Here’s one of my favorite pictures of my youngest son, Dexter, playing t-ball when he was about 5 years old — he’s the one in the pitcher’s position. This picture, which was taken between batters hitting off the tee, is special because the second baseman is in exactly the same head-down position, looking very intently at the… grass? I don’t know how I was so lucky to catch them both in the same hilarious position!
What does this picture have to do with investing?
In this picture, Dexter is in a dangerous position. He’s not paying attention, not protecting himself, and you never know when the kid at bat might just (finally) connect with the ball and hit it directly at him while he’s busy cleaning the dirt. Smart investors do just the opposite — they keep their eyes open, planning for the worst but expecting the best, especially when it comes to a recession on the horizon.
You can follow all the economy “experts” and analyze all the stats, but no one can actually predict when the next recession will hit, how miserable it will be, or for how long we’ll have to endure it. Just like asking 5-year-old kids to play t-ball, the economy does not always go according to plan. All we know for sure is that another recession will be thrown our way.
That said, there are still steps you can take to protect yourself from the next recession.
Your top priority should be to make sure you are invested in recession-resistant assets that are unaffected by the ups and downs of a volatile economy. You should know how your investment will perform in a down economy. That’s not always easy, but you can at least use research and data to make better decisions.
For example, I was talking to one of my friends who has a small portion of his portfolio with a hard money lender. He was explaining to me how well they do, how long they’ve been around, and how the money is protected by the assets. I am very familiar with this model as that is how Steve and I met when everything started to melt down in 2009. Before Hughes Capital, we invested in a large lot of vacant land that we thought was well protected by a low loan-to-value, which is a financial ratio used to compare a loan to the value of the asset purchased with said loan. Steve and I were part of a larger group that had lent $11 million dollars on a $37 million appraisal. Based on those numbers, it seems like a no-brainer, right? Well, the property went belly up and the developer stopped paying his interest payments. When things go bad with vacant land, it doesn’t hold its value and it just becomes an expense.
I know a lot of you have heard me tell this story before, and some of you were investors along with Steve and me, but I think the lesson is worth repeating. What we thought was a safe investment turned into a 25% loss of principal, and we spent six years of our lives foreclosing on it and eventually selling it at a loss. On top of that, while we were trying to get out of this disaster-of-an-investment, we were forced to feed the beast since vacant land doesn’t produce a dime of income but conveniently has plenty of expenses.
So, what did we learn? We like real estate that produces income no matter what the economy is doing. The returns aren’t huge and there isn’t a ton of future upside potential — to most that sounds boring, but for us, that is exactly why we do it. It’s important to produce consistent cash flow and not have to worry about the volatility of the economy or the real estate market. It may lack the thrill of an uncertain investment that teases you with a “promise” for unbelievable returns, but it’s safe. I’d rather skip the morning cortisol spike others get waiting for news to tell them whether or not their investment has earned them money or cost them money. We don’t count on the “educated guesses” of the future of market to make money. For real estate, that means we aren’t betting on appreciation, but know it’s just the cherry on top when we do get it. We know our downside and we believe we will have very little to no negative effect in a market downturn. This has been our tried-and-true formula for years now.
Don’t be like Dexter (whose short-lived t-ball career ended years ago). Keep your head up, protect yourself, and don’t unknowingly get hit by the next recession.