Investing for Business Owners: 4 Ways to Manage Risk and Diversify Your Portfolio

Entrepreneurs and business owners often approach risk differently than most, especially when it comes to their comfort with uncertainty.

As one founder put it, “The risks are endless…they never go away when you’re an entrepreneur.” This is the reality business owners face daily as they strive for growth and earnings.

Managing risk becomes even more complex when balancing a business with personal financial health. In my experience, many business owners tend to focus more heavily on their business and neglect their personal finances. While their business might be their most valuable asset, it’s essential to carefully manage their personal wealth to help reduce overall financial risks.

While there’s plenty of risk in running and owning a business, a personal investment portfolio should work to complement those risks, not amplify them.

Here are four investing tips for business owners to help manage risk and diversify:

Investing Strategy 1: Avoid Over-Concentration in a Single Sector

Business owners often find themselves overexposed to the industry they work in. Focusing on a niche can be great for a business’s growth, but can lead to over-concentration, as the business is typically their largest asset. However, waiting for a liquidity or exit event (i.e. business sale) isn’t always necessary for effective diversification—there are a handful of ways to extract value while the business is still operating.

For example, if you own gas stations, you’re already heavily exposed to the Energy sector. A downturn in gas prices could affect both your business and any Energy stocks you hold. To reduce this risk, you can diversify your portfolio by investing in sectors outside your primary industry. A wealth advisor can help you find ways to reduce your exposure to Energy stocks in your portfolio upfront and consider boosting your holdings to the other sectors. This can help balance your overall asset allocation across your financial life.

Investing Strategy 2: Transfer Value from Your Business to Your Personal Portfolio

Transferring wealth from your business to your personal portfolio not only helps diversify your investments, but it can also provide some liquidity diversification.

Most owners’ and entrepreneurs’ business interests are illiquid, meaning they can’t be quickly sold for cash. If a situation arises that requires cash, a forced sale of their ownership would likely be at a lower price than its current fair value. So, when you’re shifting value from your business into your personal portfolio, you can mitigate liquidity risk by adding assets that have relatively higher amounts of liquidity than your illiquid ownership interests. These assets might include stocks, bonds, or ETFs. These investments provide flexibility, allowing you to access funds relatively quickly and effectively without having to sell a portion of your business.

One of the goals of every investment, including a personal business, is to never be a forced seller, and having liquid investments outside your business helps lessen that risk. This is why it’s vital to have various buckets of assets with different amounts of liquidity. By diversifying liquidity in their financial portfolio, business owners can access extracted wealth without selling their ownership stake, which is hopefully going to be your fastest-growing asset.

Investing Strategy 3: Utilize Tax-Efficient Strategies Like Direct Indexing

As your business grows, an eventual sale or exit could trigger significant capital gains, resulting in a hefty tax bill. Planning ahead using tax-efficient strategies can help minimize this impact.

One option for business owners is direct indexing, a unique approach that allows investors to own numerous individual stocks that fit into their chosen investment style instead of a single fund or ETF. A strategy like this can help investors build tax assets through active tax-loss harvesting, while still aiming for index-like returns.

On average about 31% of stocks experience losses during a calendar year. Direct Indexing helps investors take advantage of this normal market volatility by actively working to capture those losses through selling stocks that are currently at a material loss, and immediately reinvesting the proceeds into other holdings that fit into your portfolio’s strategy. This process not only helps preserve your overall allocation but could potentially also build a valuable tax asset over time.

The value of these losses can be substantial and can be carried forward year-over-year if they aren’t used in a calendar year. For instance, a high earner paying a 20% federal tax rate on long-term capital gains can save $20,000 for every +$100,000 in gains offset by accumulated harvested losses. And if you’re offsetting short-term gains in the process, the savings could be even higher. Talk about a powerful use for your taxable personal portfolio!

Investing Strategy 4: Plan for an Exit Early

Entrepreneurs and owners have opportunities to diversify their wealth today and can take steps to make their eventual exit more tax efficient while they are still running and growing their business. The best financial planning for business owners, in my experience, happens well in advance of a liquidity event. Don’t wait for an exit to start planning. Instead do what you can today to be prepared. If you’ve been focused solely on your business and have overlooked your personal finances, now is the time to consider how these strategic investing decisions could impact your future.

By proactively managing risks and diversifying investments, business owners can balance their personal portfolios with the uncertainties of entrepreneurship.

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