Entrepreneurs must understand the potential risks associated with diversification
by Jerome D. Love March 8, 2017
Among financial planners, it’s an axiom that investors should never put too many assets into one basket. Diversify, they say; invest in a variety of stocks, bonds, and perhaps, some gold or real estate. Diversification provides protection—for example, if the stock market collapses, your bond holdings will hold their value.
But, does the same hold true for entrepreneurs who are trying to launch and grow their business? Should an entrepreneur seek to diversify his or her business, or do the opposite and remain laser-focused on their unique selling proposition?
Stick With Your Skill Set
A few years ago, I began to think about saving for my kids’ college education, so I sought a financial planner. When we met, he looked at my situation , and told me to establish a six-month cash reserve. I told him that I had a six-month reserve, but had chosen to invest it in real estate. I had bought a house, upgraded it, and nearly tripled my net worth. The house rented for $900 per month, providing a hefty 31% annual ROI.
Prior to getting the house, my financial life had been unstable, as with most entrepreneurs. Some months I’d make a small fortune, and then I’d go three months with nothing, so it was hard to budget. I advocated for the real estate investment, as it provided a stable stream of income for me. I asked the financial planner, “Are you telling me that was a bad investment?”
His reply was, “Just don’t do it again—diversify.”
Dismayed, I went to a friend who works on Wall Street doing investments for a living, and I asked his opinion. He said, “Jerome, you know real estate. If you have something that works, work it. Your advisor was just telling you what the book says.”
My point: diversifying can be good, but if you have a solid plan, doubling down can be better.
Keep Your Efforts Aligned
As an entrepreneur, you are a risk taker. The purpose behind the concept of diversification is to minimize your risk. While I understand that, my experience teaches me that when you are a small business owner with a net worth less than $1 million, investing in your comfort zone is better. If you desire to create additional streams of income, the best way to do that is to ensure they are aligned with what you do.
One good way is to teach what you know. If you’re in the insurance business, then teach a seminar on insurance. Write a book about insurance, and at your seminars, you can sell your books. This will give you additional income and also raise your profile. It will make you appear to be the expert within your industry, which will increase the revenue from your core business.
In my own case, my area of expertise is business development. To create new revenue streams, I wrote a book on entrepreneurship and leadership. Now, I’m focusing my speaker prospects on Chambers of Commerce and other business groups, and I am doing business consulting as well as leadership training. All of this flows from my core business, and they are symbiotic.
I have an aunt who is very successful, but she learned a painful lesson about diversifying outside of her area of expertise. She owned a successful chain of McDonald’s restaurants in Fort Lauderdale, Florida. Though she knew the food service business, she sold those and then went into business with a partner, who supposedly understood the business of their shared venture’s industry. She became dependent upon him, and when he became unstable, the business tanked, and she lost a boatload of money. Based on these experiences, she shared this lesson with me: you should never invest in anything that you don’t understand.
As Sam Ashe-Edmunds wrote for The Houston Chronicle, “Moving into other different business areas can increase your sales and revenue, but might stress your business more than the move is worth. Before you enter uncharted territories, even based on proven benefits, perform an ‘if so/then what’ analysis to determine if the downsides will outweigh your benefits, or if any damage to your current business model won’t justify diversification.”
Remember, You’re Not a Celebrity Investor
As an entrepreneur, be careful about identifying with wealthy celebrity investors. Take the great superstar Magic Johnson, for example. Magic Johnson Enterprises owns, or has owned, franchised branches of Burger King, Starbucks, and T.G.I Friday’s. He founded Magic Johnson Theatres, as well as SodexoMagic, a company that provides food services to public schools in the United Kingdom and U.S. Marine Corps mess halls.
The difference is that Magic Johnson is worth $500 million and can afford to hire the very best business consultants to advise him. If you’re not at his level, don’t think that having five different businesses in five different industries will build your economics. The image may be attractive but it will dilute your efforts.
The bottom line? Years ago, Magic Johnson created his fortune by focusing all his energy on doing what he was really good at: playing basketball. Every entrepreneur would be well advised to do the same. Focus only on your core business. Then, when you’ve amassed a nest egg in the tens of millions, you can think about expanding into other investments.