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Small Business Financial Article

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Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.

Business Owner Investment Mistakes: Investing too Conservatively

Business Owner Investment Mistakes: Investing too Conservatively

Following the advice of one of the world’s greatest investors, Warren Buffett, to “invest in what you know,” many business owners do precisely that by investing their personal capital in the businesses they run. They understand better than anyone the potential risk and return of their business and view it as the key to their financial security. However, at some point, business owners recognize the importance of diversification beyond their business and begin to allocate a portion of their capital to a long-term investment strategy.

Whether it is because of little time they have to devote to investments outside of their business or their lack of familiarity with the markets, business owners tend to invest their personal capital conservatively. For some, it is a matter of prudence; having most of their capital tied up in their business, they might prefer to take less risk on their investment capital. It’s not uncommon for business owners to limit their strategy to low risk investments focusing on the preservation of their capital. While that may protect their capital through periods of volatility and market declines, it can also limit the opportunity to generate the long-term returns they need to secure their financial future.

Investing too conservatively is a behavioral tendency driven by fear – the same fear that drives people out of the market when the going gets tough. When emotions drive investment decisions, they invariably lead to costly mistakes such as trying to time the market, chasing performance, or investing too conservatively. The retirement readiness of business owners hinges on their ability to avoid costly mistakes and apply the proven investment principles of discipline and patience in pursuing their long-term objectives.

Why Conservative Investing can be a Costly Mistake

The chart below illustrates the erosion of purchasing power on earnings generated from an investment in 10-year Treasury Bonds. The decade of 2000 – 2009 had one of the lowest rates of inflation, as measured by the Consumer Price Index, in the last 30 years, yet purchasing power on the earned income was reduced by 25 percent. It is important to note that the CPI, which is the official government measure of inflation, doesn’t include food and gas prices which have increased at rate three times the CPI over the last couple of years. If food and gas prices were included in the CPI, the rate of inflation would be closer to 9 percent, and, at that rate, the net purchasing power of earnings in ten years would be less than the initial investment, meaning you would have lost money.

erosion of purchasing power on earnings generated

Source: National Association of Realtors, Economistsoutlookblog.realtor.org

Investing your money in safe or guaranteed instruments may provide peace-of-mind that you won’t lose any money due to market fluctuations; however, each day that your returns fail to exceed the rate of inflation, you are, in effect, losing money, and that loss becomes more pronounced over time.

There are ways to invest conservatively that will minimize market risk, reduce portfolio value volatility and overcome the risk of inflation. The key is in knowing what your financial objective is in real terms, factoring in the true cost-of-living and taxation, in order to know the minimum rate of return you need to generate, and, therefore, the level of risk you need to incur. With an investment strategy tailored to your specific needs, you need not take any more risk than is absolutely necessary to achieve your objective.