If you are in a position to buy stocks or buy a business, then count your blessings. As you move through the various stages in your life and career, you may shift between these two options or embrace them both at the same time. You might also be fortunate enough to invest in real estate. Read this article on buying a business vs. investing in real estate.
Is it better to buy a business or invest in stocks?
Consider your risk tolerance and the amount of active participation you are seeking from your investment. If you feel buying a business is too risky, then invest in index funds. Investing in index funds or mutual funds is safer than buying a business because stocks are traded on an open market and you won’t lose your entire investment if one company fails. On the other hand, if you are energized by the thought of applying your ideas and controlling the levers of your destiny, then buy a business.
If you have the capital, the time, the interest, and the risk tolerance, then do both. Buying index funds or mutual funds takes very little effort. Pick from traditionally high performing index funds and then wait 10, 20, or 30 years.
If you don’t have time, don’t buy a business and treat it as a side project. Stick to investing responsibly in the stock market by dollar cost averaging into mutual funds and index funds. Likewise if you don’t have the capital to buy a business including working capital and a safety net, then stick to mutual funds and index funds. But before ruling out buying a business, read Can I Buy a Business with Little or No Money.
NOTE 1
So far I have been talking about investing responsibly in index funds and mutual funds over the long term. Investing in the stock market can also mean high-risk active trading which we won’t get into until the end of this article.
NOTE 2
The title of this article says “buy a business.” I am not discussing starting a business, which has considerably more risk than buying a business.
Is it Easier Financially to Buy a Business or Invest in Stocks?
It takes less money to get into the stock market and you can’t get a loan to buy stocks, making it financially easier and simpler than buying a business. Stocks are shares of ownership in a company. When you buy stocks, you are purchasing partial ownership of the company and becoming part owner. It’s easier to start investing in stocks than it is to buy an entire company, which means you can start with a small amount of money and grow your portfolio over time.
If you have consistent income that allows you to invest incrementally, you can dollar-cost average your way toward a nice sized holding or portfolio. Once your portfolio reaches a certain size, you can keep going, pivot to buying a business, or diversify by doing both.
In most cases you ‘ll need at least $50,000 to buy a traditional business. Many businesses require more capital, and there are also some viable businesses that can be purchased for less. You could find an online business with low income but promising upside and low working capital requirements at a low purchase price. See this article on how to buy a business with little money.
Cycles, Timing and Pivots in the Stock Market Versus in Your Business?
Responsible investing in the stock market means investing for the long term. Long term investing requires little attention, but it does require some attention. Savvy investors learn how to periodically assess and balance their portfolios, perhaps with a trusted financial planner, adjusting their positions and buckets to match their goals and risk tolerance at different stages in life.
Timing the market is a fool’s game. Some fools get lucky and give hope to other aspiring fools.
Running a business also requires paying attention to your investment. There is an important habit all business owners should take from the exit planning community. Hold quarterly business review meetings where you ask, “Should I grow or exit.?” This habit can start as soon as a few months after you buy the business. Once you are trained and engrained in this habit and learn all the questions to ask, all the metrics to implement, and all the outside influences to monitor, you’ll be a better decision maker. You’ll get good at pulling yourself out of the business to think clearly about the business and the environment in which it operates, including economic, legislative and geo-political issues, natural hazards, competition, supply chain, demand shifts and industry disruptors.
Both your stock portfolio and your business model require periodic evaluation and fine tuning. You’re in the stock market for the long term which requires less frequent adjustments. In fact, you should avoid making frequent adjustments. With a business, even if your plan is to own it for the long term, you need to ask the “grow or exit” question quarterly to be better prepared for shifts that may require big moves.
Time and Energy Required For Stocks vs Your Business?
Clearly your business requires more of your time than your stock portfolio (unless you actively trade which we’ll address later). Even passive businesses are typically only semi-passive and require your attention.
If you don’t have much time, you don’t have the luxury of buying a business, but you can certainly get into the stock market. If you do have time, should you buy a business or invest in stocks? Here are some things to consider.
- If you invest in the stock market responsibly, you’ll have more time than if you invest in a business. Can you spend your extra time to make money in other ways that, combined with your stock investment, beats owning and running a business? Or will you simply be happier with that extra time? See this article for more on the relationship between time and money.
- If being a semi-passive business owner is your goal, how much time would you need to operate the business before transitioning to a part-time role? When buying a business, it’s good to be able to dedicate at least the better part of a year to working in the business before transitioning to a semi-passive role.
How much money can you make in the stock market versus running a business?
Investing in index funds over the long term, one can expect a certain return based on consistent historical performance over long periods of time. These charts show that while long term investing looks very positive, short term investing, even in the S&P 500, is risky.
When running a business, there is a much wider range of positive and negative outcomes. Wild cycles can take out businesses more so than index-heavy stock portfolios. As a stock market investor, you have no operating costs, allowing you to easily weather the cycles. In business, downturns can mean decreased revenue and lack of funds to pay employees or buy materials. That’s why it is important to minimize the risk of business ownership by buying versus starting a business. This is not to say you can avoid the downturns, but at least you are able to buy a track record of profitability. If the business has been around long enough, you may even have data on performance in previous downturns. It is also critical to match your skills, experience and interests to the right business opportunity.
Personal Control in the Stock Market vs. Your Business
In the end, if you have energy and excitement to implement ideas, move pieces around, press the buttons and shift the levers, then investing in index funds or mutual funds will be too passive to satisfy your high energy and motivation. If this is you, go for it and buy that business with a good track record.
How Do You Pick the Right Business to Acquire?
Find the business that is a good fit for your skills, interest and experience. You are reading this as a new business buyer which means you should have wisely selected a business with consistent profitability. Distressed businesses or turnaround opportunities require immediate action from skilled professionals. In a stable business acquisition, you have time to win over employees, learn from them, learn the business, meet suppliers and customers, document processes, develop a strategy, and come up with the metrics you will use to run the business.
Target what you are good at.
But before you unleash that pent up energy and motivation and brainpower to acquiring and optimizing a business, I highly recommend changing very little in the first six months. In these six month, develop an exit planning framework so you can implement quarterly review sessions where you ask the “grow or exit” question that protects your investment and helps you measure your value-add.
See Essential Tips for Buying a Business.
Should I Buy and Run a Business or Actively Trade Stocks?
Both activities require active involvement and have considerable risk so in that sense we are comparing apples to apples. Yet, the answer is easy. You should buy and run a business.
In my very first finance class in business school, Professor Green demonstrated the overwhelmingly dismal results of even the best professional stock pickers. It made me wonder how many tens of thousands of finance professionals and day traders have wasted their talents generating no value or negative value relative to the S&P 500. Can you say “bullshit job?”
Of the very small percentage of winners in the crowd of active investors, they won because they were lucky enough to quit before seeing their demise. Active stock trading is a fool’s game. Are there success stories out there? Yes. But active traders are only successful for a certain time period. Even fools get lucky sometimes. They were lucky enough to quit while they were ahead. Show me a successful trader and I’ll show you an ex-trader.
A business owner invests in herself. A stock trader invests in others.
But aren’t business failures high also? Yes, but when you buy a stable cash flowing business, you’ve gotten past most of the obstacles that cause business startups to fail. When you buy a cash flowing business that matches what you’re good at, think about how much control you have over your destiny. You get to dive into the financials as an insider, set strategy and make decisions.
If a stock trader profits from inside information and gets caught, they go to jail. When a business owner uses inside information to build a successful company, they go to Disneyland.
Compare that to an active trader who tries to understand companies from the outside. Annual reports, financial statements, CEO interviews and everything else at their disposal make up a weak and unreliable information set. That’s why the majority of traders use technical analysis. Technical analysts are the chart monkeys who study stock market trends and data and make trades based on rules they have learned through experience. These rules however, are not persistent rules of nature as the stock market is man-made. It behaves dynamically, regulations change, human behavior changes and markets evolve.
But what about Warren Buffet?
- Warren Buffet is not a day trader or even an active trader. He’s an active investor seeking to hold long term positions.
- Warren Buffet leans on fundamental analysis to find his investments
No Offense
Warren Buffet is a one-of-a-kind, like his friend LeBron James. It’s easy to look at LeBron’s stature and realize you cannot compete on the court. Why do people think they can be the next Warren Buffet? Is it simply because you don’t have to be 6’9” to have a chance? Maybe so, but one-of-a-kinds are not easily replicated.
What About Real Estate?
Earlier I mentioned that if you are fortunate enough to consider buying a business and investing in the stock market, you may also be in a position to consider real estate. Just as getting into the stock market can mean passive investing or active trading, getting into real estate can mean passive investing or active flipping. Real estate flipping creates value while active trading does not, but both have similarities in that they are active and high risk.
In another article, I discuss investing in real estate relative to buying a business. It has a comparison table similar to the one below. In the table below, I included a column for passive real estate investing to tie these two articles together.
If you have the funds to invest responsibly for the long term in both real estate and the stock market, do both. These two activities are relatively safe and responsible ways of investing passively for the long term. While passive, real estate investing can require a little more involvement than investing in index funds. It also requires a bit more capital to get started. If you cannot stand the stress of being a landlord and don’t want to pay a property manager to take on that stress, then stick to responsible investing in mutual funds and index funds.
Can You Make More Money Investing in Real Estate or The Stock Market?
You can read many opinion pieces favoring one or the other. In truth, it can boil down to the article writer’s personal experience and biases. Furthermore, if the writer takes an objective approach citing national statistics, this is of little practical use since real estate markets are hyper local.
| Buy and Hold Real Estate | Buy and Hold Index Funds or Mutual Funds | Actively Trade Stocks | Buy and Run Profitable Business | |
| Short Term Benefit | LOW | LOW | UNKNOWN | HIGH |
| Long Term Benefit | HIGH | HIGH | LOW | MEDIUM |
| Required Funds | MEDIUM Down payment | LOW | LOW | MEDIUM Down payment |
| Ability to Borrow | HIGH Traditional lenders | NA | NA | HIGH Traditional SBA lenders |
| Acquisition Skills | MEDIUM Evaluate suitability as a rental | LOW Diversification is built-in, time is on your side | HIGH Still, it’s mostly luck! | HIGH Evaluate quality of earnings, potential, many moving parts, few good comparables |
| Management Skills | LOW Property management, construction trades | VERY LOW Periodic monitoring and portfolio balancing | HIGH Still, it’s mostly luck! | HIGH Speed, skills, incentives, communications, permits, expertise and recommendations |
| Market Exposure | MEDIUM No control over market but real estate generally rises over long term | MEDIUM No control over market but indexes generally rise over long term | VERY HIGH No control over stocks and sectors which can turn on a dime | HIGH No control over market forces, but able to mitigate risks |
| Exit Pressure or Challenge | LOW Seller’s market comes and goes and comes back again | LOW Time is on the side of long term investors | HIGH Timing is critical, yet un- masterable | MEDIUM Ideal exit when profitable and trending up |
| Investor Effort | LOW | VERY LOW | HIGH | HIGH |