Good entrepreneurs can be bad investors

Starting a business and making it grow takes passion, confidence, and a willingness to bet the ranch on a single great idea--everything, in other words, that can also make one a lousy investor. Exhibit A is the man who calls himself the Pond Guy. "I have zero interest in investing," says Greg Wittstock, who started a backyard-pond installation and supply business as a student at Ohio State back in 1991. Fifteen years later he's doing $60 million in annual sales with his Aquascape Designs, now based west of Chicago. "My passion in life is my business," he says. "I have a hard time getting passionate over other people's companies."

Once, though, he did. In early 2000 Wittstock got himself a nice home theater system and, like many of us, fell in love with his TiVo. So he did what came naturally: He plowed his entire 401(k) into TiVo shares. "When I'm passionate about something," Wittstock explains, "I put my money behind it."

How did he do? Never mind for now. The point is, investing your entire 401(k) in a single stock is a terrible idea, even if you get a hot tip from God or, better yet, Warren Buffett. Wittstock's bet illustrates the larger issue, which is that many of the characteristics that enable people to succeed as entrepreneurs can be handicaps when it comes to managing their investments.

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For instance, Benjamin Tobias, a CPA and financial planner in Plantation, Florida, says that entrepreneurs tend to be overconfident: "They think they understand everything because they're successful in business." Unfortunately, overconfidence is one of the worst failings an investor can have. When University of California business professors Brad Barber and Terrance Odean studied the investing behavior of men and women with money at a major discount brokerage, they found that the men traded way more, reducing their annual returns by nearly one per cent versus the women. Need we add that, as the professors put it, "psychologists find that, in areas such as finance, men are more overconfident than women"?

Then there's the problem of diversification. Successful entrepreneurs tend to have a disproportionate share of their assets tied up in their business. It's the arena they know, and when they have cash to invest, they sometimes see themselves as expert stock-pickers in the very same industry.

Tempting as it may be to try to leverage this expertise, it's smarter to "tilt away from this to provide diversification benefits," says Barber, an expert in investor psychology. In other words, if you're a homebuilder in suburban Denver, for heaven's sake, don't invest your nest egg in homebuilding stocks or Colorado real estate.

Tobias encourages his clients to think about diversification in the broadest possible way, taking account of the nature of their primary business, any real estate and other investments they may hold, and of course their portfolio of stocks, bonds, and other securities. "We talk to clients about diversification constantly," he says. "Not just your investment portfolio but your whole life needs to be diversified."

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The hard lesson is that investors shouldn't act like entrepreneurs. The goal of investing isn't rapid riches via intense concentration of capital and efforts. Nor is it entertainment. Investing is really very simple. The idea is to diversify, minimize taxes and expenses, and stay with the program for the long haul. If you don't have the patience or the humility to do this, hire someone who does.

"Most of my clients have accumulated a lot of net worth," says Tobias, who works with quite a few entrepreneurs. "But they're my clients because they've already made some mistakes."Getting business owners to embrace a boring but prudent strategy can be a challenge. Tobias says it's often useful to let them have a relatively small separate trading account in which they can chase hot tips and generally blow off steam.

His office does the paperwork, and occasionally the client gets to say, "I told you so." But over time, says Tobias, this "play account" tends to wither, thanks mostly to trading losses. Tobias says he's also careful to craft portfolios that won't plummet when the market goes down because it undermines client staying power: "Everybody has a point where a portfolio goes down a certain amount and they're going to freak."

Hiring a professional can be a good idea for keeping entrepreneurs and their portfolios out of trouble, says Barber, who also likes index investing for this reason. Buying a mutual fund that robotically mimics a major stock index can keep you from doing the kind of trading that only generates taxes and expenses while impairing returns.

In fact, most investors would be better off if they simply divided their portfolio into four index funds--large US stocks, small US stocks, foreign stocks, and short-term domestic bonds--and then forgot about them except for rebalancing annually, a course advised for the inattentive by the investment adviser William Bernstein in his book The Intelligent Asset Allocator. Bernstein wrote in 2000: "If the next 20 years are anything like the last 20, then you will outperform the portfolios of 75 percent of all professional money managers."

The good news is that entrepreneur-investors like Wittstock tend to focus most of their time and energy where it will generate the greatest return: in their businesses. "An hour a year," says Wittstock. "That's about what I spend" on outside investments.

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Okay, so how did he do with TiVo? Wittstock says he made out okay, but he must have been awfully lucky. Over the years the stock has had its ups and downs but overall has lost about 90 percent of its value from its high in January 2000. He is still mad that his wife (who prefers real estate) sold half his position about a year ago.

Now that Wittstock owns much less TiVo, his retirement portfolio won't be as exciting, but according to Barber, that's okay. Entrepreneurs, he says, "should be boring in their financial investments and daring in their entrepreneurial investments."

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