March 23, 2023

JF3122: How to Reduce Risk and Lock in Profits | 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.

In this episode, Travis talks about the need to balance risk and reward when it comes to investing. He warns against the dangers of greed, shares how he personally works to reduce risk in his own portfolio, and discusses his preference for value-add multifamily projects vs. new real estate development projects.

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Travis Watts: Welcome back, Best Ever listeners. I'm your host, Travis Watts. You're listening to Passive Investor Tips. Disclaimers, as always, never financial advice; not telling you or anyone what to do, so please seek licensed advice. These episodes are all informational and educational purposes only. So with that top of mind, pigs get fat and hogs get slaughtered. Do I have your attention? We're talking about greed and locking in profits. How do those two pertain to one another?

Well, first of all, having a certain level of greed may be appropriate... Especially here in a capitalist society, like in America, it's the hog or the person who tries to get too greedy, tries to get everything for themselves who ends up being sent to the slaughterhouse. If you follow stoicism, or you've ever tuned into what stoicism is all about, they talk a lot about the four virtues: wisdom, temperance, justice and courage. Temperance is essentially moderation. So the lesson could be applied to many aspects of life. For example, is it good to eat fruit every day as part of a balanced, complete diet? Perhaps. But should you over indulge in fruit and just eat fruit exclusively and nothing else? No. In the same way of thinking, "Maybe I'll have a glass of wine at dinner. Is that appropriate?" Possibly. But should I have 10 glasses of wine at dinner? No. So temperance can also be related to greed, and overly greedy people usually end up losing when it's all said and done.

I remember years ago, I was doing this investment, it was a non real estate deal, but it was private equity, and it was a fund, and I remember looking at the pro forma and the projections, and they were projecting about a 20% plus annualized cash-on-cash return right out of the gate, starting in year number one. And I've gotta admit, I got a little greedy and I thought, "Wow, that is extremely strong cash flow. I'm not getting that in my multifamily investments, or my brokerage account, or these ATM machines, or anything else I'm doing. This is a really, really, really good opportunity for me to get a lot of cash flow." So I went about three times as hard in terms of money I put into the deal as I would have otherwise for any ordinary multifamily deal that I was doing at that time... And it ended up being a Ponzi scheme. So I ended up losing a ton of money, and there's no one else to blame but myself, because I got greedy.

So with that in mind, let's imagine for a minute a teeter-totter, and on the left is someone who's being extremely conservative; we're talking about money under the mattress, we're talking about a high-yield savings account giving you 1% or 2% a year. And on the far other spectrum is extreme greed. So we need to know as investors how to balance this teeter-totter. And one way that we can reduce risk and help balance this spectrum is by locking in profits. So let's take a look at a couple practical examples. Let's say you had invested $10,000 into a stock, or maybe crypto, something that's publicly-traded, something that's non real estate for that matter. So the most risk that you're ever taking is when you make that initial investment, because you have not received any form of distributions or cash flow or dividends or passive income, if you will, or any equity upside gains; so 100% of your investment at that very moment is at risk.

So now let's say that your stock or your crypto investment over time - I don't know, we'll use a couple years as an example. Let's say it doubles in value. You'd put in 10 grand, now it's worth approximately 20,000. This now becomes your opportunity to balance the teeter-totter and to lock in profits and to take a little risk off the table. So using those two examples, you would have a couple of choices here. You could sell half of your shares or half of your holdings, because that effectively puts your initial total investment of 10,000 back into your pocket, and then you could just let the rest ride. If it goes up, it goes up; if it goes down, it goes down. But you're not really taking any risk at this point, because you got your initial investment back.

The other thing you could do is set a stop loss order. And it essentially just sets an automatic sell at a specified price point. So you can either say "These shares are now worth $20 a share, when they used to be $10. I'm gonna set a stop loss at $10", and that way, you can keep riding the wave of euphoria, and if it goes up and up forever, you're good, or if it comes all the way back down to 10, it'll automatically sell out and you're effectively have your money returned to you.

Break: [00:05:44.21]

Travis Watts: I won't get in the weeds of it, but you can do trailing stop losses to trail the current price by a certain percentage. So you could say "If this falls 5% or 10%, then sell everything. I want out" and then you would lock in your profits at that point. And now looking at an example of real estate, let's say that the real estate you invested in has now doubled in price over a series of years - you could either refinance and put a new loan on the property at the new valuation and maybe be able to extract or return your initial investment, which would be awesome, and again, taking your risk off the table... Or you might just want to sell the property, because it did go up so much in value. So the point is to lock in profits or to reduce risk in some form or fashion if and when your investments have increased in value.

So what I'm sharing with you is just simply my philosophy on investing and money; it doesn't have to be yours, but it's why I prefer investments that pay me on a monthly basis, because every dollar I get back, I'm reducing my risk. So if I put $100,000 into a multifamily syndication or private placement, and we fast-forward a few years, and I see that I've received $20,000 through cash flow distributions, the way I look at that is I just reduced my risk by 20%, because my max loss at that particular moment in time would be 80% of what I initially put in, because I already got 20% back.

So when I place money into an investment, my main concern aside from capital preservation and not losing my money that I put into the deal is how soon or quickly do I get my initial investment back? And this is also why I don't personally invest in new development real estate projects, whether that be syndication or anything else. There's nothing inherently wrong with that business model, but it's a higher risk profile, that I'm not comfortable with... Because I have to put up, say, 100k in that example of a syndication, and I have to wait years and years and years with no cashflow, no refinances, no return of equity, and hope that it gets built on time, and that it sells for the price that they're hoping to sell it for, or that it gets occupied according to plan... And that to me is just too much risk to take.

If I had done instead a value-add project, which is mostly what I do, then we would have been cashflow-positive on day number one without having to do anything to the property. So right after closing, we start raking in the revenue at that point, and then we add value to the apartments. We make them nicer, newer safer. So we're adding value to the residents, giving them better quality of life and living conditions, and we're adding value to the property, making it look nicer, and newer, and we're adding value to investors by being able to raise the rents after we complete renovations, which helps put more money in the pockets of the investors.

So with all of this in mind, the key takeaways here is don't be overly greedy and look for opportunities to reduce your risk as you go along your investing journey. Thank you guys so much for tuning in. As always, I'm Travis Watts. You're listening to Passive Investor Tips right here on best ever. Like, comment, subscribe. I love hearing from you guys. Thank you so much, have a best ever week, and we'll see you in the next episode.


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