Concentrate on diversifying

Although the book’s appeal has proven to be a bit more broad, Low Risk Rules was initially written for the entrepreneur after the sale of a business. This excerpt from the book introduces the first building block of the wealth preservation portfolio: diversification. 

There are many ways to build financial wealth. But a few ingredients are common among most who have built equity in a valuable business. A commitment to excellence. A vision for a better future. Customer focus. Hard work. Discipline. Persistence. Courage.

But think back, and along the way you’ll likely recall a number of moments when things could have gone off the rails. Perhaps they did, and you were able to salvage it. But if we’re honest, we know that luck plays a role in all of our successes. If a few things out of our control had gone differently along the way, we might not be sitting where we are today.

So building wealth is a consequence of hard work combined with a little luck. It takes humility to come to that realization, and, frankly, not everyone is able to accept it.

It’s also a matter of concentration.

Concentration of effort—focusing on an ambitious goal to the exclusion of other activities.

And, importantly, concentration of your assets. Most business owners have the vast majority of their net worth tied up in their enterprise. This is how fortunes are made. Buffett in Berkshire Hathaway. Gates in Microsoft. Bezos in Amazon. Concentrating your investments can be a path to tremendous wealth.

We know intuitively that it wouldn’t be prudent to build a portfolio out of a single public company’s shares, but we don’t think twice when we invest everything in a single private company that we run and control.

Here’s the thing, though: whether it’s your company or not, concentrating your wealth in a single asset is risky.

Imagine you had your entire wealth invested in shares of the Wang computer company instead of Microsoft. It sounds crazy today, but at its peak in the 1980s, Wang was generating $3 billion in annual revenue and employed over 33,000 people. Yes, people actually bought computers with “WANG” emblazoned on them in big, bold capital letters. But by 1992 the company was bankrupt and equity investors were wiped out.

Although his investment went to zero, Martin at least got to keep this cool t-shirt.

If building great wealth requires at least one successful, concentrated bet, protecting it requires the opposite. You need to protect yourself from tail risks. You need to diversify. This is about making sure that you benefit from growth in various parts of the economy over the long term, without trying to jump in and out. You just maintain exposure to them and ride the waves.

Diversification requires you to get comfortable with what is, by definition, mediocrity. A well-diversified portfolio is going to behave a lot like other well-diversified portfolios. This can be hard to accept if you’ve built your reputation and self-image on being exceptional. I’m not saying you can’t build a portfolio that will perform exceptionally well over the long term. You can and should be trying to do that. But what I am saying is that you can’t build a portfolio that will do that all the time, and attempting to do so is a mistake.

So when you’re considering investing your liquid wealth outside of the business, or when you’re investing after an exit, you need to pivot your perspective. The goal is no longer to build wealth. The goal is to build a moat around it in order to protect it. And you must adhere to different principles.

I’ve known several entrepreneurs who have leaped from startup to startup. They are not fulfilled without a constant challenge. Many of us know at least one individual who has left the stability of a successful company to join a new venture because they missed the excitement of starting something new.

If this is you, I encourage you to go for it, because the world needs more people like you. But with a caveat. You’re no longer a beginner bootstrapping a startup. You’ve built resources that you can use to protect your future and that of your family. Set some of that wealth aside to build a conservative, diversified portfolio you can depend on in the future. Decide up front how much you want to risk in the new venture, and have contingency plans ready if your new ventures eventually need to raise more capital than you’re willing to invest.

And then move forward with boldness and without fear, because we know that, no matter what happens, you’ve built that moat around your wealth. You’ve taken steps to safeguard the security you and your family may one day need. And that involves spreading out your bets.

So step one in protecting wealth is to reduce your risk by taking more, yet smaller, risks. Whether you like it or not, you’re going to diversify.