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Is Your Portfolio Lopsided?
Owning a small business changes the rules on asset allocation

Joel McIntosh doesn't have an investment account, aside from his IRA, because profits at his educational publishing company, Prufrock Press in Waco, Tex., started surging only recently. "There was a time when putting a dollar into the business would cost you two," he says. "These days, I can put a dollar in and get two dollars out in profits."

The result: Perhaps 85% of McIntosh's net worth is represented by his ownership of the book publisher and only 5% by his retirement plan. The rest is tied up in his home. What's more, his retirement dollars are divided about equally among three growth-oriented mutual funds -- a high-technology fund, a global growth portfolio, and a blue-chip fund. That's fine for any other 35-year-old -- young people should go for growth -- but McIntosh is already doing that via ownership of his company.

He is, in a word, undiversified, a common problem among owners of small companies. "An entrepreneur typically has most of his or her wealth invested in the company," notes Barbara Raasch, a financial planner with Ernst & Young in Manhattan. What's more, owning a company means a large part of your personal wealth is tied up in a very illiquid entitity, making it hard to raise cash. When it comes time to invest, she says, "what's needed is to look at alternative assets."

The idea behind asset allocation is pretty basic: Don't put all your eggs in one basket. Market studies have shown that different kinds of assets and industries rise and fall at different times. By spreading your assets around, you can ensure that losses in one sector are more than offset by gains in the others, assuming there isn't a generalized economic decline that cuts across all lines. For an example, you need look no further than this year. Major indexes of big stocks are still showing double-digit gains, while smaller stocks are actually showing losses averaging 20%. A properly balanced portfolio would probably would have come out unscathed.

Your father might have diversified his portfolio with gold, but the yellow metal has been a black hole for nearly a generation. Or he might have owned some real estate, but you already do, too, in the form of your home and, possibly, your business property. So your best bet for diversity is through financial assets -- assets that, as Raasch says, are "very, very different than what you have now." In practice, that means trimming your holdings in areas that have had long and very profitable runs, and transferring the assets to investments where you have little or no presence. Some likely strategies:

Go global: Like Prufrock Press, the typical American small business is purely or largely domestic in nature, and by definition, it's small. So the last thing you'll want to buy is an aggressive growth or small-cap stock or mutual fund, since either replicates all the risks you're already taking. Big-cap stocks, such as those in the S&P 500-stock index, are a somewhat better choice, since they're less volatile and give you some foreign exposure. Better still might be shares in big foreign companies -- many are available through mutual funds that specialize in them or as American Depositary Receipts, which allow U.S. investors to buy foreign shares on U.S. exchanges in dollars. This exposes part of your portfolio to different economic cycles than the one that affects small U.S. companies. One caveat: This also confronts you with currency risk. Even though ADRs are denominated in dollars, they represent shares priced in local currencies. When the dollar rises in value relative to other countries' currencies, the dollar value of their companies' stocks falls.

Bonds: Fixed-income securities seem very unfashionable -- until you realize that their meager 5.5% return has been beating most stock indexes this year. They have other virtues, too. If you own high-quality issues -- U.S. government bonds are the benchmark for other U.S. and many foreign bonds issues -- you know you'll get your principal back when they mature. Buy taxable bonds, which yield the most, in retirement accounts. And buy tax-free municipals in investment accounts, if you're in a high-tax bracket. If you can afford it, buy individual bonds rather than shares in bond mutual funds. Funds never mature, and you can lose principal in a bad market. And don't be lured into junk bonds or junk funds by their higher yields. They're tied to a company's profit just like its stock is, so they trade more in rhythm with equities than with gilt-edged bonds. If you're counting on them to cushion an economic downturn, you've come to the wrong place.

Cash and near-cash: These are even less popular with today's investors than bonds, because money-market yields and bank savings rates are low. But Raasch says the very first investment an entrepreneur should consider is the safest short-term, money-market investment of all, Treasury bills, U.S. Treasury debt that matures in up to a year. They're considered close to cash in their liquidity, or how easy it is to find a ready buyer or seller.

Your business itself probably entails considerable risk, and T-bills are at the opposite extreme. There's no risk whatsoever -- assuming the U. S. government doesn't default on its debt -- and they're a perfect planning tool for business owners who know they've got major personal expenses coming up (a child's college tuition or a wedding) because you can match the maturity to the date of the event.

You can buy T-bills in both retirement and taxable accounts. The minimum is $10,000, and they can be reinvested in new bills every six months automatically through the Federal Reserve's Treasury Direct program with no fees or commission. And you'll be in good company: According to his most recent disclosure form, Federal Reserve Chairman Alan Greenspan has been keeping most of his investments in short-term Treasury securities.

Too tame, you say? Not really, when you consider that even the bravest entrepreneur needs to sleep soundly once in a while. In that regard, clipping coupons sure beats counting sheep.

By Timothy Middleton in Short Hills, N.J.



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