Should I Reinvest My Profits in the Business or Invest Elsewhere?

Question from a client:

I’m 37 years old and my business has done well over the last year with further growth on the horizon. With the increase in profitability, I’m torn between keeping money in the business for future growth or do I take it out to diversify my portfolio?

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Keeping your money in your business:

By doing so, you can fuel growth, expand operations, and potentially increase the value of your business. This strategy is particularly attractive if your business is still in its growth phase or if you believe there are untapped opportunities for expansion.

Keeping funds within your business provides a level of control and flexibility as you can allocate resources towards areas that need development where and when required– as they say cash is king!

There is also the tax implication to consider. Let’s say for example you increase your salary by $3,000pm which you would then use to invest elsewhere. Assuming the additional amount gets taxed at 33% you would get $2,010 in the hand (assuming no other deductions). If we invest that $2,010 in an investment that achieves 6% pa, your total return would be $120.60 for that monthly contribution. Now if we look at leaving it in the business with your businesses value growing at the same rate of 6% you would get $2,160 in the hand with a return of $129.60. This may not seem like much, but a little bit contributed monthly with compound interest makes all the difference. There are other tax implications depending on the investment class and owner, however this should give you something to consider.

You might also want to consider the rate in which your business’s value is growing per year. If the value of your business is growing at 20% and is expected to continue, then trying to find a similar return from a traditional investment elsewhere will be near impossible. It’s also worth mentioning that reinvesting money into your business gives you ‘hands on’ control, after all it’s your company and you call the shots if you need to react in any way to market conditions.

There are of course risks associated with this approach. Placing all your financial eggs in one basket exposes you to diversification risk and the uncertainties of the business landscape. Economic downturns,industry disruptions, or internal challenges. This could jeopardize the stability of your investment, potentially leading to losses.

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Diversifying into other investments:

On the other hand, diversification offers the benefit of spreading risk across different assets and sectors. By allocating funds into stocks, bonds, real estate, or other ventures, you can mitigate the impact of adverse events affecting any single investment. This strategy is often recommended as a means of safeguarding wealth and achieving long-term financial security.

Diversification can also provide access to alternative sources of income and capital growth. Depending solely on the performance of your business may limit your potential for wealth accumulation in the long run compared to a well-diversified investment portfolio.

Nevertheless, diversification also comes with its own set of challenges. Identifying suitable investment opportunities requires research, expertise, and sometimes a willingness to accept lower returns in exchange for reduced risk, as mentioned before.

The decision to keep money in your business or diversify it into other investments is not one-size-fits-all. It depends on various factors such as the stage of your business, Your life, your risk tolerance, and financial goals. Ultimately, striking the right balance between reinvestment and diversification is key to optimizing returns while managing risk effectively. Consulting with a financial advisor (like BOM) who can help you and conduct a thorough analysis across various scenarios will help you make an informed decision to help you achieve your goals.

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Disclaimer: This is not financial advice. Each person is unique with their own unique set of factors and goals to consider.
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