Maximizing Investor Funding: Strategies For Entrepreneurs

Investment is a complex concept in personal finance, but it is also a cornerstone of financial independence and wealth-building. It is the process of determining where you want to go on your financial journey and matching those goals to the right investments to help you get there. This includes understanding your relationship with risk and managing it over time.

There are several types of investors, including angel investors, venture capitalists, and personal investors. Each type of investor has different goals, risk tolerances, and investment strategies.

Angel investors are high-net-worth individuals who provide financial capital to startups or entrepreneurs, often in exchange for an equity stake in the company. Venture capitalists, on the other hand, seek to invest in small businesses that are already in the early stages and have potential for growth. Personal investors, on the other hand, are individuals who invest their own capital, usually in stocks, bonds, mutual funds, or exchange-traded funds (ETFs).

Regardless of the type of investor, the basic philosophy of investing remains the same: committing capital with the expectation of receiving financial returns. Investors put their money to work in various types of endeavours and assets, such as starting a business, investing in real estate, or purchasing stocks, bonds, or commodities.

By understanding the basics of investing, individuals can boost their confidence and feel more comfortable getting started on their financial journey.

Understand your risk tolerance

Understanding your risk tolerance is a crucial step in deciding how to use investment from an investor. Risk tolerance is the level of risk an investor is willing to take, and it can be tricky to gauge accurately. It involves assessing how much market volatility and loss you can tolerate as an investor. Here are some key considerations to help you understand your risk tolerance:

Investment Goals

The first step is to identify why you are investing. Common investment goals include saving for education, achieving financial independence, or retirement planning. Understanding your investment goals will help you determine how much risk you are willing to take. For example, if you are saving for retirement, you may have a longer time horizon and be more comfortable with higher-risk investments.

Time Horizon

Your time horizon refers to when you plan to use the invested money. Generally, a longer time horizon allows for taking on more risk. If your investments lose value, a longer time horizon provides the opportunity for them to recover. On the other hand, a shorter time horizon, such as saving for a house down payment, may require a more conservative approach to ensure your goals are met within the desired timeframe.

Comfort with Short-Term Losses

It's important to consider how comfortable you are with potential short-term losses. Investments can fluctuate, and stocks may decline in value. If you need to access your money in the near term, you may be forced to sell at a loss. Investors with a longer time horizon can hold on to their investments, hoping for recovery and potential long-term gains.

Emergency Funds and Non-Invested Savings

Having some savings set aside in liquid accounts is crucial, regardless of your risk tolerance. This emergency fund can help you cover unexpected expenses without touching your investments. If you find yourself keeping a large portion of your savings in cash due to investment anxiety, it may indicate a lower risk tolerance.

Tracking Behaviour

Consider how closely you plan to monitor your investments. Will you be tracking them daily, weekly, or only semi-regularly? If the idea of market fluctuations causes anxiety or excitement, a diversified portfolio focused on long-term goals can help manage those emotions. If you actively seek out new investing opportunities, you may be more open to higher-risk ventures, but be sure to research them thoroughly.

Net Worth and Risk Capital

Your net worth and available risk capital, or liquid capital, play a significant role in your risk tolerance. Investors with a higher net worth and more liquid capital can generally afford to take on more risk. Additionally, if the investment or trade makes up a small percentage of your overall net worth, you may be more comfortable taking a more aggressive approach.

Investment Experience

Your level of investment experience is another factor in determining your risk tolerance. If you are new to investing, it is generally advisable to proceed with caution and gain some experience before committing significant capital.

Understanding your risk tolerance is essential for making informed investment decisions. By considering these factors, you can assess your comfort with risk and make investment choices that align with your financial goals and tolerance for market volatility and potential losses.

Diversify your investments

Diversifying your investments is a crucial strategy to reduce risk and enhance the potential for long-term returns. Here are some detailed tips to help you diversify your investments effectively:

Spread the Wealth

It is essential to diversify across different asset classes, such as equities, commodities, exchange-traded funds (ETFs), and real estate investment trusts (REITs). Avoid putting all your money in one stock or sector. Consider investing in a range of companies you know and trust, and don't be afraid to look beyond your home market and go global. This will help you spread your risk and potentially increase your rewards.

Consider Index and Bond Funds

Adding index funds or fixed-income funds to your portfolio can be a wise decision. These funds track various indexes and provide excellent long-term diversification. By including fixed-income solutions, you further hedge your portfolio against market volatility and uncertainty. Index funds often have low fees, putting more money back in your pocket. However, their passively managed nature might be a drawback during inefficient market periods.

Keep Building Your Portfolio

Regularly add to your investments using a strategy like dollar-cost averaging. This approach smooths out market volatility by investing the same amount of money over time, reducing your overall investment risk. With dollar-cost averaging, you buy more shares when prices are low and fewer when prices are high.

Know When to Get Out

While buy-and-hold and dollar-cost averaging are sound strategies, it's important to stay informed about your investments and overall market conditions. Keep an eye on the companies you invest in to know when it's time to cut your losses and move on to the next investment opportunity.

Keep an Eye on Commissions

Understand the fees you are paying, whether monthly or transactional. Be aware of what you are getting in return for these fees, as the cheapest option is not always the best. Many online brokers now offer $0 commission-free trading for stocks and ETFs, but trading mutual funds, illiquid stocks, and alternative investments often comes with a fee.

Diversification Within Asset Classes

You can further diversify your portfolio by breaking down asset classes into more specific categories.

Diversification Within Stocks

Diversify across different industries, company sizes, and styles (growth vs. value). This helps reduce market risk as each business is affected differently by the economic cycle. Mix cyclical sectors, such as consumer discretionary and real estate, with defensive sectors like consumer staples and healthcare, which are less impacted by economic fluctuations.

Diversification Within Bonds

Bonds offer different levels of creditworthiness, with Treasurys being considered almost risk-free. Longer-term bonds provide higher returns due to increased interest rate risk. Diversifying across bond issuers, such as governments, municipalities, and corporations, can add another layer of diversification to your portfolio.

Diversify Geographically

Invest in both domestic and international markets. International markets can be further divided into developed markets, which tend to be more stable, and emerging markets, which offer higher growth potential but with increased volatility.

Avoid Over-Diversification

Finally, remember that it is possible to over-diversify your portfolio. If adding a new investment increases overall risk and lowers expected returns without reducing risk accordingly, it defeats the purpose of diversification. A manageable number of diverse investments, such as 20-30 different options, is generally recommended.

Choose investment accounts

The type of investment account you choose will depend on your financial goals and personal circumstances. Here are some of the most common types of investment accounts:

• Standard brokerage accounts: These offer access to a wide range of investments, including stocks, mutual funds, bonds, and exchange-traded funds (ETFs). They are usually held by individuals, though joint accounts are also available. There are no limits on contributions or withdrawals, but any gains are taxable.
• Retirement accounts: These are similar to standard brokerage accounts but come with tax benefits. The two most common types are traditional IRAs (Individual Retirement Accounts) and Roth IRAs. IRAs are limited to $7,000 in contributions per year for those under 50, and $8,000 for those 50 and over. Withdrawals from IRAs before the age of 59 ½ may incur penalties.
• Investment accounts for children: These include custodial brokerage accounts, which are set up for minors with money gifted to them. The child gains control of the account when they reach the "age of majority" (18 or 21, depending on the state). There are also Roth or traditional IRAs for children with earned income.
• Education accounts: These include 529 savings plans and Coverdell Education Savings Accounts, which can be used to save for education expenses. 529 plans can also be used for K-12 tuition, while Coverdell accounts can cover elementary and secondary education costs.
• Health Savings Accounts (HSAs): HSAs are used to save for medical expenses and are tied to high-deductible health plans. Contributions are made pre-tax or are tax-deductible, and withdrawals for qualified medical expenses are tax-free.
• Employer-sponsored retirement accounts: Many employers offer tax-advantaged retirement investment accounts such as 401(k)s, 403(b)s, SIMPLE IRAs, and SEP IRAs. These often include employer matching contributions, though these may require a period of "vesting" before they become accessible.

When choosing an investment account, it's important to consider your financial goals, risk tolerance, time horizon, and tax implications. It's also crucial to understand the fees and restrictions associated with each type of account.

Monitor and rebalance your portfolio

Once you have determined your investment goals and risk tolerance, you will need to monitor and rebalance your portfolio to ensure it stays on track.

Monitoring Your Portfolio

When you first created your financial portfolio, you took into account your goals, age, and risk tolerance. You then created an asset mix that you were comfortable with, which likely included a ratio of stocks to bonds. Now that you've established that ratio and your investments, it's important to continuously monitor your financial situation. As circumstances change over time, you may need to adjust your portfolio.

Rebalancing Your Portfolio

Rebalancing refers to making adjustments to your portfolio when your preferred asset allocation has shifted. There are many reasons to make changes to your original investment plan. If something has changed with your overall goals or life circumstances, you should check your asset mix to see if it still works for you. For example, your investment time horizon is always getting shorter. An asset mix that worked for a goal originally 20 years away might not be appropriate when your goal is now only five years away.

The amount you want to save may also change if you decide you need less or more than expected. You might also discover that your risk tolerance isn't what you thought it was. If you see your balance drop when you have plenty of time to reach your goal, you may not worry as much since you expect it to recover. However, if you see market volatility closer to retirement, it can be unsettling.

In addition to changes in your circumstances, market fluctuations may cause your asset allocation to move outside your comfort zone. Your portfolio's risk level may change even if you don't make any modifications to your investments. As the underlying value of your funds fluctuates, your allocation may begin to drift away from your target mix. As a result, you may find that you're over- or underweighted in stocks, exposing you to more or less risk than you're comfortable with.

You can rebalance your portfolio at predetermined time intervals or when your allocations have deviated a certain amount from your ideal portfolio mix. Rebalancing can be done by either selling one investment and buying another or by allocating additional funds to either stocks or bonds.

Strategies for Rebalancing Your Portfolio

There are several strategies for rebalancing your portfolio:

• Calendar-based rebalancing: This method designates a frequency for resetting the portfolio back to the target asset allocation, such as quarterly or yearly.
• Threshold-based rebalancing: This method is triggered when a portfolio experiences a change in its asset allocation that exceeds a certain threshold. One drawback of this method is that it requires regular monitoring and may not be practical if you manage your own portfolio.
• Calendar- and threshold-based rebalancing: This approach combines both rebalancing strategies. Based on a calendar frequency, your portfolio is rebalanced if its assets have strayed by more than a specific percentage from the target allocation.

Taxes and Rebalancing

When rebalancing your portfolio, consider tax-efficient best practices to potentially improve your investment performance without sacrificing your risk/return profile. To minimize transaction costs and taxes, you could opt to partially rebalance your portfolio to its target asset allocation. Focusing on shares with a higher cost basis or on asset classes that are extremely overweighted or underweighted will help limit taxes and transaction costs.

You can also rebalance with portfolio cash flows. Instead of buying or selling investments to rebalance, move dividends and interest to your portfolio's underweighted asset classes. When withdrawing money from your portfolio, start with your overweighted asset classes. If you're 73 or older, take your required minimum distribution (RMD) from your retirement account(s) while you're rebalancing your portfolio, and then reinvest your RMDs in a taxable account with an underweighted asset class.

Consult a financial professional

Consulting a financial professional is a crucial step in making informed investment decisions. Here are some reasons why seeking their guidance can be beneficial:

• Expertise and Credentials: Financial professionals, such as certified financial planners (CFPs) or registered investment advisors (RIAs), have the necessary qualifications and expertise to guide you. They are well-versed in various investment options, including stocks, bonds, mutual funds, and real estate. By understanding your financial goals and risk tolerance, they can provide tailored advice.
• Risk Assessment and Planning: Financial advisors help you evaluate your comfort level with taking on investment risk. They will explain the potential risks and rewards associated with different investment options. Additionally, they assist in creating a comprehensive financial plan that aligns with your short-term and long-term goals, ensuring you are on track to achieve them.
• Diversification and Portfolio Management: One of the key advantages of working with a financial professional is their ability to help you diversify your investments. They can guide you in allocating your investments across different asset classes, such as stocks, bonds, and alternative investments. This diversification can reduce risk and improve your portfolio's overall performance.
• Tax and Estate Planning: Financial advisors often provide tax strategy guidance, helping you understand the tax implications of your investments. They can also assist with estate planning, ensuring your assets are distributed according to your wishes and minimizing potential tax burdens for your beneficiaries.
• Ongoing Support and Emotional Perspective: In addition to investment advice, financial professionals offer ongoing support and emotional perspective during volatile economic times. They can provide a sense of reassurance and help you stay committed to your investment strategy, even during market downturns or recessions.
• Access to Resources and Tools: Financial professionals have access to sophisticated tools and resources for investment analysis, risk assessment, and portfolio management. They can leverage these tools to make more informed decisions and provide you with a comprehensive view of your financial situation.
• Saving for Specific Goals: Financial advisors can offer guidance on saving for specific milestones, such as purchasing a home, planning for retirement, or funding your child's education. They can help you prioritize your financial goals and create a roadmap to achieve them.
• Fee Structures and Fiduciary Duty: When choosing a financial advisor, it's important to understand their fee structures. Fee-only advisors charge a percentage of assets under management, a flat annual fee, or an hourly rate. Commission-based advisors earn commissions on the products they sell. It's also crucial to ensure your advisor acts as a fiduciary, legally bound to act in your best interest.

Frequently asked questions