JUNO INVESTING ©

Whoʼs Playing Double or Quits?

JUNO INVESTING ©
Whoʼs Playing Double or Quits?

 

 

The editorial below reflects the views of the editorial contributor only and content may be out of date. This article is sourced from a previous JUNO issue. JUNO’s content comes from sources that it considers accurate, but we do not guarantee that the content is accurate. Charts are visually indicative only. JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions.

SPRING 2015

By Martin Hawes, Financial Writer / AFA

There’s a strange gap in New Zealand. Here is a country with hundreds of thousands of small to medium-sized enterprises (SMEs). They are represented in every industry in the country and comprise 97 per cent of businesses in New Zealand. But the owners of these businesses almost always miss out on the plethora of personal-finance and investment books, articles, seminars and newsletters targeted at other groups of people.

Investment for SME owners is seldom talked about. In fact many people think that SME owners should not invest: they have their business, which is like a little super fund, and they should concentrate on that.

 In fact, nothing could be further from the truth – these people need financial and investment guidance just like everyone else. The conventional wisdom is that the SME owner will use business profits to reinvest in the business and build an increasingly valuable asset that can be sold on retirement. On a continuing and often long-term basis, the owners use free cash flow to buy more plant and equipment, increase stock levels and reinvest to expand the business.

Continually reinvesting profits into the business is like playing double or quits. One day there will be a downturn. And if you have everything in the business, that downturn will be difficult to survive.

Reinvesting in the business means SME owners can end up very well off – indeed, some of them, rich. Nevertheless, the owner may have a very valuable business, but not a lot else. As such, their futures hang on just one asset – if anything goes wrong with the business, a lot goes wrong with their future. 

Many SMEs do fail, and having investments outside the business becomes a good safety net when problems strike. The investments that are made elsewhere may not give as high a return as the owner’s business, but they will provide security and mitigate risk when things get tough.

SME owners should continually plan what they do with their profits. Every year, they should identify the things that will give the best returns as well as mitigate their risk. This may mean resisting their instinct to put all profits back into the business and instead allocating profits to where they will give the best result for their well-being.

Importantly, as a part of these plans, rather than play double or quits, some cash should be invested into a portfolio of other more diversified investments.

As a business owner, your aim should be to get rich and stay rich. To thrive in the long run you must be able to survive the periodic downturns. Business can buck economic trends and the real test is not simply how well you do during the good times but how you manage the slumps.

This means that you not only get through a downturn but that you have some capital to expand at times when your competitors are struggling to keep their heads above the water. 

SME owners do need to be investors. Take advantage of the currently strong economic climate to invest some of your profits outside the business. Invest those funds well and have them available to use when the business climate changes.

So, how should you go about investing outside your business? Here are a few basic principles for SME owners:

1. Start slowly with only relatively small amounts of your profits going to investment outside the business. Especially so for younger people, who have time on their side; as you get older and closer to retirement you should increase the amount in the investment portfolio.

2. Right from the start, make sure that you are well diversified. Remember that high returns are not the primary objective for the money that is invested outside the business – this should be coming from the business. Therefore, look for security through a wide range of bonds, shares and property.

3. Invest some money internationally. The event that causes difficulty for your business may also cause difficulty for other businesses that you could invest in via the share market. Diversifying away from New Zealand may help you through tough times as they arise in this country.

4. Most SME owners should not manage this investment portfolio themselves – they are busy enough running the business and do not usually need another set of tasks involved with managing money. Instead, find a broker, bank or financial adviser who will invest with minimal input from you.

5. Remember that diversification is the objective: avoid investing in industries that your own business is in. For example, farmers may want to buy shares in PGG Wrightsons, or a builder might wish to own some Fletcher Building shares – a natural instinct given knowledge of the industry. Familiarity will draw you towards an industry that you understand, but you should resist the temptation because a downturn in that industry will affect both your business and your investments.

There’s a strange gap in New Zealand. Here is a country with hundreds of thousands of small to medium-sized enterprises (SMEs). They are represented in every industry in the country and comprise 97 per cent of businesses in New Zealand. But the owners of these businesses almost always miss out on the plethora of personal-finance and investment books, articles, seminars and newsletters targeted at other groups of people.

Investment for SME owners is seldom talked about. In fact many people think that SME owners should not invest: they have their business, which is like a little super fund, and they should concentrate on that.

 In fact, nothing could be further from the truth – these people need financial and investment guidance just like everyone else. The conventional wisdom is that the SME owner will use business profits to reinvest in the business and build an increasingly valuable asset that can be sold on retirement. On a continuing and often long-term basis, the owners use free cash flow to buy more plant and equipment, increase stock levels and reinvest to expand the business.

Continually reinvesting profits into the business is like playing double or quits. One day there will be a downturn. And if you have everything in the business, that downturn will be difficult to survive.

Reinvesting in the business means SME owners can end up very well off – indeed, some of them, rich. Nevertheless, the owner may have a very valuable business, but not a lot else. As such, their futures hang on just one asset – if anything goes wrong with the business, a lot goes wrong with their future. 

Many SMEs do fail, and having investments outside the business becomes a good safety net when problems strike. The investments that are made elsewhere may not give as high a return as the owner’s business, but they will provide security and mitigate risk when things get tough.

SME owners should continually plan what they do with their profits. Every year, they should identify the things that will give the best returns as well as mitigate their risk. This may mean resisting their instinct to put all profits back into the business and instead allocating profits to where they will give the best result for their well-being.

Importantly, as a part of these plans, rather than play double or quits, some cash should be invested into a portfolio of other more diversified investments.

As a business owner, your aim should be to get rich and stay rich. To thrive in the long run you must be able to survive the periodic downturns. Business can buck economic trends and the real test is not simply how well you do during the good times but how you manage the slumps.

This means that you not only get through a downturn but that you have some capital to expand at times when your competitors are struggling to keep their heads above the water. 

SME owners do need to be investors. Take advantage of the currently strong economic climate to invest some of your profits outside the business. Invest those funds well and have them available to use when the business climate changes.

Martin Hawes is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com. This article is of a general nature and is not personalised financial advice.