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Get Rich Quick: An Exercise in Risk

There is an old adage, “slow and steady wins the race.”  It has been shown time and time again that the best way to build and maintain long term wealth is a well-disciplined savings and investment plan that starts early and builds over time.  For most people that are trying to retire or working their way there this is going to be the key to success.  As a financial adviser, I believe in this wholeheartedly.  I preach this to clients and help provide these clients with the correct discipline to stay on track. However, there is a large group of my clients, entrepreneurs and executives alike, that didn’t earn their wealth this way.  They took a risk by either starting a company themselves or accumulating a concentrated position in one company as part of their compensation. In either case, these companies took off and the individuals became wealthy as a result.  Their wealth was primarily created by being highly concentrated in one stock or business. So how do I rationalize stories like these, with the belief that a well-diversified, disciplined savings approach is the best way to build wealth?

The simple answer is these individuals have different ways of diversifying, different ways of balancing risk and, most importantly, a comfort with the risks they are assuming. So while their way of building wealth seems much different than a traditional wealth accumulation strategy there are many similarities.q

Calculated Risk:  In speaking with entrepreneurs and other professionals that built their wealth by being highly concentrated I have found one common thread.  These people understood the risk they were taking.  They understood that they could end up with nothing and they were comfortable with it.  For most people this type of risk would be unfathomable.  They would not be able to sleep at night knowing that all their hard work could amount to nothing. But these “risk takers” had calculated the risk and felt that the potential payout was worth the inherent risk. As an adviser, my job is to help clients manage their financial lives based on the client’s risk tolerance and goals. So while for most people that means a steady savings and investment plan, for these individuals the calculated risk that they were taking fit into their risk profile.

Conservative Balance: The interesting thing I have also found with these same individuals is that while they were comfortable with the risk they were taking within their business lives. They were very risk averse when it comes to any money outside of their concentrated position or business.  They build up larger cash reserves than most people typically should and their investment portfolios outside of their business definitely skew more to the conservative side.  With all of the risk they are taking in one area, they are balancing it out in most others.

De-risking: While these individuals are comfortable taking these initial risks they often struggle with letting go of the risk when it is appropriate.  This tends to be a time when many of these individuals engage with me or other advisers to help proved some investment discipline.  As with most entrepreneurs or successful professionals, they have an endless drive and are convinced that no matter what happens they can go out and build another company or do something to earn enough money to be happy.  This is where investment and financial discipline is important.  Although these people built their wealth by taking risks, maintaining this wealth is about de-risking.  Whether the wealth was created by the sale of a business or a jump in stock, de-risking and setting money aside creates a foundation for future success and can put them in a position to still take calculated risks when appropriate. The goal is to help these individuals avoid what I call “Serial Entrepreneur Syndrome.”  Too often I speak with people that built and sold a business, only to reinvest everything in a new venture and have it fail and them be back to zero.  At the time of the initial sale had they taken the steps to de-risk even a portion of their proceeds, they still can start a new venture but this time  they have a safety net that wasn’t there before and their family and future are secure no matter what the outcome of the second, third or fourth venture.

This same thought process holds true for folks that build their wealth from stock accumulation.  They become so emotionally tied to their company that they think that is the only way to continue to build their wealth. But by taking a little of the exposure off the table they set themselves up for a more stable future.  They already have their income tied to the success of the company, there is no reason to have all of their wealth tied to it as well.

Diversifying in other ways:  When we talk about diversification we are almost always talking about it from an investment portfolio standpoint. We spread our investments over a series of asset classes in an attempt to reduce our overall risk. These entrepreneurs diversify their risk in a different way.  They view their company as the investment portfolio.  They reduce their risk by making sure the business is running correctly and by reducing risks within the company. They try to hire the right people. Allocate their capital appropriately and manage revenue and expenses efficiently.  By taking these positive steps they are reducing the potential of failure within the company.  So while their overall risk is much higher than if they had a well-diversified portfolio of investments they are taking steps to reduce their risk exposure along the way. Yes, there are other outside risk factors that can always effect a business and not everyone does a great job managing their companies risk exposure. But that is why this type of risky behavior is not for everyone and why the potential payout or benefit can be so great.

In order to rationalize this more risky wealth accumulation strategy it is important to understand that these individuals are not just putting all of their eggs in one basket for the remainder of their life.  They are calculating the risk it will take to create their wealth. They are then taking steps to balance that risk in other areas of their life, hiring professionals to help them de-risk and help maintain their wealth and diversifying their risk exposure in other ways. This type of wealth accumulation strategy would not work for most people.  Most people don’t have the stomach to deal with the potential negative consequences of this level of risk. But for those that do, and also have the discipline to assess their situation thoughtfully along the way, this can be a very powerful way to create wealth as long as they are comfortable with losing it just as quickly.