Last weekend, I read William Bernstein’s latest investment book, Rational Expectations: Asset Allocation for Investing Adults.
Unless you’re someone who uses a target retirement fund (which means you’ve outsourced the asset allocation stuff for your portfolio to someone else), you probably ought to read through Bernstein’s book, too.
Though the book’s math creates a bit of drudgery and Bernstein’s opening paragraphs perhaps display a mildly-offensive ethnocentricity to anyone outside his faith tradition, his wonderfully insightful and well-written book contains much, much wisdom.
Bernstein’s book makes the super-important point that you and I need to judiciously manage the risk of our retirement savings. We want, for example, to earn decent returns (which probably means loading up on risky equity investments). But we also need to stay alert to the financial risks we bear.
Okay, no doubt about it. Bernstein’s book provides wonderfully useful financial advice to individual investors. But the book also provides, I suggest, really useful ideas to small business owners and entrepreneurs. And here I want to summarize (briefly) three of those ideas.
Idea #1: Asset Allocate in Your Retirement Savings
A quick first point—and the main point of Rational Expectations: You and I have to be smart in the asset allocation we use in our retirement savings. (The money we’ve stashed away in our Individual Retirement Accounts, 401(k)s, SEPs, and so on.)
I’ve argued elsewhere (see here) that the first and most important step when planning your investments is to do good income allocation. And I still think that. But once you or I have the savings thing smoothly working, we should get smart about how we invest that money.
Note: If you’re using a target retirement fund, like one of those supplied by Vanguard, I think you are doing smart asset allocation. Even if you could tweak (or in the language of asset allocators, “tilt”) your allocations to gain some extra return, I respectfully suggest that your efforts are more profitably directed toward making better entrepreneurial and management decisions.
Idea #2: Build Businesses That Withstand Shocks
More generally, Bernstein discusses a couple of portfolio risk issues that actually apply to your and my small business ventures.
For example, Bernstein notes that investors need to construct their portfolios so as to withstand “bad returns in bad times”.
In other words, investors need to build their portfolios in a way that allows the investor to survive something like the recent “Great Recession” that followed the collapse of Lehman Brothers. (He has a series of useful ideas about how you do this, and fortunately the ideas are all pretty simple and common-sense. For example, he suggests you hold a bigger percentage in super-safe bonds.)
But Bernstein’s high-level advice rings true for any small business owner or entrepreneur running a business. Business owners also need to build their businesses in a way that lets them survive bad times.
For example, what can you or I do ahead of time to maximize our ability to survive something like losing our biggest customer or product? To allow our businesses to survive or restart after some sort of natural or personal disaster (Hurricane Katrina or a serious personal health crisis)?
Important stuff to think about, right? I think so.
Idea #3: Allocate Resources for Exploiting Opportunity
One other big, very useful idea for small business entrepreneurs flows out of Bernstein’s asset allocation book—the idea that as opportunities occur you want resources available to exploit the opportunity.
When you’re talking about asset allocation in the context of retirement savings, for example, one of the reasons that you and I should have a bunch of money in safe bonds is so that when stock prices collapse, we can sell bonds (which may have gone up in value) and then buy stocks (which may unfortunately have massively fallen in value.)
Over decades, you and I can noticeably boost our investment profits if we possess not just the personality but also the financial resources to buy assets at bargain prices.
And this logic applies to small businesses and entrepreneurs, too.
Occasionally, the small business will get great opportunities to hire some super-talented team member, buy a retiring competitor’s business, or pick up a building or a piece of machinery at a fire sale price.
When these opportunities occur, the business owner wants resources available (probably both cash and time) in order to take advantage of the opportunity and then reap the financial rewards.
A Closing Comment: Business Differs from Investing
Can I make one other comment in closing about small business and entrepreneurial risk? I don’t want to end this discussion before I point out that in one important area at least, investing works very, very differently from starting or running a small business.
In the world of investing, for example, lots of experienced, sophisticated observers strongly believe that people are wrong when they think they can, through smarts or hard work, improve their returns or reduce their financial risk relative to simply investing in an index fund or a collection of index funds. Especially once the costs of this active management get paid. And I would agree with these observers.
Note: Using asset allocation techniques should remove a lot of the risk (the non-systemic part) from your investment portfolio. But even with asset allocation, you or I will still be bearing systemic risk. Systemic risk is risk related to the entire “system”—stuff like interest rates moving up and down, weather, armed conflicts between peoples, and so on.
This “active management doesn’t work” viewpoint flows from a belief in the efficient market hypothesis (at least at a practical level) and from empirical studies of the actual results delivered by the overwhelming number of investment advisors and wealth managers.
However, in the world of small business, I will politely argue that you can improve your returns and dial down your risk by employing best practices and by making smarter management decisions. Further, I think that by being smart and working harder, you’ll find yourself adding profit.
Just a point I wanted to clarify.