Twenty years ago, Steven Smith shoveled all his cash into just one investment: his company, Tec Laboratories Inc. At first, it was because he needed every dime to build the Albany (Ore.), manufacturer of over-the-counter skin medicines for poison oak, poison ivy, and head lice. But later, after Tec Labs had grown, Smith was reluctant to invest elsewhere. "Even when I took money out," he recalls, "I didn't feel it was mine — I never knew when the company would need it." Today, after more than a decade of 20% annual growth, he expects to double revenues again in a few years, from their current level of nearly $10 million. So has success given Smith an itch to invest elsewhere? Hardly. "For a successful entrepreneur, a dollar in the business can return 300%, 400%, 1,000%," he says. "It's very hard to wean yourself away from that heady return."

Indeed, it's hard to argue with that kind of math. But as an investment strategy it leaves a lot to be desired. Why? Because your money stays right there, in a single, illiquid, relatively risky company that's concentrated in only one industry and usually one region. That breaks all the rules of prudent investing. Ideally, you should invest in a wide range of stocks and bonds, in the U.S. and overseas. Diversification is a cornerstone of modern portfolio theory because it protects you against setbacks in any single asset class and increases your chances of owning at least one well-performing investment.

Sounds logical, right? But just try telling that to a successful entrepreneur who has built a business thanks to high tolerance for risk, a hands-on management style, and confidence in his own abilities. William Newell, president of Atlantic Capital Management Inc., a Sherborn (Mass.) financial adviser, notes that the market is traditionally driven by greed, hope, and fear — and most entrepreneurs just aren't scared enough to be good investors. What's more, most off-the-shelf financial advice from books and magazines is written for wage earners. It does not take into account the lopsided risk profile of business owners, so even the most carefully crafted asset-allocation plan could be disastrous for you. Relying on stock-picking truisms such as "Buy what you know" — companies you deal with every day — might exacerbate the problem if you wind up concentrating even more money in your own industry or region. And the owner of a developing company has no business dabbling with the "10 hot stocks to buy now."

What entrepreneurs need is an asset-allocation plan that recognizes two key points. First, as a business owner, you're already taking on all the risk you can handle. Second, you want simple investments that don't involve a lot of maintenance, because time spent stock-picking takes time away from your highest-returning investment. Think of it this way: Business brokers say that if things go right, you'll make 20% to 40% a year from the rise in value of your company. By contrast, even in the past 10 halcyon years, the stock market has averaged less than 17% annually. That said, you still need to invest outside your business — not to earn a higher return, but to reduce your risk, secure your retirement (chart), and still have enough cash for your everyday personal affairs. The trick is to construct a portfolio designed to compensate for your company-rich, cash-poor profile. Here's how it might work, divided up by asset class.

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