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Building Wealth: Risk Concentration is Faster than the Market

by Jim SchleckserAug 23, 2022Entrepreneur

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When building wealth you want to protect yourself from the downside of risk, and to do that you must avoid having all your financial eggs in a single basket.

So, the first word from financial management typically is diversification. But these advisers aren’t saying that if you’re interested in building wealth, you need to practice a bit of risk concentration.

Let me explain.

 

Concentrating Your Risk

The only way of building wealth faster than the market is to take a concentrated position of risk: to put all your eggs in that single basket. Then, your goal is to do everything you can to protect the basket.

Risk concentration is the strategy used by entrepreneurs who start a business and invest everything they own–including their time and money–to grow the company and its value. There’s no diversification involved here: Most entrepreneurs spend their waking hours working on or thinking about their business. Ask anyone in financial management about this; they’d say it’s too risky.

But what they’re missing is that it’s by concentrating their risk into a single asset–their company–that entrepreneurs get the enormous upside of someday selling their business for an incredible return on their investment.

Look at a list of the wealthiest and most successful people around–Bill Gates, Jeff Bezos, Mark Zuckerberg, and even Elon Musk–and see that they’ve all used this strategy for building wealth.

Even famed investor Warren Buffett made his mark early building wealth by making a few concentrated bets on holdings like Coca-Cola and The Washington Post.

As an entrepreneur, you’re picking your shot and doing everything you can to make it successful.

 

It’s Not a Strategy for Everyone

Of course, there’s a reason that financial management would want us to diversify beyond a handful of assets. We’re taking on a lot of risks that we could lose everything. No doubt, anytime you open up a business, your risk level increases as you face the possibility that you could eventually run out of money and go out of business.

As a side note: Plenty of research shows that most entrepreneurs are more risk-averse than you think. They think their idea for a business is a great bet. They aren’t taking risks for the sake of taking risks alone. They’re making what they believe is a smart, calculated bet that can pay off in enormous ways.

You can’t get that same payoff when you spread your investments in a diversified portfolio.

But let’s be clear: This strategy is not suitable for everyone. There’s been significant research done over the years that’s found that most people will do more to avoid risk than to try and generate a positive return. The fear of going to zero is a profound deterrent for many people in ways where they will never make the kind of concentrated bets needed to generate serious wealth.

Paradoxically, most people concentrate their bets to some degree when working for a company. Their salary, bonus, and benefits are linked to this business–only they might not have the upside of having an ownership stake in it.

 

Time to Diversify

There does come a time when it’s prudent to listen to financial management and begin to mitigate your risk. This happens after you cash out of the business. Once you’ve earned your freedom money, it’s time to embrace diversification strategies that will cap your upside and protect you from losing what you’ve gained. While it’s challenging to eliminate the risk, your goal should be building wealth in a portfolio where the chances of losing everything should be close to zero.

It all comes down to whether you are interested in building wealth–or maintaining it. To create it, practice some risk concentration. And then, once you have it, embrace diversification to protect what wealth you’ve built.

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