Build a resilient portfolio
In business diversification is a key strategy. A business may start with one core product or service but to grow & scale they need to diversify by selling multiple products & services, opening up new locations or expanding into new markets. The key is to diversify, but don’t dilute. If you spread out your business too much you lose your core focus and profits suffer.
On the wealth side most people have minimal diversification. If you follow traditional investing advice you have 3 assets: cash, stocks & bonds.
While your financial advisor will say you’re diversified at the end of the day you’re still exposed to general market risk. Majority of stocks move in correlation together as they are grouped into mutual funds, index funds & EFTs.
Think about all the uncertainty right now in the market with Russia, Ukraine, Fed increasing rates to battle inflation, and the looming threat of COVID. If 100% of your investments are in the stock market you have to be willing to weather the storm and ride the waves.
Having multiple income streams makes your wealth more resilient. Someone with 1 income stream has more risk than someone with 100 income streams. If your sole income source falters you’ve got a lot more to lose than if 1 of your 100 income streams has an issue.
Picture building your wealth as a series of building blocks. Each block is an asset that produces income. The more blocks (income streams) you have the stronger and more resilient your wealth will be.
Through private investing you can diversify among various industries, asset classes, geographic locations, operators, and more.
Hard Money Lending
Within an industry such as Real Estate you can diversify among asset classes
Mobile Home Parks
You can invest into assets based on geographic location
High Growth Markets - Austin, Charlotte, Charleston
Stable Markets - Louisville, Indiana, Dallas
You can invest with different operators, who are the people who actually run the business you are investing in. For example I’m invested with 4 different multi-family operators and 2 different self storage operators.
Understanding Each Block
Every income stream you analyze will have similar characteristics but be unique in the details. As you develop your plan to stack your blocks you need to have a clear understanding of each asset’s 4-factor profile and how it fits into your vision & strategy.
The 4 Factors are: risk, return, time & turn.
What is the risk of losing your capital? The number one goal of investing is to never lose money. Loss of capital destroys any progress you’ve made through compounding and can set you back years.
The risk of an investment can be broken into two categories:
To measure the risk of the asset you need to look at the underlying collateral backing the investment. An investment backed by a “hard asset” such as real estate is more secure than an investment backed by “soft assets” such as contracts, intellectual property, and relationships.
Real estate can go through boom & bust cycles but it’s never going to go to zero. Even if you purchased a property at the very top of the market and the property lost 40% in value, if you hold on long enough, the value will recover. They aren’t making any new land these days.
By investing in the stock market you are purchasing a soft-asset piece of paper. Yes there is a company behind the paper who owns hard-assets such as building, land, equipment, and machinery. However the value of the paper, aka the stock price, is based on the expectations of performance. A company could release quarterly earnings stating they had a record year of profits and the price could go down if analysts were expecting even higher profits. Crazy to think about a record year results in a reduction of company valuation.
What about a stock that you purchased at the height of the market that drops 50%? You could hold it hoping for a rally but it’s also possible that the stock continues to drop. Eventually it could go out of business or get acquired by another company for pennies on the dollar.
The success of an investment will be highly dependent on the team or individual managing the asset.
A great operator can make money on a bad deal
A bad operator can lose money on a great deal
The better job you can do assessing the operator the better you will manage the risk.
When I’m vetting an operator I’m looking
Follow them on social media
Listen to their podcasts, subscribe to their newsletter
I want to truly understand how they think
Do they seem sincere in wanting to educate me?
Do they value me as a potential investors?
What does their communication look like?
How many deals have they successfully completed?
What does their team look like?
How much do they personally have into the deal?
Who can I talk to whose invested with them before?
The good news is the hunt for great operators comes to a stop once you find a solid group of operators that have consistent deal flow. You don’t need to find 100 operators, you need to find 5 to 8 that you really get to know, like and trust. As long as each one can pitch 3 to 4 deals per year you’ll have plenty of opportunities.
How much do you expect to profit from this asset? What is the frequency of cash flow? Are you getting distributions monthly, quarterly, annually, or in 3 to 5 years? Is there a possibility of a negative return in which you have to put more capital into the deal?
Here are the 4 metrics we use to analyze every deal:
Cash on Cash - how much cash are you getting back in the first 12 months divided by the cash you put into the deal. If you put $50,000 into an investment and you get a return of $5,000 in 12 months you’ve got a 10% cash on cash return (or “CoC”)
Equity Multiple - total money returned divided by total cash invested. $100k returned on $50k investment is 2.0X multiple. $75k returned on $50k investment is 1.5X multiple. You need to take into account time when comparing equity multiples. A 1.5 deal on a 2 year hold is better than a 3.0 deal over 8 years. A quick rule of thumb is to divide the equity multiple by the years. 1.5 / 2 = 0.75 compared to 3.0 / 8 = 0.375.
Average Annual Return - the total percentage return on your investment divided by the number of years. Example: $100k returned on $50k invested, for $50k profit over 5 years. $50k profit / $50k invested = 100% return / 5 years = 20% average annual return.
Internal Rate of Return (IRR) - the annualized effective compounded return rate. IRR takes into account the time value of money based on how long the investment lasts. You can use IRR to compare multiple projects of different length, a 3-year vs. 5-year investment.
Internal Rate of Return (IRR) vs. Average Annual Return (AAR)
The key difference between IRR and AAR is that IRR takes into the account how quickly you get paid back. As the saying goes, a dollar today is worth more than a dollar tomorrow. Especially when inflation is going crazy the quicker we can get our capital back to reinvest into new assets the better.
How much of the investment’s success is based on your personal time?
You deserve a bigger return based on the amount of time you personally invest. Someone who starts and operates a business should earn more than a financial partner who’s only responsibility is writing a check. Someone who is good at day-trading stocks should earn a lot more than someone who auto-invests into index funds.
Your time commitment is a huge factor in designing your lifestyle. As an entrepreneur actively running multiple businesses I want passive income from low-time commitment assets. I want to invest into assets that are operated by another entrepreneur who is dedicating the majority of their time to make it a success.
If you are building a multi-million dollar business do you really want to be dealing with BS issues at rental properties that produce $200 a month each? I don’t. I want to keep it simple and ditch the high-time commitment assets and exchange them for low-time commitment ones.
How long is your capital locked up for, what is the investment horizon, when will it be returned to so you can “turn” it and acquire a new asset?
Liquidity is the scariest part of private investing for new investors. With stocks and bonds you can sell and receive the cash within a few days. With the majority of private investments that is not the case. Your capital can be tied up until the operator decides to refinance or sell the asset. Most deals are 3 to 5 years. You may choose to invest in some deals that lock it up for 10 years.
How do you balance locking up capital for years at a time? Stagger your investments. If you are consistently investing every year, after the ramp-up period, you’ll start to receive your “turns” (return of capital + profits) every year. You will then redeploy that new capital into a new investment which will marinate for another 3 to 5 years.
The target returns I’m looking for vary depending on these 4 factors. I’m willing to accept a lower return on an investment that has very low risk, no time involved and will turn the capital quickly. I’m not going to accept a crappy return on an investment that will be higher risk, require time to be invested and tie up my capital for years.
Value-Add Apartment Syndication: Normal risk, zero time, 3-5 year typical hold
Cash on Cash: 7-8%
Equity Multiple: 2.0
Average Annual Return: 20%
New construction apartments deals that are higher risk because of varying factors I’m expecting a higher return, somewhere around 3.0X my initial investment in 5 years
I invested into a coffee company which is higher risk than apartments due to all the variables of scaling a business, being people-dependent & weather dependent the returns should be extremely high if successful.
If you want to learn more about building wealth & passive income through private investments drop me an email email@example.com I’m in the pre-launch stage of a coaching program to teach other accredited investors how to capitalize on these amazing opportunities.