Investing in a business can make you rich. It can also make you poor.

Sonnie Bailey

17 April 2020

[I wrote this article before COVID-19 struck us. I’ve published this article, at the risk of being seen as tone-deaf, because the key point is relevant, in good times as well as bad. It’s just more apparent right now.]

For most of my clients, I recommend that they invest in widely-diversified, low-fee, index-based managed funds.

The reality is, when people come to me for financial advice, they almost always approach me for advice in relation to financial assets (such as cash, term deposits, bonds, shares, or managed funds that invest in those assets).

But that’s not the only option I consider. Whenever I provide advice about financial assets I always make it clear that there are many ways to invest.

Before considering financial assets, I consider things such as:

  • Whether and to what extent they should repay debt.
  • Whether property is appropriate for them. (It’s often not, but sometimes it is.)
  • Whether there are opportunities to invest in themselves: either through education or entertaining a change in career (which might involve risks and opportunity costs).
  • Whether they might be able to invest in a venture, such as a business.

It’s the last one — investing in a business venture — that I want to touch on in this article.

Investing in a successful high-growth business can make you rich

Sam Altman, former president of Y Combinator, has a terrific blog. One of my favourite articles by Sam is “How to be successful”. In this article, he explains that “You get rich by owning things”:

“The biggest economic misunderstanding of my childhood was that people got rich from high salaries. Though there are some exceptions — entertainers for example — almost no one in the history of the Forbes list has gotten there with a salary.

“You get truly rich by owning things that increase rapidly in value.

“This can be a piece of a business, real estate, natural resource, intellectual property, or other similar things. But somehow or other, you need to own equity in something, instead of just selling your time. Time only scales linearly.”

If you want to become outrageously wealthy, the best way is usually by investing in a business.

Bill Gates and Jeff Bezos didn’t become mega-billionaires by investing in index funds or buying residential property.

It’s not even necessary to be the person starting up the business. As long as you can get equity in a company (for example, by being an early investor or early employee with stock options), you can become wealthy.

Investing in a business can also make you poor

In an article titled “How to lose time and money”, Paul Graham says:

“[T]he way most fortunes are lost is not through excessive expenditure, but through bad investments.”

He explains:

“It’s hard to spend a fortune without noticing. Someone with ordinary tastes would find it hard to blow through more than a few tens of thousands of dollars without thinking “wow, I’m spending a lot of money.” Whereas if you start trading derivatives, you can lose a million dollars (as much as you want, really) in the blink of an eye.

“In most people’s minds, spending money on luxuries sets off alarms that making investments doesn’t.”

Investing in a business with high growth potential is risky. If it works, the rewards can be immense.

But if it goes badly, the losses — financial and otherwise — can be immense.

The best way to turn a large fortune into a small fortune? It’s not by spending too much. It’s by making investments that go bad.

Whether or not to invest in a business is a decision that is personal to you. But it’s valuable to make these decisions with your eyes wide open to the risks and opportunities.

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