South Florida has always had a vibrant community of family-owned enterprises. Entrepreneurs are drawn here by the positive business climate, rapidly growing population and favorable tax environment.
Entrepreneurs share many traits. They are focused, hard-working and risk-taking, but they also tend to be concentrated in one asset: their business. Creating a successful business often leaves little time for other matters. So after years of hard work building a profitable enterprise, the business often represents the bulk of an entrepreneur’s net worth.
With such concentration, their wealth is almost entirely predicated on the business’ performance. When entrepreneurs do invest in other assets, they too frequently invest in businesses similar to their own, feeling well-equipped to evaluate such companies. This only exacerbates risk since similar companies are similarly vulnerable.
The past 15 years have seen multiple cycles of boom and bust in the U.S. economy, which have been especially pronounced in South Florida. Given the long dry spell during the latest recession, it was critical for entrepreneurs to have assets to help protect their wealth.
To accomplish this, entrepreneurs should build a “total wealth portfolio.” This strategy relies on liquid, complementary investments to protect against unexpected market movements. Said another way, in normal market environments when the typical private business performs well, the investment portfolio merely provides additional returns. But when the business suffers, the investment portfolio should act to protect capital.
Each business is unique, so customization is important. When selecting appropriate vehicles for the complementary portfolio, it is critical to understand the business’ strengths, weaknesses and geographic footprint, and review historical performance through different market cycles.
Take the real estate entrepreneur who has successfully built a business investing in residential or commercial development in Miami-Dade. Throughout much of the ’90s until 2007, the business benefitted from a rise in demand for Miami homes and office space, resulting in strong revenue and profit growth. However, during the last recession, demand waned, credit dried up and the business suffered. An investment portfolio allocation to traditional bonds may have helped preserve capital as investors flocked to safety and bond prices rose.
On the other hand, in an environment like today, where credit has become readily available, profits are healthy and interest rates are low, positions that generally produce higher returns with some higher volatility like small-cap equities and select foreign markets are advisable. In this manner, the liquid investment portfolio is complementary to the core business and the entrepreneur keeps his money working with limited risk.
A “total wealth portfolio” is even more critical for those owners who want to pass their business, or the wealth created by it, to their children, grandchildren or other family members. Ensuring that risk is not concentrated in a single company or sector will help maintain the wealth that can form a legacy for the benefit of their family or the greater good through charity.
Entrepreneurs are natural risk takers. It’s what makes them successful. But after working so hard to build a business, it’s imperative to preserve the wealth that comes with that success — for themselves and future generations.
Hannes Hofmann is the U.S. Southeast Head of Investments at J.P. Morgan Private Bank in Miami.