When most investors look at their portfolios to determine how they can diversify them more, they often don’t consider investing locally. They look to Wall Street, global economies, and precious metals. Even though they may not find much satisfaction in many of these investments, they still don’t look elsewhere.
If this sounds like you, here’s a new option for you – local investing.
When you invest locally, you use your money to support local small businesses. There are two types of investments:
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Equity investments: This is when you buy an ownership stake. Investors pay the owner cash, which he can use on whatever he would like such as reducing the business’ debt, purchasing more products, or hiring employees. The investors receive a percentage of the profits.
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Debt investment: This is when you pay some or all of the debt of a business. In exchange, you receive interest income and the repayment of the investment amount over time.
Many local small business investors diversify their portfolios this way because they take pride in their community, and they firmly believe this industry will be what revitalizes the economy.
Small businesses bring money into the local economy. They create jobs to lower the unemployment rate, and they increase tax revenue. For tourism areas, they bring tourists in and get them to spend money. Small businesses also have an effect on political participation.
How to Choose Small Businesses for Investing
When investing in small businesses, there are a few things you should look for.
Gross margin is a percentage of the difference of how much the products sell for and how much they cost to produce. For equity investments, look for high gross margins. Some examples of companies with high gross margins are onces that sell organic products, pet food, and personal care items.
Brand strength is another important factor. The bigger the brand, the more attention it will receive from consumers. Look for the uniqueness of the brand too, because competitors will have a difficult time copying it.
Make sure you know the CEO well before you invest. You must feel comfortable with him and his views about the future of his business and industry. You don’t want the business to fail as an investor, so you need to make sure the CEO is invested in making it a success.
Recurring revenue is a hot factor for investing. If the business has revenue that continues to come in even when there hasn’t been any new business or sales, that’s a cue to you that the business has something good – it will continue to make money, and it has a lower risk of collapse.
What to Be Aware of Before Investing Locally
Don’t be fooled. Just because a company has a headquarters in your community doesn’t mean it’s a local small business. Many companies derive revenue from other cities and countries, so make sure to research possible investments thoroughly.
While investing locally can come with decent returns, it can be quite risky. Don’t think you’re sure to make a good return on a small business just because it seems as though it’s going to be a success.
Remember, most small businesses don’t survive past five years. It’s best to invest in those that aren’t startups – or if they are, only invest if they are backed by a lot of money and already have a decent amount of support from the community.
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Is It Good for Your Portfolio?
The more diversified your portfolio, the better. Due to the riskiness of this type of investment, it’s not wise to invest a large portion of your portfolio in small businesses. While you could win big on them, you could lose big too.
To save yourself from losing all of your money, don’t turn away from traditional investment opportunities such as stocks, bonds, and alternatives. Reserve about 10% of your portfolio for small business investing.
Depending on how close you are to retirement age, it’s best to consider how much you want to devote to stocks. An old rule is to subtract age from 100, so if you are 50, you should only invest 50% in stocks. With 10% in small businesses, you will have 40% for other investments.
Of course, as you feel more comfortable with your small business investments, you can boost that percentage to 20% – but only if you really feel it will be a success. If not, stay safe, supportive, and sure so that you’ll end up making money with your local investments.
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