As an entrepreneur, you have a ton of opportunities to invest. It’s for this reason, I think entrepreneurs get into more trouble than those that get jobs right out of college. As an entrepreneur you’re a fast-moving, get it done kind of person. It’s easy to spend money on your company or idea, spend it on growing yourself and invest in things without a real plan. As the quote from Reid Hoffman says, “An entrepreneur is someone who will jump off a cliff and assemble an airplane on the way down.”
This strategy works for getting businesses off the ground. However, it’s an awful approach to finance. Trying to cobble together investments without any tactical strategy is going to lead to disappointment. The first thing you want to do is adopt a system of managing your finances like what we mention in the Financial Rehab series.
Once your finances are in order and you have a designated amount for savings coming in, then we can talk about investments. Before investing in any “investment vehicle” I recommend having an emergency fund and if you’re married, life insurance.
With that out of the way, let’s dive into the exciting world of investment and make it extremely boring.
Another Money Management System
Just like you want to have a system to follow for managing your personal finance you want to approach saving and investing in stages and in process. With the financial rehab work we did, we tore out old habits and replaced them with new ones. We used what others have come up (the envelope system) with and reappropriated it for ourselves. With investments, it’s good to build and for me, the best way to build is with a system and rules.
For our purposes, we will include all your liquid cash in the living expense as part of your overall savings. Ideally, you want 10 to 20% of your overall investments in something liquid so that you can access it. A common rule of thumb is to take your age and subtract it from 110 and that’s the percentage you want to be inactive non-liquid investments. Example, 110-30=80.
The basic rules here are similar to our other post.
- If the living expense and emergency account is “full” start savings aka investment account
- Up to 50% of your investments should be in lower-risk investments such as index funds.
- No more than 10% of your money should be in any investment that is risky and that you lack knowledge around.
3 Investment Stages For Entrepreneurs
The three stages of investments are low risk, medium risk, and high risk. With low and medium-risk investments, you typically look long term (10 years or more). Each stage represents a requirement of knowledge and a risk to your initial investment. For example, low-risk investments are ones where you’re ignorance in the financial instrument could cost you earnings but rarely does it cause you to lose money (long term). At that stage, it’s a boring long haul and collecting interest and dividends. However, medium-risk investments, present a higher risk of you losing your investment in the first place. I’m not talking about just a recession type dip, but if you choose wrong here or don’t have a strategy you can lose your principal investment.
Typically if you’re reading about investments online they discuss bonds as the lowest risk investment. However, for the last 20 years bonds have been a low return and create unnecessary difficulty when accessing your money. You can find out more about bonds by doing your due diligence. If you’re extremely risk-averse then bonds might be an option for you. However, I find that index funds with a stable company are 10x better than bonds. The key is long term thinking. Down markets are inevitable.
Recommended: At least 50% of your investments should be in a low-risk foundational investment.
Medium Risk Investments
Bonds, money market accounts and index funds are about as safe as you’re going to find in the world of investments. However, if you are willing to take on slightly more risk you open up the world of more opportunities. In particular, you open up mutual funds and the world of real estate. Unfortunately, the rules are going to have to be created by you from here on out. Whether you put 70% into index funds and 30% into real estate and mutual funds or do 50/50 is really up to how risk tolerant you are.
The challenge with medium risk investments is that you can lose your money here. With index funds, you can be pretty ignorant of the financial world and do well. However, if you purchase the wrong home with the wrong strategy you’re going to lose money. Buy the wrong mutual fund and the same will happen.
Recommendation: Pick something you’re interested in. Start small and if possible start with a group. Grow from there.
With medium-risk investments, you could lose some of your money. With high risk, you could lose it all. Ideally, you only want to invest up to 5% of your money into these types of investments. If you’re extremely savvy and experienced, maybe up to 10% but never more than that. Even the most experienced angel investors (think “Shark Tank”) agree with this. The big reason is that the risk that you will lose it all is very real, but so are up to triple-digit returns.
Recommendation: If you are interested in these high-risk investments then I recommend paper trading for at least a year. Use pretend money and keep track of your trading. There are several ways to do this for day trading stocks in particular.