November 24, 2022

JF3003: Diversification: The Great Wealth Preserver | Passive Investor Tips ft. Travis Watts

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.


Warren Buffett once said, “Wide diversification is only required when investors do not understand what they are doing.” In this episode, Travis Watts explains why he doesn’t agree with this particular quote and shares a few short, true stories to demonstrate the importance of diversification.

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Travis Watts: Welcome back, Best Ever listeners. You're listening to Passive Investor Tips. I'm your host, Travis Watts. In today's episode we are talking about diversification, the great wealth preserver. I want to start by saying this -- well, first I should probably give some disclaimers... Never financial advice; not telling you or anyone what to do. Please seek licensed advice when it comes to your own investing strategies. With that in mind, what I wanted to say is there's generally two philosophies when it comes to diversification. You've got "Put all your eggs in one basket and watch that basket very closely." These are people who go all in. A deal comes across your desk, it looks like you're going to 4x your money in a short timeframe, so you're gonna put every single dollar that you have into that deal and make sure that that happens. Or there's the philosophy of "Don't put all your eggs in one basket. Diversify into many different baskets." And that way, if one deal goes south or doesn't go as planned, you have many others to supplement and keep your portfolio afloat.

So let me share with you guys a quote that I don't particularly like. I share a lot of quotes that I love on these episodes. This is one I don't like, by Warren Buffett; he's been quoted as saying "Wide diversification is only required when investors do not understand what they're doing." So I want to give you a couple short stories, true stories, people in my life, and one story of myself of why I don't like that particular quote, and why that may not always be the case. Number one is a story of my uncle out in Colorado. Leading up to 2008, '09 and '10 he was a house flipper, so he had a lot of background in construction, and he would build his own homes. And then he got into fixing and flipping properties. So I don't know all of his numbers, but it kind of goes like this. He bought a $2,000 home, he flipped it, he made let's say $100,000, then he bought a $500,000 home and he flipped it, and then he started getting into these $800,000, $900,000, million dollar luxury market homes out in Denver, Colorado as the recession kicked in, in 2008 2009. The home he was in at that time, that he hadn't sold yet, probably went down I would guess around 50%, and that put him completely underwater and wiped out his profits for the last several years. So it was a terrible thing. But my point is, did he know what he was doing? Well, he did. He had, again, a construction background, he had done this successfully many times. He understood his own fundamentals, he understood his strategy, he understood why he did these things, but he didn't see the financial crisis, as many people didn't, on the near horizon.

Another story, my day trader friend, many years ago - very similar in structure. He's a day trader still today; he flips companies and stocks. So he would have $1,000 on day one, and would turn that into $5,000, that five went to ten, and I think he was up to somewhere around $25,000, which for him was actually a ton of money. And he had gotten training, he had had much experience for many years, and he goes into this particular trade and he goes all-in. He pushes all the chips on the table and says, "I think after this (whatever it was; the Fed announcement, or this, that or the other; COVID, or I can't remember what the circumstance was), I think the markets going to do A." Well the market did B, and he had gone all-in. He had virtually no diversification. It went completely against him and nearly wiped out every dollar, because what he was trading was a triple-leveraged investment. So for every 1% the market would make, this would go down at least 3%. So with a big shift that happened, say 20%, it nearly wiped out - well, at least the majority of his portfolio.

So those are a few stories. The last one I'll share with you is, as a passive investor myself, I was looking at some deals years ago, and on paper, the projections looked amazing. We're talking about 20% annualized returns year over year for about five to seven years, and I thought, "Oh my God, this is better than a multifamily syndication. This would be great for my portfolio; my cash flow is gonna go way up. This is amazing." And when normally, let's say, I would put $50,000 into a limited partnership or real estate private placement, I decided, for whatever reason, I'm gonna go $175,000 on this deal, because it's so good. And that is, my friends, the one deal - well, there was two of them, actually - that ended up going south on me, and I still haven't recovered my money out of them. It was a 40% to 50% loss at this point; we don't have final numbers yet, even though it's been years... It's in receivership. Just to cut to the chase, it was a Ponzi scheme. And it was a non-real-estate-related investment. But again, I had done a lot of real estate private placements, I had done my due diligence, I knew the general partner... He was actually not part of the Ponzi scheme; he had invested a large portion of the portfolio into a Ponzi scheme, of course, unknowingly... And it was kind of a third party of that branch that ended up being the trouble.

So to conclude these three short stories, we all pretty much knew what we were doing. We all had training. It's just that unforeseen circumstances happened. A market move that went the opposite direction, than it historically otherwise would have, a 2008 meltdown crash, and an unforeseen Ponzi scheme in my situation.

Break: [00:06:32.20] to [00:07:38.11]

Travis Watts: Some things are simply not in your control. That's the takeaway here. So let's say that the biggest risk, in your opinion, or your biggest fear is total and ultimate fraud, just to kind of play off of my example that I shared. So investing with someone like a Bernie Madoff, or in the publicly-traded company Enron years ago, that ended up bankrupt, as fraudulent... Hundreds, if not, I'm sure, thousands of people's lives were ruined by these events. They were ruined by this company, Enron, they were ruined by Bernie Madoff... There were people committing suicide, employees, even the son of Bernie Madoff committed suicide, in (I think it was) 2010. It was tragic, tragic stuff. But what I want to say about being an investor is the ones who survived were the ones who diversified. They were the ones who maybe had a $10 million net worth to invest, and they had 1 million allocated to Madoff. So overall, a 10% drop in their portfolio, things like that. The ones that got completely annihilated, obviously, they went all in; they said, "Wow, these are the best returns I've seen in a long time. Here's my whole portfolio. Go manage it for me." That was a mistake. And in the case of Enron, I'm sure a lot of employees were buying up all the company stock, and I'm sure a lot of their 401K's were all the way in on Enron stock... So when that stock went down to zero, they lost everything, because lack of diversification.

So as you and I walk through our due diligence before we make an investment, and we crunch numbers, and we look at projections, and we look at track record, and we vet markets, and maybe we do background checks, just remember that there is a portion that is always out of your control. There are things that happen in this world, especially in real estate, dealing with real people, and real estate, like floods, tornadoes, hurricanes, earthquakes, political changes, employment centers that relocate to new markets... There's an element of due diligence, and there's an element of skill that's required to be a passive investor, but just please know, there's also an element of luck to any investor that we're talking about.

So with that, to your success, my name is Travis watts. I'm the host of passes of investor tips right here at best ever. The purpose of this particular series is for me to create for you 100 episode series of the How To, the Why, the philosophy, the goal-setting the strategies, the tools, tricks, tips... I want to share it all with you for free. I don't want to package these videos up into a program and sell it for thousands of dollars. I'm not trying to get you to buy anything. I'm here to be a free resource and mentor in the industry. To that point, if we haven't connected on social media, let's do it. Travis Watts, or Instagram and Facebook, you can find me at Passive Investor Tips. Share these episodes with anyone you think could find value in them. Thank you so much for tuning in. Have a best ever week, everyone, and we'll see you on the next episode.

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