping an investment strategy simple while enhancing prospects for solid returns over the long term. These principles are meant as a starting point rather than a final plan. Use them to guide your do-it-yourself investing, or to put the burden of proof on any adviser who suggests something more complex. Your first question should be: “Why would that be better than the simple strategy I’m already following?”
The keep-it-simple approach can help you sleep at night, free of the second-guessing and doubt that plague aggressive traders seduced by the latest fads.
ALLOCATE PROPERLY. Study after study concludes that the single most important factor in investing success is asset allocation — the mix of stocks, bonds and cash in a portfolio. Over the long term, stocks have earned in the neighborhood of 10 percent a year, enough to double your money every seven years. But stocks — as we’ve been reminded recently — are too risky for money you will need in the next five to 10 years. The bulk of that money should go into bonds, which are less volatile, though also less profitable, averaging returns of around 5 percent a year. Cash, like bank savings and money-market funds, is very safe but generally earns nothing once inflation has done its damage. A common rule of thumb says one should keep enough cash for 6 to 12 months of expenses. Of the remaining holdings, the bond portion should equal one’s age, i.e. 50 percent for a 50-year-old. The rest of your portfolio should be in stocks.