I awoke late on Sunday morning — it was after 9 a.m. Tanja and I had stayed up way past our bedtime watching the first six episodes of the new season of House of Cards, and I was jolted awake by my 100-pound, 4-year-old German Shepherd, having his 20th or 30th (I can’t keep track anymore) epileptic seizure in our master bathroom.
The seizures are not a pretty sight. He thrashes around, gnashing and snapping his canines in the air, frothing at the mouth, and, on the really bad ones, losing control of his bowels. Luckily, this seizure wasn’t as severe, and we could get him outside. (Additional seizures sometimes follow the first, so we try to take him outside when we can.) We give him a control substance three times a day, and it has certainly improved his condition, but it hasn’t completely fixed it, either. We usually get the luxury of having the seizures happen at 3 a.m., so this one was at least better timing.
Why do I tell you my woes about my dog and my lack of sleep? Because it reminds me of investing. All of us have probably felt like we are having a seizure as we’ve watched something we have invested in go down the drain or way under-perform.
If you haven’t felt this way, either you are amazing or you are not investing. It happens to all of us.
So how can you protect your principal and not take undue or unnecessary risks with your investments? It helps to understand the downside and to know who you are dealing with. A crystal ball would also come in handy.
We can assume there’s no chance of having a crystal ball, so let’s talk about the downside. Throughout the last nine years or so, my exposure to alternative investments has taught me a lot about risk and reward. I have learned a few things that I think are blatantly obvious but continue to stump even the most experienced investors.
Risk and reward do not match up in the real world. Certain investments appear to be safer than others, but that simply is not the case. Yet many investors can’t get it out of their head, so they continue to believe that anyway.
This article is not to sell you into one of our funds, but since I know them best, I’ll use one as an example.
Our number one thought with any fund or investment is principal preservation followed by the return on investment. As I’ve shared before, volatility within your portfolio has a devastating effect. A loss of 40% of principal must be made up with a 67% gain on the remaining principal to just get back to even. That doesn’t consider the time value of the money lost and the opportunity cost. You probably need closer to 100% to get back to where you should have been, depending on your timeframe.
We stress test our funds to the best of our ability to see what they would look like in an economic downturn. That is one of the reasons we like the single-family residential market.
People always need a place to live, and if you keep your assets — the homes — within the core rental market, there is a lot of protection of principal. Even more so with our homes purchased in the Midwest through our fund Guardian.
We call these properties “starter homes” because they’re in the category of the affordable core rental market and they only sell for $30K to $60K. In an economic downturn, these homes don’t fluctuate much in price and renters downsize to these affordable homes out of necessity. It’s important to note that these aren’t “dream” homes. These are affordable homes that work well for families just starting out, AND for when the economy dips and people need to downsize. That is the type of asset you want to own during a downturn.
That is just one example, but it hits the nail on the head. Whatever your investment, you need to know how to answer the question: “If scenario A, B, or C happens, how would that affect my investment?” Because whatever you’re envisioning (or whatever you’re hoping doesn’t happen) will usually happen down the road.
We’ve talked quite a bit about the downside. Apart from that, it goes without saying that you need to know who you are dealing with. If you can’t rely on people to do what they promise, and if they don’t have integrity, then you have nothing of value. Move on. We all know this in theory, but it’s a good reminder NOT to be tempted to do business with someone you don’t trust.
It is hard to always know if your risk and reward are matched, or even better, to find investments that have more reward than the commensurate risk. Non-traditional investments can and do provide that and should always be part of a diversified portfolio.