How to diversify your portfolio through franchise investing
Yes, yes. We’ve all heard the old adage about putting your eggs in one basket. But it’s some of the most important investment advice you’ll ever receive.
Investing your money too heavily in one asset class, such as leaving all your investments in the stock and bond market or going all-in on the latest memecoin, can have an outsized impact on your net worth.
Sure, you could win big on Dogecoin. But “win” is the operative term because limiting your investing in this way is a gamble. You could lose big or (less-talked-about) leave money on the table.
Instead, wealth managers encourage portfolio diversification: allocating your assets in a mix of investments to “spread around” your overall risk, while also helping increase your returns by blending in higher-return investments like alternatives along with your stocks and bonds. This approach can help you take advantage of the good times without losing your shirt in a sudden market correction or long-term economic event like a recession.
But what does good diversification look like, and what makes franchising a good fit? In this article, we provide some details on how franchising figures into a healthy, stable portfolio.
Portfolio 101: Diversification
Anyone who follows financial advice hears a lot about the importance of diversification. But what does that look like in real-world terms?
Think of diversification as a balanced diet – but for your money. As with nutrition, not everyone has the same needs and goals, but we know some basic principles work for everyone. Starting with this concept, wealth managers can help clients create a portfolio with their goals and personal circumstances in mind.
Economists call this approach modern portfolio theory (MPT). First popularized in the 1950s, it remains the most influential approach to investing today. While MPT initially looked only at the mix of stocks versus bonds, in recent decades the mix has expanded to include alternative assets. Now, in addition to your stocks and bonds, wealth managers recommend other holdings such as real estate, venture capital funds, hedge funds, appreciable assets like wine or art, and (our personal favorite) franchising.
So, what’s the right portfolio mix for you? Many advisors believe that your portfolio should follow the 50–30–20 allocation mantra: 50 percent in equities, 30 percent in fixed income, and 20 percent in alternatives.
But in reality, your asset allocation will vary based on your…
- Marital or family status
- Net worth
- Financial obligations
- Retirement objectives, and
- Personal risk tolerance
A wealth manager can help you understand your individual financial goals and circumstances and build a well-balanced portfolio that works for you.
Why franchises make great diversification options
Naturally, we’re partial to one alternative asset above the others, but with good reason. Franchising carries many of the benefits of other alternative assets – without some of the drawbacks. It can provide you with steady, predictable returns and scalability over time.
Franchising benefits your portfolio in several ways:
Low market correlation
Stocks and bonds are often lauded as creating reliable returns for investors. While this is true in aggregate – the 100-year average for stock market returns is a respectable 10 percent overall – that doesn’t capture the whole experience. The years and decades within that 100-year window feature moments of dramatic wins and equally dramatic losses. Right now, the market is experiencing record-breaking performance. But things change, and sometimes overnight.
While every business is tied to the overall economic climate, franchising has a low level of correlation to the public markets. When you use franchising to balance your portfolio, you protect part of your assets from market volatility, which can steady the ship during market fluctuations. Adding franchising to your investment mix means that when the Dow plunges or the markets react to current events, your financial outlook will remain more constant.
A well-balanced portfolio will also offer protection against longer-term fluctuations in the economy. “Recession-resistant” assets and businesses are those that tend to perform well even during times of economic hardship.
Franchises are often service-based businesses, which are considered “recession-resistant.” The most resistant are those that fulfill customer needs: haircare, automotive services, home improvement, child-care and education, and healthcare are all good examples. If consumers absolutely can’t do without it, the investment is likely to perform well regardless of the economy.
Simply put, inflation is when the buying power of your cash decreases and the cost of goods goes up. While there are many reasons this can happen, the important thing is to have a plan for hedging against it. Franchises provide a reliable way to ride out periods of inflation.
Why? Inflation often occurs due to increasing demand and competition for products or services. (We’re currently seeing this inflation scenario play out with supply chain and production issues due to the pandemic.) During these periods, goods-and-service businesses are well-positioned to respond by increasing prices. For this reason, franchise businesses can sometimes perform above their average during periods of inflation.
How you can diversify with traditional franchising
Franchises are one of the most popular asset classes for diversified portfolios. They offer the promise of steady, predictable returns without the volatility of other alternative assets. But single-location franchise ownership is a hands-on experience. As the owner-operator, you’ll wear many hats, and invest significant hours making your business profitable.
So how do the rich use franchising to build wealth without sacrificing all their time to manage them? Already-wealthy investors who diversify into franchises take a different approach.
The myth: Passive franchising
Experienced investors know that the true wealth-building potential of franchises is all about scale. These “next-level” franchisees own dozens or even hundreds of franchise locations. Many invest in franchises across multiple industries and use them to amass wealth.
Investors accomplish this by building or hiring a management team to run the business for them. While some decisions and tasks still fall to the owner, the majority of daily operations are carried out by a well-paid, specialized team that oversees each business unit.
Because of this model of ownership, franchising sometimes gets marketed as a “passive” income opportunity – but reports of “absentee franchises” should be taken with a grain of salt. As you can see, this model of franchise investment requires capital expenditure above standard franchise and operating fees. Also, not all franchises are suitable for this type of operation; so, unless you have a lot of money to invest and in-depth experience with franchising, a fully passive franchise experience is unlikely.
The reality: Semi-absentee franchising
What’s more common in franchise businesses is a semi-absentee approach. In this model, you hire a location manager to take care of the day-to-day business. Rather than manning the store (or stores) yourself, your time is invested in “managing your managers.” Owners still check in regularly to ensure smooth operation, handle intermittent issues, monitor key performance indicators (KPIs) that are benchmarked with the franchises locations across the country, and fill in on-site when needed.
Time freedom is achievable with semi-absentee franchising, but it doesn’t happen right away. It’s also important to note that the semi-absentee model is best suited to certain low-headcount industries and operations. For instance, fitness locations, laundromats, car washes, vending services, and other easily automated businesses make good semi-passive income options. However, these options may require significant capital reserves to get up and running. In fact, many semi-absentee franchise models require that you have at least $250k in liquid assets and a $500k net worth.
Diversify with fractionalized franchising
Investing in franchises is a great way to diversify your portfolio if you already have the capital to work with. But if you don’t currently have $100,000+ to get your franchise journey started – or want a truly passive investment option to give you both income and time freedom – you can still add this important asset class to your investment portfolio with FranShares.
Fractionalized franchise investment takes a portfolio approach to franchising, allowing fund investors to participate in a wide range of locations and brands, professionally sourced and managed. As with other fractional opportunities such as land, vacation rentals, and art investment, investing with FranShares allows you to reap the benefits of the franchise model without becoming a direct franchisee or building a network of managed locations on your own.
Increase your diversification power
Investing with FranShares also broadens the diversification potential of your investment. Because you’ll invest in a portfolio of businesses, you’ll have holdings that cover a variety of industries, in a selection of strong geographic markets:
- We invest in recession-resistant industries such as home services, automotive maintenance, fitness, beauty, waste management, and healthcare. These opportunities are carefully vetted and have a strong track record of weathering economic changes.
- Our funds invest in strong franchise territories across the country, meaning your investment will be better protected from geographic economic risks, such as natural disasters and local economic downturns.
How to start diversifying with FranShares
If you’re interested in adding fractionalized franchises to your portfolio, getting started is easy. With a low investment entry-point of $500, you can build a more diversified portfolio without sacrificing your time or managing a manager.
Ready to learn more? Read more about fractional investing here, or get on our waitlist so you’ll know when our next fund becomes available.