Investment Strategy for Entrepreneurs

You're still in your prime earning years, you've been downsized one time too many, and you decide to go into business. You've financed the start up with a home equity loan or personal savings; perhaps you've even set up a health savings account to handle health care costs. But you've also got to think about investing for retirement. Are there any special considerations for a sole proprietor when it comes to investment strategy? To answer that question, we contacted three area wealth managers who agree that a conservative approach makes the most sense for entrepreneurs.

Risky business

Entrepreneurs are both the same and different from other investors – the same in the sense that investment strategy depends on the answer to three basic questions: What are your goals? What are your constraints? What is your risk tolerance? They are different in that they should not approach investment with the same risk-taking zeal required to start a business. Noted Jason Stephens, COO of Thompson Investment Management, "With entrepreneurs, the tendency can be that if you're taking a lot of risk on the business side because you're financing the business yourself, you might not want to take so much risk on your

investments for your personal savings, or for your retirement. Oftentimes, we have a situation with other investors where we're trying to convince them to take a little bit more risk. With entrepreneurs, because the risk tolerance is always so high, it would probably be a good idea for them to have some stability with their personal investments."

Conversations between wealth managers and entrepreneurs tend to be different, other wealth managers agreed. Lauri Binius Droster, senior vice president of RBC Wealth Management, said entrepreneurs should have some emergency money in case things start out slow. Some entrepreneurs have too much invested in high-flying types of stocks (think dot-com bust), or they try to make a quick buck when they should have more diversification in their portfolios, including some bonds and cash reserves.

The proportion between stocks and bonds always is case-specific. "Maybe an entrepreneur is taking risk in starting a business because his or her spouse has a stable job and a pension," Binius Droster noted. "There is a pension in the family and they've got some security, so maybe they can be a little bit more aggressive in their investments. It depends on their age, too. The older you are, the more conservative you need to be as you get closer to retirement."

Marilyn Holt-Smith, CEO of Holt-Smith Advisors, said the type of business also comes into play. "More capital-intensive businesses like manufacturing usually require up-front loans, while a personal service business has little out-of-pocket start-up costs," she noted. "I would not normally advise a start-up entrepreneur to take money from a tax-deferred retirement account to fund their business start up. There may be taxes to pay, penalties if money is withdrawn before a certain age, and the opportunity costs can be huge. There is a possibility that you would never catch up again with your retirement savings."

Stephens said some clients still own their businesses; others have fully divested themselves from a business. Those who have divested themselves usually fall into two opposite categories: the risk-averse and those who prefer to take a lot of risk in retirement because they still have that appetite. "For them, we try to come up with an investment strategy that isn't too risky relative to what their goals are at this point in life," he said, "but we also give them some kind of an outlet to take some risk with part of the portfolio just because they have that fire they want to feed."

For financially stable entrepreneurs, a sound strategy would be an equal division investment in stocks and bonds. "If you've got enough assets to meet your goals, you can have a much less risky portfolio and you can find some kind of a balance – maybe 50% in stocks and 50% in bonds," Stephens said. "If you have goals that are a little bit higher, you may need to tweak the portfolio and get it a little bit more aggressive."

You can tell an entrepreneur is risk-averse when he or she opts to either start or maintain a business during retirement. Some people in this position cannot sell their business to help build their nest egg; others, including people who are still trying to get back to pre-recession levels or could have their buying power eroded if inflationary fears materialize, need supplemental income because they haven't reached their investment goals. "We're seeing that more," Holt-Smith noted. "Mass media are reporting that more people are not going to retire, or will push off retirement. The idea creates an alternative way of supplementing your income instead of going into full retirement."

In some cases, entrepreneurs invest too conservatively. "My experience is entrepreneurs tend to contribute less to retirement accounts because they expect to sell the business eventually to fund their retirement," Holt-Smith said.

If entrepreneurs launch the business with contracted work in hand, they have the luxury of immediate income. Binius Droster notes they also have more tax liability unless they put some money in a retirement plan, including a self-employed plan. "I had one client who started a business with money coming in, went to do their taxes, and discovered they owed tons of money," she stated. "I said, 'Well, talk to your tax person about putting money into a retirement plan for yourself, kind of like your own 401(k).'"

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