Eggs in How Many Baskets? Prioritizing Building Wealth While You Build Your Business
Employees of publicly traded companies are often granted company stock as part of the compensation package. From a portfolio management perspective, holding a large amount of stock in the same company that provides you a salary increases your dependency on the company's financial stability. If the business were to become less stable, not only would the stock decrease in value, but the employee could also potentially find themselves out of their primary income source. Employees granted stock often mitigate this risk by selling some of the company stock and reinvesting it in other assets to diversify their growing wealth away from their primary income source.
But what about when you own your business? The situation becomes more complicated. One strategy that's often followed is to put everything except living expenses back into the business while growing it and then selling part of the company or taking on a strategic investor to help you begin to diversify elsewhere. Retirement planning is put on the back burner until the business has grown to a point when you can monetize it. But we think there is a more thoughtful approach that works well for many investors.
The Key: Diversification
While it may seem like a good idea, if you rely solely on your business as your source of wealth, this can expose you to a lot more volatility than you think. If all of your capital is locked up in your business, your business dictates your course. Creating and regularly adding to a separate investment portfolio diversifies your assets effectively. If you invest away from inherent exposures in your business, it can be a powerful tool to help diversify and smooth volatility across your business and life. For instance, if your business is vulnerable to cyclical sectors, you may consider creating an investment portfolio that is defensive against those sectors. Building a less correlated portfolio to your business cash flows or your seasonality can mean that you'll be able to use your investment income to bolster your business if you need to. At DeWitt Capital, we have proprietary portfolio-building tools that can help us utilize data to design portfolios specifically designed to reduce volatility.
Retirement Savings Tax Advantages
There can be significant tax advantages to setting up the right kind of retirement plan for your business and ensuring that you set aside money to invest every year. While there are upfront fees and ongoing costs associated with formal retirement plans, they also allow you to save in a very tax-advantageous manner. Depending on your situation, a 401(k) plan and a cash balance plan are tools you can use to save effectively and look towards a future income stream you can access without having to sell your business. They can also be a great way to attract and retain talented employees.
How About Timing?
When you're putting everything back into your business with the idea that you'll eventually fund your retirement by selling all or part of it, you're essentially making two wagers. The first is that you'll be able to sell when you are ready and not before, and the second is that when you are ready, the market for your business will be at a good point for an exit. Having to liquidate because you are no longer able to run the business or sell when either the company is struggling or the market isn't right can limit the amount you realize. You only get to sell it once, and your retirement life will be dependent on the amount the market accepts. If you've planned for a source of retirement income away from your business, you'll have more flexibility when it comes time to sell.
The Bottom Line
Even as you're building your business, it makes sense to think about your wealth as an entirely separate stream of future income. Thinking about diversification across your total asset profile can get you started on a journey to financial independence.
