A friend approached me in shul a few weeks ago, offering me access to a unique real estate deal where he can get me a family and friend’s discount. Returns are expected to be about 15%. He mentioned a few people in the community who invest with him. They are all sophisticated physicians or attorneys at major firms, who are financially successful in their own right. The fact that he attracts sophisticated investors is a good starting point for my own due diligence, but how do I evaluate if this investment is a worthwhile opportunity?
In the frum community, more investment dollars have been lost from participating in “deals” pitched by friends and family members than anything else. Of course, I don’t have years of data to support this assertion, but, anecdotally, it’s hard to find someone of means who has not at some point set their finances back by getting involved in an investment scheme pitched by someone in their social circle.
That being said, let’s dissect what I know about your scenario and offer some thoughts about how to evaluate these opportunities going forward.
Investments to avoid: Many readers may not have a background in investing and financial planning. However, you do have intuition. If something seems too good to be true or gives you an unsettling feeling, then take your time to get a second opinion or avoid it completely.
A good rule of thumb, avoid investment schemes where any of the following phrases are used in the sales pitch:
1) “Access” to a unique opportunity
2) You will receive a “friends and family discount”
3) Advertising consistent “mid-teen returns”
Your friend said all these phrases. Why are you so fortunate to be presented with such a unique opportunity? It’s not because you are special or that your friend likes you more than others. It’s likely because he needs your money and other pools of capital have dried up. Unless you have some information that supports why this real estate project is better than all the other ones that go south every year, I’d avoid it like the plague. If you invest, at best you get your money back with a small return. However, the more likely scenario is you won’t see your money again.
Risk & Returns: Risk and returns are inextricably linked. This is a timeless investment axiom. If you want to achieve the “mid-teen” returns that your friend is advertising, you will need to take a lot of risk with your money. In plain English: Higher risk means you have a higher probability of losing your money. If your friend is aiming for such high returns, then he intends to take a lot of risk with your money.
For some reason, many high-income individuals think they have found the silver bullet investment of high returns and no risk. This doesn’t exist. If you want to make risky investments, then it should only be with a small portion of your portfolio. That way, in the likely event that this deal goes belly up, it won’t derail your finances.
Your friends are irrelevant: Always remember that some of the most sophisticated people are also the worst investors. Success in one area of life does not necessarily transfer to other areas. While your friends may be successful in their field of expertise, it does not make them knowledgeable about evaluating real estate opportunities. Furthermore, they may have different goals, family dynamics, and financial circumstances than you. In short, what your friends are doing with their money should not be part of your due diligence process.
What to look for: If you made it this far in the article and are still not convinced that you should avoid your friend’s offer, then you should at least attempt to assess the deal being proposed. You can start by asking for some basic information, which will help assess whether this is a legitimate opportunity or just a way for your friend to speculate with your money.
Audited ten-year track record: First, ask him for an audited performance track record from all the deals he has worked on over the past ten years. If he doesn’t have at least a decade worth of experience, where he saw different market cycles, or can’t provide an audited track record from a legitimate third party (i.e. a major accounting firm), then you should avoid the project.
Eating his own cooking: If he can provide these pieces of information and the numbers are satisfactory, then ask him how much of his own money he is putting into the project. Never trust someone who won’t invest a significant sum of their own money in the investment they are proposing.
Other factors: The next form of due diligence is personal. If everything else checks out, you need to make sure this real estate project is suitable for your needs. Ask yourself the following questions:
Will this investment help me achieve my goals?
Does this investment make sense relative to my overall portfolio?
What are the tax ramifications?
What is the term of this investment?
Assuming all these other items check out, perhaps you will want to proceed. Though I’d still suggest investing only a small portion of your overall portfolio, as is prudent with any speculative investment.
The bottom line: The truth is you can live your whole life, achieve all your goals, and amass a fortune, without ever investing in any special deals with “family and friends discounts,” “mid-teen returns,” and special “access” granted to you by a benevolent friend. Anything you want to accomplish in life can be done in the public markets, which offer liquidity and transparency.
Keep in mind that the key to successful investing is NOT trying to achieve the highest possible returns. Rather, it’s the ability to reach your financial goals. Increasing the probability of achieving your goals is done primarily by minimizing investing missteps.
The reality is that most of these deals turn into financial disasters. The project implodes, the returns are drastically lower than anticipated, or something else doesn’t go according to plan. Most people would benefit from having a policy to stick to a well-diversified portfolio of publicly traded securities and let compounding work its magic.
Let the big machers in your community participate in these “opportunities.” You can stick to boring plain vanilla investments and achieve everything you want in life with much less stress and risk.