There's an old joke about a bar owner who bragged, "I opened this place 15 years ago with $78 in my pocket and boy, have we made progress! Today, I'm $298,000 in debt!

No doubt about it, debt can kill a small business, and seriously hurt your chances of reaching a finance company for a small business loan or other financing.

So here is an important thing to remember: Managing your debt load is just a piece of your overall debt puzzle. And recognizing red flags that indicate you are in trouble is another.

The bigger picture - how debt can impact your small business, the steps you can take to control debt, credit and borrowing issues, and who to go to for help if you need lending help - those are the underpinnings of the debt management structure.

It's also important to understand what debt management is not.

It's not, for example, another name for bankruptcy, although that's a common misnomer. Debt management doesn't mean you are in bankruptcy, or even on the way there. Bankruptcy is usually reserved for those who can't pay their debts and need legal protection. Debt management is reserved for those who can pay their debts, but need a little help in doing so.

Put it this way:

Bankruptcy is permanent and debt management is temporary.

Bankruptcy is for small business owners who don't even have enough cash on hand to pay for food and shelter. Debt management is for people who can't afford to pay all of their debt obligations.

Bankruptcy is for small businesses that have no money to pay creditors. Debt management is for people who have simply fallen behind on their payments to creditors.

Bankruptcy is for small business owners who can only afford to pay cents on the dollar on their debts. Debt management is for people who plan on paying 100% of their debts (with a potential break on interest, depending on the good graces of their creditors).

Bankruptcy is for small business owners who will soon lose some, most or all of their assets. Debt management is for people who don't lose assets.

Bankruptcy is for small business owners who may never get credit again. Debt management is for people who will get credit again.

In short, debt management is a viable alternative to bankruptcy for those entrepreneurs who can afford to meet their debt obligations. But note that, if a bleak debt situation goes largely ignored, the path from debt management to bankruptcy can be a short one.

 

As the revenues roll in from your burgeoning small business, it's tempting to use some of that cash to pay down your debts. But should you do that instead of investing the money for the future?

It's a fair question. In fact, Old King Solomon would have a difficult time deciding what to do.

But there is a guiding light out there in the economy that can help you decide -- interest rates. Why should it all come down to interest rates? In our dilemma here, it's a good idea to invest money if you can earn a higher interest rate than you are paying on your loans and debts. For example, if the interest rate on your small business loan is six percent and you invest in a mutual fund that promises a higher return, then your money is working harder and smarter for you as an investment.

That said, there's no guarantee that your mutual fund will even earn four percent next year. Heck, it could lose four percent.

So that's why I favor paying off your debt first. The interest rate fees you kill by paying off the loan alone make that strategy a savvy move. And being debt free is a small business owner's dream.

But I also come down on the side of practicality. If you insist on going the investor route, put the maximum you can in your self-employed retirement plan (SEP). In a word, SEP's are like a "Solo" 401(k) that cater specifically to small business owners and sole proprietors who want to save for retirement on a tax-advantaged basis. Since your retirement plan distributions are tax-deferred and come out of your own pocket as a gross, and not net, amount of your earnings, you'll hardly notice the money is missing.

It's simpy a matter of paying yourself first.

Come to think of it, paying yourself first is a good debt strategy of its own.

 

In these blogs, I talk off and on about the importance of not having all of your investment eggs in one basket. Too many investors, unfortunately, put all of their money into last year’s highest performer and cross their fingers. That's a losing strategy, and if you don't believe me, ask an Enron investor.

What such investors really need is a tried and true technique for investing successfully—diversification. Doing so is one of the best ways to protect your investment portfolio from the pendulum swings of the economy and the markets. Simply defined, diversification has you divide your investments across different types of assets. Since a separate account portfolio may invest in different securities, a decline in the value of one security may be offset by the rise in the value of another.

While there have been hundreds of books written on the right way to diversify a portfolio, no one of them can possibly provide you with a perfect understanding of what it takes. What I can try to do here is educate you on the basics, including how diversification works and  why it’s important.

Some background first. Wall Street pundits say they divide the history of investing in the United States into two periods: before and after 1952. In that year, University of Chicago economic student Harry Markowitz published his doctoral thesis – a thesis that would make up the foundation for his breakthrough treatise on investing called Modern Portfolio Theory. Markowtiz’ paper caused such a stir and impacted so many investors that he won a Nobel Prize in economics in 1990.

What is modern portfolio theory? In Markowitz’ view, ground zero for investors is avoiding risk at all costs.  Markowitz defines risk as a "standard deviation" of expected returns.

Loosely translated, instead of considering risk on a single security level, Markowitz emphasizes measuring the risk of an entire portfolio. When considering a security for your portfolio, don't base your decision on the amount of risk that carries with it. Instead, consider how that security contributes to the overall risk of your portfolio.

Markowitz then considers how all the investments in a portfolio can be expected to move together in price under the same circumstances. This is called "correlation," and it measures how much you can expect different securities or asset classes to change in price relative to each other.

For instance, high fuel prices might be good for oil companies, but bad for airlines that need to buy the fuel. As a result, you might expect that the stocks of companies in these two industries would often move in opposite directions. These two industries have a negative (or low) correlation. You'll get better diversification in your portfolio if you own one airline and one oil company, rather than two oil companies.

When you put all this together, it's entirely possible to build a portfolio that has much higher average return than the level of risk it contains. So when you build a diversified portfolio and spread out your investments by asset class, you're really just managing risk and return.

Markowitz has a good point about risk, and its implicit partnership with diversification. After all, everybody’s heard the stories. How the guy at the gym or the lady at the hair salon made a fast killing on last year’s stock picks—or a friend tripled his “investment” one 
morning at the horse track. These are all well and good, but they’re stories about gambling, not investing—risky business that’s fine for entertainment if you can afford it, but not for financial planning. That’s because basing your financial decisions on guesswork not only 
prevents you from growing your money, but also increases your risk for losing it.

Which is one of the many reasons why I like diversification: it’s a technique that, combined with rebalancing, removes the guesswork and emotion from investing.

 

On Wall Street, you often hear the big money guys talking about "bullet-proofing" their portfolios.

In other words, designing your investment portfolio in such a way that even if your portfolio takes a body blow, it's easily absorbed with minimal damage to your investment assets. No investment plan is immune to losses – the idea is to limit those losses so they don't destroy your financial future.

Make no mistake, protecting your portfolio should be job one for investors, if only for good peace of mind. Research indicates that a loss causes about twice as much pain as a gain causes pleasure. During periods of market volatility, investors experience the sense of loss more acutely. For anyone with short memories, the bear market of 2000-2002 is a vivid example of that.

One example of bulletproofing your portfolio comes in the form of "Hurricane-Resistant" investment portfolios.

Remember Katrina? We all do. It wreaked billions of dollars of damage along the U.S. Gulf Coast in August, 2005. But some saw opportunity in tragedy. Writes Adam Shell, in a USA Today piece shortly after
hurricanes Katrina and Rita hit, "ever since Hurricane Katrina crashed into the Gulf Coast on Aug. 29, nimble traders and money managers have been reshaping their portfolios in an attempt to sidestep — and profit from — the potentially devastating one-two punch packed by Katrina and Rita."

In this case it's the notion that some industries and companies will profit handsomely from the damage inflicted by Mother Nature. Andrew Corn, CEO of Clear Asset Management told USA Today in the same story: "Like most tragedies, there is a silver, or in this case, a golden
lining."

This year the U.S. Weather Service is forecasting a big uptick in hurricane activity in the Western Atlantic, with the possibility of a whopping five "major" hurricanes reaching U.S. shores. Of course, I hope that doesn't happen. Lives will be lost, as will homes and livelihoods. But if it does, and you care to profit from it, there is a plan.

The key in building hurricane-proof portfolios is to pick the sectors - and the companies within those sectors – that are poised to profit from natural disasters. Obviously, construction and home repair providers - -think Lowes or Home Depot - -might be a natural for a disaster-proof stock portfolio. Energy and utility companies can fill a niche, too.

Even clothing retailers tend to do well in natural disasters. Companies like Abercrombie & Fitch and The Gap are often the first places shoppers go to replace - -what else? - - their clothing lost to a hurricane or other natural disaster.

While no actual hurricane mutual fund exists today, it's highly possible to cherry pick the companies you think will grow and prosper even as most others wither on the vine after a natural disaster like Katrina or Rita.

Remember, there's really no avoiding the ebbs and flows of stock market performance. Hits are inevitable and typically occur because of a bear market, a recession, inflation fears, or a currency problem. That's why the goal is to build-in protection for your capital, maybe even make a profit even when traditional portfolios are spiraling downward and still be able to beat or keep up with the markets when they are rallying.

That's why bulletproofing your portfolio is so critical – it protects you and your money and creates more opportunities to grow your investment portfolio.

Even after a hurricane.