Advice for young entrepreneur with highly variable income?

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Topic Author
MrBrainwash
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Joined: Mon Jan 30, 2012 10:57 pm

Advice for young entrepreneur with highly variable income?

Post by MrBrainwash »

I'm 29 years old and have no debt. I worked for a large tech company after graduating from college and recently quit my job to start a company of my own. I have a 6 figure sum to invest and am trying to figure out what is appropriate given my current situation.

I have a 401k and a Roth IRA, and I'm investing those funds in a retirement portfolio that is pretty standard for a person my age (all index funds, heavily skewed towards equities). That part I am comfortable with, but it's my taxable accounts that I'm not sure about.

Since I'm starting a company, it could be some time before I have any income, maybe even as long as a couple of years. Given that, I have 3 years of living expenses in cash. I'd like to figure out what to do with the rest of my taxable accounts.

First, about 50% of my taxable accounts after you take out the 3 years of living expenses is invested in the stock of my former employer. I have no desire to sell any of the stock because I would incur large capital gains taxes, and I believe the stock to be an excellent investment. Another 20% is in a Fidelity balanced mutual fund, VFINX (Vanguard S&P 500 Index), and a bunch of individual stocks (this part of my portfolio was constructed before I got wise to the Bogleheads philosophy). If I sold that stuff, there would be some capital gains taxes, but not a huge amount, so I'm willing to liquidate it and redistribute it, if necessary. The final 30% is in cash.

On the one hand, I feel that the 30% in cash (a 6 figure amount) is earning practically nothing, and I should invest it. On the other hand, I do not currently have any income, so even though I've got a few years of living expenses squirreled away elsewhere, I like the safety of having that cash. My dilemma is that if my business is successful and I'll have a good source of income from it within a couple of years, then I'd prefer to invest aggressively and assume that I won't need to touch the money for 20 years. On the other hand, my business could totally fail, in which case I might need to liquidate some investments in a 3 - 5 year timeframe.

Any advice on what I should do? I've thought about putting the cash in a short term bond fund, but yields are so low that I'm not sure there is any benefit to that vs. CDs. I've also thought about putting the money in less volatile equities, like a portfolio of dividend stocks, and then hoping that I don't get caught with my pants down if I need to sell some in 3-5 years. Or maybe I should just leave it in cash and quit worrying about it, since the success or failure of my new business will have a much bigger impact on my finances than the investment returns I may or may not realize on these funds.

Thanks for any insights.
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Noobvestor
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Re: Advice for young entrepreneur with highly variable incom

Post by Noobvestor »

Fellow entrepreneur here. First, if you're not making much money right now from your biz, can you qualify for 0% cap gains? Second, regardless of the first point, I would say sell your old company's stocks - it's just too much concentration risk. Third, assume the worst, hope for the best - if things turn out well, you'll have way more money to invest, and won't miss having been less in the market for a few years with your currently-lower amount of money (what I had invested a few years back really doesn't matter now that I've cashed in some chips and changed around my allocation - my 2000s 100%-stock allocation bounced up and down, but all now seems small compared to what I am able to put into it). If things don't turn out well, you'll be glad you kept your money in a safer/saner balance. I suggest some combination of I Bonds and intermediate/long-term tax-exempt funds.
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Topic Author
MrBrainwash
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Re: Advice for young entrepreneur with highly variable incom

Post by MrBrainwash »

Thanks for your thoughts.

You make a good point about the 0% capital gains rate. I may quality for that, and if so, I should take advantage of it.

I already maxed out my I Bond purchases for this year. Why do you recommend intermediate/long-term tax-exempt funds? I was under the impression that if the duration of the bond fund was longer than my time horizon for possibly needing the funds (3-5 years), then I should stay away. Vanguard's California intermediate tax-exempt fund (VCAIX) has a duration of 5.4 years, which I suppose might be alright, but that's pushing the limits of my time horizon. I has an SEC yield of 2.09%, so I'm not sure that it's worth messing around with, when I can buy a 5 year CD from Ally yielding 1.79% and eat the (small) penalty if I need the money sooner. Also, why do you recommend tax-exempt when I'm likely to be in a low tax bracket? Just because the yield spread between taxable and tax-exempt isn't big enough for it to make sense?
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interplanetjanet
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Re: Advice for young entrepreneur with highly variable incom

Post by interplanetjanet »

MrBrainwash wrote:First, about 50% of my taxable accounts after you take out the 3 years of living expenses is invested in the stock of my former employer. I have no desire to sell any of the stock because I would incur large capital gains taxes, and I believe the stock to be an excellent investment.
This is a pretty serious concentration risk. If you are sure that you want to hold these for now, consider buying puts to protect against downward risk - this is one case where options can sometimes make sense.

-janet
livesoft
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Re: Advice for young entrepreneur with highly variable incom

Post by livesoft »

With no income, how much of that old 401(k) are you converting to your Roth IRA annually at your very low tax-rate?

With that large taxable account, I see no reason why you do not put your cash in tax-advantaged and use bond funds instead of cash: Wiki article link: Placing Cash Needs in a Tax-Advantaged Account

Is there some kind of option that you can use to hedge the risk of all that former company stock? How much of that stock can you unload since you have no income and long-term capital gains are taxed at 0% if your tax-bracket is low enough?
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exeunt
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Re: Advice for young entrepreneur with highly variable incom

Post by exeunt »

I agree with interplanetjanet.

As an entrepreneur, you are effectively an investor in a highly illiquid microcap firm. Your equity risk is through the roof. I would seriously consider a strongly anti-equity tilt to hedge that exposure--meaning lots of long bonds, TIPS, and puts.
Topic Author
MrBrainwash
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Re: Advice for young entrepreneur with highly variable incom

Post by MrBrainwash »

interplanetjanet wrote: This is a pretty serious concentration risk. If you are sure that you want to hold these for now, consider buying puts to protect against downward risk - this is one case where options can sometimes make sense.
That is a good point. I know little about options since I've always viewed them as un-Boglelike. Any recommended sources for learning what I'd need to know to hedge my concentration risk?
Topic Author
MrBrainwash
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Joined: Mon Jan 30, 2012 10:57 pm

Re: Advice for young entrepreneur with highly variable incom

Post by MrBrainwash »

livesoft wrote:With no income, how much of that old 401(k) are you converting to your Roth IRA annually at your very low tax-rate?
I didn't know that was possible. I thought I could only rollover the 401(k) to a traditional IRA. That sounds like a great idea. I will have to investigate how to do it.
livesoft wrote:With that large taxable account, I see no reason why you do not put your cash in tax-advantaged and use bond funds instead of cash: Wiki article link: Placing Cash Needs in a Tax-Advantaged Account
Thanks for the link. I see the benefits of that strategy, but I'm not sure if the potential financial benefits are worth the hassle. I will have to crunch some numbers and see.
livesoft wrote:Is there some kind of option that you can use to hedge the risk of all that former company stock? How much of that stock can you unload since you have no income and long-term capital gains are taxed at 0% if your tax-bracket is low enough?
I wouldn't be able to unload that much of the company stock while still staying in a low-enough tax bracket for the 0% capital gains rate. Options are a possibility, it is a large-cap company and I'm sure there is a liquid options market for the stock.
mac808
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Re: Advice for young entrepreneur with highly variable incom

Post by mac808 »

I'm an entrepreneur of similar age in a similar situation. My AA is 50/50, with 50% in intermediate term muni bond funds VWIUX/VWLUX. (If you aren't drawing a salary, then taxable bonds might be a better bet for you.) The problem with holding cash is that over time, thanks to inflation, it loses value in real terms. I might even shift my AA this year to 30/70 stock/bonds. As entrepreneurs, we take enough risk in the market, I prefer to be much more conservative with my investments. I remember about four months ago my business hit a rough patch and I thought it might fail (or require a cash infusion from me to continue), AND the market was down 4-5% two days in a row...that was not a pleasant time.
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