Do successful entrepreneurs achieve similar success when it comes to portfolio investing? Is applying sound business principles all that successful investing boils down to?
Surprisingly, the answer is a definitive no. Very few natural entrepreneurs do well at managing their personal portfolios – the instincts that serve them well in business are actually not just ill-suited to the world of portfolio management, but quite the opposite of what is required.
Either people over-invest all their assets into their business interests, which has its own risks, or hold onto cash.
Sometimes it’s easier to tackle a large problem by simply breaking the problem into manageable pieces. We think every investment decision should begin with this question: ‘What is the goal of this investment?’ The answer can take many forms.
After some analysis, all of the answers can be broken into two broad goals. One: Creating wealth, and two: Preserving wealth.
Related: The Seven Deadly Sins of Investing
Once you have whittled it into one of those two buckets your direction and decision framework becomes far clearer. So let’s dig a little deeper into the differences. Wealth creation and preservation have contrasting characteristics, which make them polar opposites of one another.
The trade-off between risk and return
Business owners for the most part are well aware of the characteristics of wealth creation. These are the same principles they use day-to-day to ensure their business is successful and dynamic. Wealth preservation principles are on opposite ends of the spectrum.
The truth is most investment goals are with individuals’ after tax earnings. They are trying to save for a child’s education, retirement, maintaining purchasing power or ensuring not all their eggs are in one basket.
In this lies the crux of the entire investment process. People need to think about investing with a different mind-set to how they would manage their business assets or investment in their own business. The reason is because long-term wealth creation involves a trade-off between risk and return.
With preservation, you are looking to ensure with consistency that the wealth is in fact preserved in real terms. This means achieving a return outcome that keeps up with and surpasses inflation over the investment period.
In order to do this investors need to ensure that they hold a basket of investment assets that work together to ensure that risk is minimised while maintaining enough upside to match the investment goal.
This investment should be robust enough to withstand market fluctuations that could wipe entire industries or assets out at any point in time. This is why investing further into an individual’s existing business or property carries its own risk.
That business is likely to be affected by a certain set of economic and industry specific factors, some of which can be controlled, while others are due to the nature of the environment the business is in.
This tells us that they are concentrated risks, which the investor should seek to avoid. Diversification is the key to increasing the probability of reaching your investment goals.
The power of diversification
Diversification should occur at many levels: Asset class, industry, sector, geographical and currency levels. What this essentially means is that an investment portfolio should consist of many different assets with unique characteristics. This allows them to behave in different ways under certain market environments.
If everything behaves the same way under the same conditions then there is no risk reduction. Similarly, many entrepreneurs often have more than one revenue stream in their business.
So if you’re making an investment decision, it begins with the ’Creation vs. Preservation’ question. From there you can apply the correct set of principles. If it is preservation then often you need to outsource some of this decision-making, as objectivity is key.
As a business owner or employee you are responsible for your own wealth creation in your profession or business because a preservation strategy will never make you wealthy but it will certainly keep you wealthy if applied correctly.