Has a client ever asked for your recommendations for investing locally?
That’s what happened to Angela Barbash, a registered investment advisor who runs a firm called Revalue in Ypsilanti, Michigan. After the financial meltdown of 2008, her clients were eager to find local alternatives to Wall Street and she was clueless. Local securities were never part of her training or exams. She went to a Slow Money conference in San Francisco in 2011 and was surprised to discover other financial advisors who were being asked the same questions.
Fast forward eight years and Barbash now is reinventing the wealth-management profession. She’s done enough research in her region to identify promising local investment opportunities, some for accredited clients and some for everyone else. She organizes a regular call involving representatives from local banks, federally designated community development financial institutions (CDFIs), and community investment funds, as well as impact investors, to work together to identify promising local businesses for their collective investment. They also share some of the due diligence and strategize about how to split opportunities among their clients.
You may not be aware of it yet, but local investment is a huge, growing asset class. In the four years since investment crowdfunding was legalized, nearly half a million people have invested $340 million in 1,500 small companies. The average successful offering was $270,000, with an average investment of about $750. The disproportionately successful CEOs were women and people of color—precisely those people the conventional capital marketplace has overlooked.
Today, Americans have about $56 trillion dollars in long-term financial investments: in stocks, bonds, mutual funds, pension funds and insurance funds. Locally owned businesses (most of them quite small) account for 60-80% of the private economy, depending on how you define “local.” If the capital markets were operating well, at least $34 trillion (60% of $56 trillion) would be going into local businesses. In fact, almost none is. The potential growth of this sector is staggering. (And the potential collapse of global markets, as money comes home, should be noted too.)
If local businesses were not profitable, it would be understandable why Americans do not invest in them. Yet it turns out that smaller companies are more profitable than big ones. The most recent data from the Internal Revenue Service, from 2013, show that sole proprietorships, which most small businesses are or start out as, are three times more profitable than C corporations, with the profitability of partnerships falling in between. In our not wildly dissimilar neighbor to the north, Canada, the most current data suggest that the most profitable companies have 10-20 employees, while the least profitable are the largest, with more than 500 employees.
What about risk? Don’t most small businesses fail? No. Most small business startups fail. So if your client is risk averse, your job is to steer her to the 90+% of local businesses that have been around for 5-10 years with a proven business model and tested management.
The universe of local investments, moreover, is much larger than just small businesses. Your clients can invest in themselves (to get out of credit card debt, for example), in their kids and neighbors, and in local real estate, coops, nonprofits, and municipal bonds. Moreover, there are easy and inexpensive ways you can tap tax-deferred pension savings and invest them locally, using self-directed IRAs and solo 401(k)s.
As tens of millions of Americans go deeper in debt because of the COVID-19 economy, you should be advising your clients to invest in themselves rather than Wall Street.
Ultimately, there are at least four reasons you should tell your clients to consider local investing:
- Higher Returns – Some local investments, in your own home or in energy efficiency for example, almost always pay a higher rate of return than Wall Street.
- Social Returns – Besides your private return, a local investment pays a social return. More income circulates in your community, which enhances the tax base, which pays for better schools and police, which improves your quality of life.
- Lower Risks – If you have good information about a family business down the street that you love, your investment in it is probably safer than in a relatively unknown company in the stock market. We know that community banks, which base lending decisions on long-term relationships, have fewer defaults than big banks, which rely on computerized credit reports.
- Real Diversification – Right now, what you call diversification is all within the context of globally traded stocks and bonds. Local securities are truly different and are unlikely to be as effected by global market swings.
Mindful of diversification, you should suggest your clients proceed down this unfamiliar path slowly. Barbash recommends that highly risk averse people invest no more than 1% in local business. Those with a moderate risk tolerance might invest 5%. Those who enjoy higher risk taking could move to 10%. She concedes, however, she is only referring to investment in local businesses and community capital funds. The other forms of local investing in yourself, such as getting out of credit cards or investing in your own home, are low risk and can justify a substantially higher allocation. In fact, Barbash admits that nearly all her own retirement savings are in her house and her business.
If some of you are skeptical of these options—that’s great for the rest of you. As Barbash discovered, this is a huge new business niche without much competition. She’s now THE go-to company in Michigan for local investment advice. By definition, however, local investment advisors must be local. Who will be the first wealth manager to bring these practices to your community?
Michael H. Shuman is an economist, attorney, author and entrepreneur. He is the author of 10 books including The Small-Mart Revolution; Local Dollars, Local Sense; The Local Economy Solution; and Put Your Money Where Your Life Is: How to Invest Locally Using Self-Directed IRAs and Solo 401(k)s. Learn more at michaelhshuman.com.