Passive Investor Tips is a weekly series hosted by full-time passive investor and Best Ever Show host, Travis Watts. In each bite-sized episode, Travis breaks down passive investor topics, simplifying the philosophy and mindset while providing tactical, valuable information on how to be a passive investor.
In this episode, Travis talks about the need for diversification in order to protect yourself from factors that are outside of your control. He offers three things to keep in mind about overcoming volatility with a constantly changing economy and shares why he thinks value-add multifamily is the holy grail of investing.
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TRANSCRIPT
Travis Watts: Welcome back, Best Ever listeners, to another episode of Passive Investor Tips. I'm your host, Travis Watts. Today's episode is titled "Risk, recession, regrets and how to overcome volatility." Never financial advice, not telling you or anyone what to do; educational and informational purposes only.
So with that top of mind, it's not all rainbows and butterflies out there. I know I speak a lot to the benefits of passive income and to real estate investing, but the fact of the matter is, if you're in this game long enough, if you're diversified, if you've done a handful of deals or more, over several years, you will probably experience either some losses, or some pause of distributions, or a capital call... There's going to be something, and that's why you always hear the saying that there's no promises or guarantees when it comes to investing. But let's talk about how to balance risk if we are going to be an investor and we know there's going to be volatility and hard times ahead.
So let me put it to you this way - to me the holy grail of investing is to have a healthy return with very limited risk. That would be the most ideal situation. So we can look at a couple of extremes, like buying penny stocks, which are very speculative, they get traded on the Pink Sheets... Some of these penny stocks either go to zero, or they go up 1,000%. You have to understand that you're taking a tremendous amount of risk in order to get that high potential return. Now, we can move all the way to the other spectrum of investing, and we could look at something like US Treasury bonds. And while it's true they have limited risks, because after all they are backed by the federal government, they're considered one of the safest investments worldwide, I'll put it that way. The problem is that the yield is usually very small with those, so it may not help you achieve your goals and objectives if you're only making three, four, maybe 5% returns, depending on where interest rates go from here.
So this is why I talk about real estate all the time on the podcast, and why I particularly like value-add multifamily real estate, because you can have a combination of monthly cash flow distributions, potential equity upside, and tax advantages as you go along. So it's kind of the holy grail of investments, at least from my perspective. So a bond is essentially a passive income instrument, it's going to give you a yield payout, but the downside is it's probably not going to go up in value.
And going back to the penny stock example, it's an equity play, right? It's kind of that buy low, sell high mentality; it's probably not going to have dividends or passive income associated with it, because it's not a big blue chip company that's mature and sending out regular distributions to investors. So you're gonna lack the cash flow, but you might get the equity, and on the bonds you're gonna get the passive income, but you're going to lack the equity there.
So regrets and diversification - how do these two correlate? I was watching the new series on Bernie Madoff; I think it's on Netflix, it's four different episodes... And even though I know the story, and I've watched the movies, and I know how this plays out, I'm always fascinated to be reminded that the people that got hurt the hardest out of that whole Ponzi scheme were the people who went all-in; and we're talking about very educated people, people with financial licenses, hedge fund managers, mega millionaires. The people that said, "I'm gonna go in 80%, 90%, 100% with this guy and this one investment" were the ones that got truly financially ruined.
Anybody who had just cherry-picked that as a small investment in their portfolio did fine, relatively speaking. So this all gets back to just simple diversification 101. And I think about myself in this situation. Let's say that Bernie Madoff was still out there today, he had never been caught, he's still running this Ponzi scheme, and I'm deemed to be lucky enough to have an opportunity to invest with this guy or with this firm. Well, I would approach it the same way I approach all investments that I do in private placements, which is I wouldn't have given the guy more than probably 5% or less of my investable portfolio, and that's how I treat new operators in the space. If I haven't known you for years and had lots and lots of conversations and a high level of comfort dealing with you, I'm not just going to walk over my portfolio to you.
Break: [00:05:38.04]
Travis Watts: Diversification isn't about trying to just avoid fraud and scams and Ponzi schemes and things like that; it's to diversify against the unknown factors that are largely out of our control. For the same reason that if I've found an amazing investment myself - let's say I found a property I was going to flip or buy and hold or Airbnb or something, I wouldn't go all in. I wouldn't be liquidating all my investments and saying, "I'm gonna go buy this $5 million mansion and Airbnb it", because there might be some unknown factors that happen. I'm out in Florida, and maybe a hurricane hits the property. There can be things unforeseen, is the point.
And I'll never forget my uncle in 2008-2009 out in Colorado - developer, super-smart guy, investor, house flipper, he just kept rolling 100% of his gains and profits and equity into the next deal. So he was starting with these $200,000 homes, and then it became these $400,000 homes, and then it became these million dollar homes, and then 2008-2009 happen and he nearly lost everything. He got wiped out in the Great Recession, and that's because he relatively speaking didn't have any diversification. He went all-in on one deal, on one project.
So here's three things to keep in mind in regard to losses, or setbacks, underperforming assets, paused distributions, whatever it is you may be going through; we'll summarize that as volatility. Number one is perspective. Let's look at 2022, the S&P the NASDAQ, all the major indexes of stocks crashed; they plummeted anywhere between 20% and 30%. But if you zoom out and you just look at 100-year chart of the stock market, you'll find that a) that's not unexpected, and the historic returns have been between 8% and 10% annualized when you average it out.
So the takeaway is to have a mindset of being a long-term investor. You can apply the same principle to real estate, we could use that as an example. Let's say that real estate prices fall apart this year. I'm not predicting that, I'm just saying what if that happened; or like 2008 2009. Well, don't forget that the average single family home in 1990 was around $123,000, and today, it's over $400,000. So if you just zoom out and commit to being in this game long-term, you should do fine over the long haul.
Number two, nobody has a perfect track record. If you're a new investor or a new investment firm or company, you might temporarily have a rather flawless track record, only because you're new. Once you start going into recessions, and market cycles, and you've done 10 to 20 different deals, you're probably going to have some underperformers, you might even have some losses. So just using that perspective and understanding that none of us are perfect, and things happen even if they're outside of our control.
And number three is have a balanced portfolio. And I want to clarify what I mean by this, because nearly 100% of my investable portfolio is passive income focused. So someone might see that and say, "Well, you're not diversified then. Where are your equity deals?" Well, you've got to remember that my private real estate has very little correlation to the public stock market. And my stock portfolio has very little correlation to the ATM machines that I invest in. And my high yield savings account or my money market account at my brokerage firm has very little correlation to the real estate I own, whether that means private or public real estate.
So the bottom line is that none of us can accurately predict black swan events. Additionally, natural disasters, wars, political risks - there's always going to be something that's going to hit some segment of the economy that's never going to end, so the best thing you can do is to diversify against unknown risk.
So these are interesting times that we live in. There's plenty of risk out there, there's lots of volatility. So how do we overcome this volatility? Well, perhaps with a little humility and perspective. Remember that it's 80% mindset, it's 20% skills. With that in mind, thank you guys so much for tuning into Passive Investor Tips this week. I'm Travis Watts, have a best ever week, and we'll see you in the next episode.
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