Diversification (aka How To Survive A Crash)

I was emailing with my friend Harry this past week and we started talking about crypto and the inevitability of a massive crash. I am certain the big crash will happen. I don’t know when it will happen and I think it may be some time before it does. But better safe than sorry. So I’m going to write some thoughts about how to survive it.

I told Harry my personal story of having 90% of our net worth go up in smoke in the dot com bubble and crash.

The only reason it was not 100% was that we owned two significant pieces of real estate that were about 10% of our net worth before the crash and became our entire net worth after the crash.

We were not diversified. We had all of our money in venture capital and internet stocks and had ridden that wave all the way up. Before Flatiron Partners (the venture firm I co-founded at the start of the Internet boom), we had no net worth. So everything we had, we made in the 1996-2000 period. And we essentially lost it all when the bubble burst.

Had we not sold Yahoo! and other stocks to purchase the real estate and pay the taxes on the gains, we would have been wiped out completely.

You might think “you could have sold when things went south” and that is a good point. But when things blow up, your first instinct is that they will come back. They didn’t this time. The selling just continued. A few companies we owned a lot of went bankrupt. These were public stocks that went all the way to zero. So, while it is true that we could have and should gotten out when the bubble burst, we did not, and in some cases could not.

So selling when a market blows up is not the best way to protect yourself from a crash. Selling long before it blows up and diversifying your assets is a much better way. Like we did with real estate, but with a lot more than that.

I like a mix of cash (t-bills, money market funds, etc), blue chips stocks (Amazon, Google, etc), real estate (income producing with little to no leverage), and a risk bucket (venture capital, crypto, etc). I think 25% in each would be a good mix. We have more in the risk bucket but I am in the VC business professionally and have been for 30+ years. 25% in each is where I’d like to get to in time.

I have advocated many times on this blog that people should have some percentage of their net worth in crypto. I have suggested as much as 10% or even 20% for people who are young or who are true believers. I continue to believe that and advocate for that.

But we don’t have that much of our net worth in crypto. We probably have around 5% between direct holdings and indirect holdings through USV and other crypto funds. I think that’s a prudent number for a portfolio like ours.

I know a lot of people who are true believers in crypto and have made fortunes in it. They are “all in” on crypto and have much of their net worth (all in some cases) invested in this sector. I worry about them and this post is aimed at them and others like them. It is fine to be a true believer and being all in on crypto has made them a lot of money. But preservation of capital is about diversification and I think and hope that they will take some money off the table, pay the taxes, and invest it elsewhere.

That is the smart and prudent thing to do. I wish I had done it during the internet boom. I did not, but the next time we made a bunch of money, I did. I learned the hard way. I share my story so that others don’t have to.

#blockchain#stocks#VC & Technology

Comments (Archived):

  1. LIAD

    Major props on the post.Now we’ve had the preservation piece, perhaps you could do another one on “accumulation of capital”.

    1. fredwilson

      Taking risk is the key to accumulation. You have to do it intelligently, of course, and multiple bets, if you have the ability to do that, are helpful. There is a lot of luck involved

      1. JamesHRH

        I used to think that successful people who attributed a part of their success to luck were virtue signalling.I was wrong, Luck plays a part.

  2. William Mougayar

    Until that big crash happens, there will be (and has been) several mini crashes already. Those can be deadly too because the volatility is quite high, and the price swings are quite steep. Anyone can get seasawed with it.

    1. fredwilson

      Yeah. But they may be teaching us the wrong lesson. Which is that things always come back. Until they don’t

      1. William Mougayar

        Yup. The wide gap between Valuation and Value can go on for so long.

      2. Girish Mehta

        Your tweet a few days back (attached below) was confusing.Your tweet reads as – Buy a mix of crypto for portfolio diversification.That is an illusion of diversification, without the benefit of diversification. Very dangerous.Diversification works with un-correlated assets. One of the lessons of past crashes is investors diversifying in assets they *thought* were un-correlated but which turned out to be not so…results in lot of pain. https://uploads.disquscdn.c…Little evidence of un-correlation amongst different cryptos. Just one example of move from a few days back. This has been the pattern whenever there has been a big move in cryptos..in both directions. https://uploads.disquscdn.c

        1. JamesHRH

          No its not, he’s saying make crypto a part of your diversified portfolio and then take a diversified portfolio approach to crypto.Back in the 1990’s, founders would freak out when they found out that the VC who sat on their board had then funded a competitor with a different flavour of tech.Everyone thinks it is greed based, which is true. Its also humility based……VCs don’t really know which invests are the winners.

          1. Girish Mehta

            Referring to the tweet, not today’s post. Not how I read the tweet.I understand his point in today’s post (which he has said before as well).Q: If you had only X to invest, what crypto would you buy ?Answer 1 : Allocate not more than % to crypto (today’s post).Answer 2: Buy a mix of crypto.The illusion of diversification is dangerous. In this case – the asset allocation diversification is many, many times more important than the diversification within the asset class.

      3. JamesHRH

        Its hard to explain that to people – its almost an experienced only based learning.I love the adage ‘ Its easy to buy a stock, the tough part is selling. ‘

        1. sigmaalgebra

          Attributed to John Maynard Keynes:The market can remain irrational longer than you can remain solvent

      4. sigmaalgebra

        If a business actually goes to a solid zero, out of business, then like a dead duck it ain’t coming back. But for @jlm’s real estate, even if the building is no good or even totally destroyed, the land is still there and sometimes still with value enough for good return.Sure, say, on the outer banks, the land may disappear. Otherwise nearly always the land will remain!But not even good results with real estate can correct the saga of the American family — rags to rags in three generations!

      5. Pete Griffiths

        The funny thing is that the first time I made serious money I did diversify – unfortunately it was a crash that killed all asset classes.

      6. HarryGreenhouse

        They are teaching us the wrong lesson. And a lot of people don’t realize that they are being conditioned for a drubbing.You can go into a casino and win money 95% of the time (sorry, I’m over my professional gaming days so that rough % is the best I got) employing a Martingale strategy and betting $100 on a hand of black-jack and playing optimal strategy If you leave every time you win and double your bet every time you lose the odds are about 50/50 each hand you play. So you’ll win $100 just about every time — until you don’t and you run out of bullets or the casino won’t let you double any higher. One of the two will happen.Harry

    2. jason wright

      but were they ‘crashes’? is that the right interpretation?what is an authentic ‘crash’?

      1. Vendita Auto

        One where the insurance pays out !!

      2. William Mougayar

        they were significant corrections, you’re right; but many of them in succession.

    3. HarryGreenhouse

      William,I’m a big fan. But there’s no reason to get seasawed. Just don’t play with anything that will keep you up at night and then it’s pretty easy to just automate your buying/re-balancing and review once a quarter if you like. I personally would like to rebalance with new capital rather than buying one asset and selling another that have performed inversely. I guess there’s a marginal tax benefit in selling the loser, but if you rebalance like that you’re selling the winner to buy more of the loser which is a tax-hit.Investing is hard. Speculating is even harder. Most of us can’t do one, let alone both. But we might have other things we can do well 🙂 So there’s no reason to do anything besides set a plan ahead of time for an asset allocation (broadly, and within crypto if you like) and rebalance according to your plan. If your plan sucks in retrospect, it probably was still better than having no plan at all. Then gift us all with your writing instead :)Harry

  3. Michael B. Aronson

    Completely agree, had almost identical experience , real estate (high quality residential and good office buildings saved the day). One thing I was I had done was sell some very highly appreciated stuff to pay off mortgage as income went to zero also. Debt free real estate is nice. I’ve also learned to keep a lot of cash as the crash is usually too severe and there are wonderful buying opportunity afterwards.

  4. kidmercury

    Every body middle class and up in a developed country should go through the experience of losing everything at least once, preferably when they are young. I honestly think it’s the only way to truly learn to respect risk.

    1. jason wright

      if they’re young (and this depends on your definition ‘young’, and ‘middle class’) then perhaps it’s their parents who will need to lose everything for it to have a real impact.

    2. Tom Labus

      or some variation on it

    3. LE

      That’s ridiculous. [1] You can also learn a great deal (and what you need) if you simply watch and pay attention as other people lose everything or make mistakes.I’ve told the example of growing up and the ‘rich’ neighbor who bought his kid a brand new car (Firebird back when that was a big deal) and told me (I was a kid as well) ‘my son has it made in the shade’. He had the nicest house on the block. Was a new neighborhood and he put in all the fancy extras that my parents didn’t. At the time he was probably in his 30’s. He owned a company that did baking and had a big contract with Acme Supermarkets. For some reason he lost the contract and then he had to declare bankruptcy. And that is just 1 of a multitude of things I have learned over the years from watching what others have done.[1] Sorry for the emphasis I always like your comments.

    4. JLM

      .This is a perfect example of “renting” somebody else’s experience.If it flies, floats, fornicates, or kills you — RENT IT.There is no sweeter sound in the world than a bullet going over your head.Some things are best not experienced directly.JLMwww.themusingsofthebigredca…

      1. JamesHRH

        Line 2 of this is the most hilarious true financial advice I have ever heard – first heard it 20 years ago.

      2. kidmercury

        Sure, though I doubt you can actually learn this lesson the easy way. Almost everyone takes too much risk and doesn’t understand that they are doing so, and doesn’t really understand contrarianism because they haven’t had the jarring psychological experience of loss yet. Granted, though, now that I think about it some more I think I would say it is more important for money/risk managers to get the loss experience directly

    5. Salt Shaker

      I’ll stick to good ole common sense, thank you.

      1. kidmercury

        Alas, common sense is, unfortunately, anything but common 🙂

  5. jason wright

    “I am certain the big crash will happen.” why?i know you are writing this post to try to caution people to not get carried way with themselves, but as an influencer your post will inevitable influence, and that could become a self fulfilling dynamic, and so i think it is incumbent upon you to unpack that sentence with a more detailed explanation of why you think it is *certain* to happen.

    1. JamesHRH

      Unpack?Just look at any crypto value graph.

      1. jason wright

        what’s your analysis?

        1. JamesHRH

          I think it is tulips.Crypto’s best feature is that it allows transactions at near zero cost. That means that whatever is transacted has to be low value.Its a low cost play and so the key word is low.Financial services aren’t going to zero tx cost, why would they?Governments aren’t going to let black markets explode or have extra-jurisdictional transfer of assets just because there is tech that does that.The amount of incumbent friction analysis on BlockChain is also near zero.Tulips is my call.

          1. jason wright

            tulips?so tulips were not native to Europe until shortly before the Mania took hold. a new and wondrous thing. the leaf colour variegation that transfixed people was caused by a virus, unknown at the time of the Mania. a lack of technical insight. the biology of tulip bulb reproduction created a time lag from purchase to outcome. the first speculative futures market.crypto has these features and more.my question is this. would the likes of Google and Facebook have sort to construct their businesses and models in the way that they have if ledger technology had been around before 1998 (Google’s first year)?tulips are pretty, and i’m guessing taste not that great. they have no other utility that i know of. crypto?

          2. JamesHRH

            I like tulips as an analogy, as they are a sustainable long term business, but not a society upending innovation.The web is a social reviolution. Crypto is a new type of flower.I agree 100% w Fred that a massive crash is coming & then crypto will find a use, likely embedded in IoT somewhere.

          3. jason wright

            the majority of projects will never ship a viable product. there will be a shake-out, but there are a few that i believe will gain traction, and because they are not trying to be too ambitious. far too many projects have a reach that far far exceeds their grasp. it’s the same old story. it’s about picking.

          4. Anthony Bertolino

            You clearly haven’t done your due diligence on Crypto.You should spend some time on the plethora of projects being build using Smart Contracts via Ethereum, Quorum…etc.

          5. JamesHRH

            I have done enough research to know that the original smart contract hypothetical involved ‘ getting items from a vending machine ‘Tulips, as in, next bolt on to major IDE.

  6. Jamie Rogers

    Wise words from someone who is generally bullish on the ability of crypto for positive disruption.

  7. Tom Labus

    Knowing that you should/need to diversify and knowing that market circumstances exists that require these moves still not make many move. Human nature in the markets is always amazing.But what I do know for sure is that I never want to see markets like Feb 09 again.

    1. Girish Mehta

      You know who did not follow his own advice on diversification and the modern portfolio theory for his personal portfolio – Markowitz. He simply split his personal portfolio 50-50 in stocks and bonds.”But, Dr. Markowitz told me, that isn’t what he did: “Instead, I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. My intention was to minimize my future regret.”Dr. Markowitz paused, then added wryly: “So I split my contributions 50/50 between bonds and equities.”https://www.wsj.com/article…Economic man (Homo economicus) is a myth created by economists. My view has long been that MPT and CAPM is a bit of a joke, and not to be taken seriously when investing (Note: Useless to me, but my risk preference is very high and also I don’t buy its assumptions. Others might find it useful).

      1. Tom Labus

        High risk in volatile times = little sleep.

  8. Lynn Kasel

    Even worse than losing money, a crash can harm one’s psychology to the point that they are not willing to invest again. Fred’s advice is valuable for those that should get back in the game.

  9. Supratim Dasgupta

    I will be honest. I was just about to put 25K in BTC and Ethereum on Monday, encouraged by the constant articles on AVC and rising prices. Part of the 25K would have come from savings and part from a 7%APR pre-approved loan Amex is so eager to give me. I was debating whether to put in in one shot of weekly installments, Now after reading this advice I probably would put in about 5k only.

    1. Tom Labus

      please, only cash that you afford to lose. no loans

      1. creative group

        Tom Labus:Some people don’t want to be saved. Some are seeking out a train wreak to be on.

      2. Supratim Dasgupta

        Yes Sir, Point noted!

    2. creative group

      Supratim Dasgupta:You are at least one year late. You are attempting to trade after all the smart money made their money and took profits. Go use that money towards your MBA.Your comment would qualify you as barely having a undergraduate degree with zero commonsense.If you can’t help yourself go to your nearest casino. At least you would have a 7% chance of winning.

      1. Supratim Dasgupta

        I quite don’t think thats how things will work out for BTC and ETH. If you are saying the best days of BTC and ETH are gone then they were never a good investment. A good investment is one that slowly and steadily rises in value and if the future is in Blockchain then BTC and ETH better be good investments and that is what am banking on.

        1. LE

          if the future is in Blockchain then BTC and ETH better be good investmentsIn your other comment you said:encouraged by the constant articles on AVCDo you really trust that your judgement is right if you are basing your investment strategy on blogs that are highly biased toward what you are investing in?And if Fred says he has 5% (post runup let’s assume) in crypto investments (much non liquid) that is based on the fact (and this is super important) that he can afford to lose that 5% without having any impact at all (as in zero, none) on his lifestyle both current and future. And even then he only has 5% not 70%. It sounds, by what you are saying, that if you are borrowing money that is not the case for you. You are not investing you are gambling. You do understand that, right? Along with ‘diversification’ the other important rule is typically ‘don’t gamble what you can’t afford to lose’.

          1. creative group

            LE:Responding to financially unsophisticated posters by their own post omissions it will have zero effect. People are seeking support for decisions not based upon sound financial fundamentals.

        2. creative group

          Supratim Dasgupta:Can you provide the blog with the fundamentals you are relying upon to make your entry point in crypto-currency. We will wait.

    3. LE

      and part from a 7%APR pre-approved loanSpeechless. [1][1] But I guess w/o knowing your exact situation I shouldn’t say that.

    4. Salt Shaker

      No one here knows your financial situation, hence your risk tolerance, but this does sound a lot like irrational exuberance. Not sure I would ever take fin advice off of a VC blog knowing the nature of VC investing is inherently high risk. It’s like reading a blog on sports betting and betting the Jets today. Sounds like you could benefit from a convo w/ a good fin advisor. The scariest part of your post is your willingness to assume debt to fund your crypto bet.

    5. JamesHRH

      You have Harbinger of a Massive Correction stamped on your forehead.I mean that in a nice way.

    6. Commander Crypto

      don’t listen to this guys, do the investment, lol. if it crashes just hold again ’til blockchain gets mass adoption. seriously, just do it.

      1. Supratim Dasgupta

        I will.:-)

  10. Nicola Junior Vitto

    @fredwilson:disqus I wonder if the strategy of putting 25% only on blue chips stocks is better than diversify with other kind of stocks. Furthermore, I’m thinking on these days if there is more probability of a general stock crash (there are some scary indicators like Shiller PE ratio) than a crypto crash: shouldn’t be safer to put all stocks – partially or totally – on some other assets (like gold or re-balancing the other three you mentioned)?I’m curious to know your vision on this…

    1. Anthony Bertolino

      This is my theory, given the total market cap of Crypto, I feel almost dumb putting a large portion of my portfolio in equities given the P/E and the consensus that is it very overpriced. I believe we are due for a correction.I have the majority of my NW in Crypto but I am nearly a full time analyst to the market and am young enough to take the risk.I personally feel like Crypto has to run to at least 1T before we can consider it bubbly. Crypto has the potential to pass the Tech Bubble, which inflation adjusted was around 9T.

  11. Vendita Auto

    “I share my story so that others don’t have to” Good on you.

  12. creative group

    CONTRIBUTORS:“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”-Warren Buffett

  13. creative group

    CONTRIBUTORS:This %/) is 100% speculation. No fundamentals to guide. If the speculators are undisciplined and don’t cash out and await a new entry it wouldn’t teach them anything.Apparently others failures are not the guide for them. Experience will be their best teacher. They will have the pity parties and stories to fall back on. The remember when times.

  14. Salt Shaker

    Wow, what an incredibly honest post. I had a few relatives who invested w/ Madoff. One cousin knew him from “the club” and shared his ROI’s w/ other family members. Access to Madoff was supposedly limited, but my cousin provided the “in.” When my cousin passed away a few years later, Madoff had the balls to even attend his funeral. Everyone was drinking the Kool-aid as illogical as Bernie’s returns were. My family members didn’t get wiped out, but a few took a really big hit.Bottom Line: If returns seem too good to be true, then they prob are. I sleep well at night cause I’m diversified, mostly index funds and some cash. I make virtually nothing on the cash, but it provides me w/ a layer of emotional security. I sleep better knowing it’s there.

    1. LE

      Bottom Line: If returns seem too good to be true, then they prob are.How many people are in a position to determine when returns are ‘to good to be true’? And what about the case where you might have 10 people running ponzi schemes at the same time so the returns don’t even appear to good to be true? What are you comparing the returns to anyway? What if Madoff hadn’t been such an obvious pig? What if the returns were better than average but not that easy to spot. How much longer could he have survived?And while it might seem easy in hindsight to spot a Madoff it is obviously not easy in real time.For example let’s say someone said they wanted you to invest in a fund that bought real estate in NYC and showed you returns that went up consistently for the past fund. You’d might say ‘ok that makes sense’ because you have other info that tells you it’s probably correct. Meanwhile you could definitely be scammed because of your assumptions. Everything could be fake but it would be believable.Remember also that Madoff had a nice amount of ‘assumption of legitimacy’ credentials that made people trust him and think what he did was ironically kosher. I would think the amount of scammers with those types of credentials is exceedingly small. I don’t think (but don’t know for sure) that most ponzi schemers are like that. Also he lived somewhat modest compared to the money that he made.Think of it this way. If you had a chance for some inside investment with Warren Buffett that made great returns and you thought you got in because of some connection what would you do? Even if it seemed ‘to good to be true’? Now don’t say ‘that’s different’ either because he is audited or what not.

      1. Salt Shaker

        Sure, 20/20 hindsight is easy. Given Madoff’s stated investment strat, his returns made no sense. It’s not like he was investing in volatile commodities or crypto, his investments were in stable, well known assets and the returns made no sense if/when one tried to replicate. Of course, not many tried to as he unquestionably had an image of legitimacy. Not sure why anyone would invest outside of large, well known fin services, other than Monopoly money they can afford to lose, and I put angel and VC investing squarely in those cats.

    2. sigmaalgebra

      Yes, part of the Madoff scam was the remark “He’s the Master. It’s closed, but I may be able to get you in.”Just why that is such an effective way to sell sewage is curious!

  15. Scott

    We have to consider how much all asset classes have run up since 2009. Crypto leads the pack but real estate and equities are also at risk of another crash.

  16. JamesHRH

    Of all the posts you have ever posted, this is the best.

    1. Reddy_s

      I second that !!!!!!!!!!!!!

  17. JLM

    .Your comment is a paen to the beauty of real estate as a means to hold wealth, derive income, absorb inflation, conduct efficient estate planning, and to ride out difficulties in the general economy.One can invest in real estate directly (fee simple ownership) or indirectly through publicly traded REITs. There are a lot of variations on the theme.Within real estate, as an asset class, there is also the opportunity to diversity amongst raw land, developed land, mixed use, office (CBD, suburban, showroom), apartments, hotels (apartments which renegotiate their leases nightly), warehouses, storage (my personal favorite for “sleeper”), and mortgages.Today, there are a number of crowdfunding vehicles which provide access to high quality commercial real estate investment opportunities which would be unavailable given their size and complexity.It is interesting that real estate saved you in the downturn.Real estate is a long term asset and I have never seen a time period which spanned 15 years in which real estate was “net down” for the time period. If one maintains the physical plant and is prudent about markets and locations, it always appreciates.Real estate, configured correctly, works while you sleep. In times of low interest rates, small improvements in cash flow create meaningful increases in net asset value.It is also an asset which can be managed with positive leverage and provide the ability to withdraw profits tax free by re-financing an existing property.Real estate can shelter you from tax liability through depreciation and interest deductions as well as allow you to conduct 1031 exchanges which forestall even capital gains taxes. Oh, yeah, the sale of real estate leads to capital gains tax treatment.I went to business school with a guy who was slightly anti-social. He was a brilliant guy, but he was suffering from PTSD and was struggling. He began to buy and renovate single family houses. It absorbed his anger and created a sense of accomplishment. I think it literally saved his life.Thirty years later, he owns 450 single family rent houses free and clear. As he finished one and rented it out, he used the cash flow to finance the next ones. It was slow, easy progress over decades. Today, the average value of his homes is north of $350,000. You do the math.Real estate saved his life and made him a bloody fortune.If you work in a risky business like VC, the first thing you should do is to break the connection created by asset class, investment cycle, risk profile, and income generation. Real estate fits that bill perfectly.If you’re really good at it, you can become a billionaire and run for President. OK, belay that sentence.Real estate. God, I love real estate.JLMwww.themusingsofthebigredca…

    1. Salt Shaker

      My father passed away when I was pretty young. I presume it was fairly early in his income producing years. That said, he was smart enough to invest in really depressed property in Manhattan. Guess what, there is no such thing as depressed prop in Manhattan today. I’m pretty sure he would have invested in the Hampton’s too as we spent as a family a great deal of time there before anyone even knew wtf the Hampton’s were. My father’s seemingly innocuous (at the time) RE investments afforded my mom an opp to raise 3 boys virtually alone.

      1. JLM

        .Your father was shrewd. The ability to discern markets which will grow and prosper over a 30 year period is both easy and not easy.You could not lose money in Austin, TX real estate in the time period of 1980 to today.Here’s the thing: The best is yet to come.Back when I was in the game at the very beginning, ATX was not a pension fund “investable” market because it was too small. Meanwhile, Dallas and Houston were on fire. Even then, people liked Austin better.Anybody could see it. Nobody saw how quick it was going to happen. The second the ATX SMSA flirted with 750K people, the pension funds flooded in.You still had to put your underwear under your pants, but that isn’t hard to do if you know what you’re doing.Every great fortune has a flirtation with real estate.JLMwww.themusingsofthebigredca…

        1. LE

          The ability to discern markets which will grow and prosper over a 30 year period is both easy and not easy.Takes many bets in many different areas for one to pay off. Unless you know something that the market does not something coming down the road.My dad made (among other things) two different nearly identical investments in real estate way back. One was in Miami Beach and one was in Atlantic City. The AC one was the surer bet because of the casinos which were on the horizon later (1977). The Miami Beach one was primarily to use for a month a year for vacation. So you know what happened. The Miami place was bought out by Gil Dezer (who built the Porsche Tower and is a Trump bud) and now they are building multi million dollar places. They bought everyone out (let’s call it 12 to 15x the investment adjusted).The AC one? I am buy that off my mom for less than they paid in the 70’s. Probably less than 1/2. The units are literally identical even same developer for both. He went bust as happens with these things.Oh yeah and that AC one? Before my Dad died I offered to buy it for much more than I am paying my Mom now. He turned me down he thought it was not enough. (My mom (who doesn’t need the money) is getting market price for it now as I was offering my dad before.)

        2. Mark Essel

          “Here’s the thing: The best is yet to come.”Now I’m searching for decent real estate funds in my IRA to balance my positions.

    2. sigmaalgebra

      I’ve kept some of your Real Estate 101 lessons before, and I’ll keep this one, too. Thx!

    3. Dave Lee

      Just because real estate has outperformed in the past doesn’t guarantee it will outperform in the future. That said, I agree with Fred that real estate is an attractive piece to have in one’s overall portfolio.

      1. JLM

        .Out performed what?As an operating business, real estate is a very solid undertaking in which knowledge, hard work, and financial leverage can create massive amounts of wealth.To put this into perspective, a 500K office building I developed (I owned a direct interest in it) was built for $72MM.We sold a 50% interest to a large pension fund for $70MM after taking a $6MM developer fee and receiving an annual $500K property management fee plus a 1% asset management fee.There was some trigger work to keep from having to recognize it as a sale and therefore subject to taxes at the time of the investment. That is part of the art, knowing how to structure a deal within the Tax Code.We essentially had no money in the deal and owned 50% of the asset. As the “active” partner we got all the depreciation and the pension fund was not a taxpaying entity anyway.When we broke ground the deal was 40% leased and it took about a year to lease out the balance — an extraordinary performance as we hit the market almost perfect. Pure luck.The building subsequently sold for $400/SF (17 years later) and the sponsors and the pension fund split the proceeds evenly.That is simple, no frills commercial development. It is not rocket science.I belabor the point to suggest that such an investment is not being compared to anything. The developer had no money in the deal. The developer made a few million on the front end.The big payoff was waiting on the market, letting the increases in the leases kick in, waiting for a cap rate wave (lower cap rates) — it is very difficult to “compare” that to anything.If you owned 25% of the developer’s share, that is a good lick.If you did 1-3 such deals a year for 10-20 years, things turn out OK.Again, it is hard to suggest that such a wealth creation mechanism “compares” on an investment basis.How bad would it have been if we only sold it for $200/SF? Not too bad.JLMwww.themusingsofthebigredca…

        1. Dave Lee

          I’ll qualify that real estate in “certain” markets has outperformed the stock market in general (ie., index fund).”The stock market, as measured by the S&P 500 Index, has had an average annual return of 10.31% from 1970 – 2016. The real estate market has had an average annual return of 11.42%. That is measured by the publicly traded REITS (the NAREIT Equity REIT Index from 1970-1977 and the DJ Wilshire REIT from 1978-2016). To put this into dollar terms, if you would have invested $10,000 in the S&P 500 in 1970, by the end of 2016, your investment would have grown to $1,005,588. If you would have invested $10,000 into the DJ Wilshire REIT index, your investment would have grown to $1,609,932.”source: http://www.investopedia.com…However, performance in the past doesn’t guarantee performance in the future. One needs to look at what’s has been driving the appreciation in real estate and will those forces continue to do so. I’m not being bearish on real estate. I’m just saying nothing is guaranteed.Regarding your commercial development, that sounds like an amazing example and quite a business/investment opportunity.

          1. JLM

            .You’re talking about a single real estate investment type — REITs. Real Estate Investment Trusts are shares in operating companies which buy and operate finished product. They are typically not developers, but often buy from developers.Developers who sell to REITS on the front end are often called “merchant builders.”REIts are public stocks. Their rules as to how much they have to dividend to their shareholders and other requirements are modestly complex.REITs have to have 100 shareholders, 75% of their assets and income in real estate, and distribute 90% of earnings to shareholders as unqualified (ordinary income) dividends.When I describe “commercial real estate”, I am talking about undertakings in which a developer builds a property (which he might ultimately sell to a REIT).I sold a large portfolio to a REIT in the mid-1990s and took their stock in payment. The stock turned out to perform very well after the transaction. We also had a “value savings clause” inserted which provided that if the REIT stock on a date certain was below a set value, they had to issue more shares.The REIT paid about a 9% dividend which was very nice.If one has ZERO money in a deal, then the returns are infinite.JLMwww.themusingsofthebigredca…

          2. Dave Lee

            Get me in on these ZERO money deals! :)Are you taking on any risk in the deals? How many have you done?

          3. Mark Essel

            Do you suggest reading on how to get started – I’m ready for my third “career”

    4. sigmaalgebra

      Dad got a college education in Industrial Arts — essentially all the trades including furniture making, finish carpentry, framing carpentry, brick laying, printing, plumbing, specialty welding, high precision machining — with the intention of being a high school teacher of such things. So, he was good at all the trades. There in Memphis, he could have directed teams in residential construction to do new construction, renovation, high end country club set construction, etc. but didn’t see the opportunity and stayed with a Navy salaried job instead.Not everyone who would be really good at such real estate work saw the opportunity. He did notice that around DC some houses about 10 years old were selling for less than when new.I have a friend in a family in Ohio successful in several different businesses who also make money in real estate, including residential renovating and renting. Their basic rule is that, sadly, the cash flow in from the rent actually won’t cover the cash flow out from paying principle, interest, taxes, insurance, and maintenance.

      1. Adam Sher

        What is Industrial Arts?

        1. sigmaalgebra

          It used to be a college major. It partly overlapped what is now college engineering. It was teaching what a lot of the labor force, the trades, used. So, furniture making, finish carpentry, framing carpentry, chemistry, strength of materials, high end welding, high precision metal machining, printing, masonry, yes, college algebra and calculus, etc.So, your wife goes shopping and gets some classic, maybe French, high end dining room furniture. The chairs have, say, some roses carved into the wood. There isn’t a straight edge or flat surface anywhere.Q. 1. How to design such a thing? It’s got to be really good as a work of art. How to form the wood? How to fit the pieces together? How to apply the finish? And it can’t cost too much!Q. 2. Your teenage son and bros play Blackjack, treat one of the chairs roughly, and break a leg. Ah, teenage boys, in the rare cases when they sit, should sit on, say, concrete blocks! Now, your wife is in tears so that it is your mission, and, if you have any chance at all of being a successful husband and father, you have to accept it, to repair the chair leg, like new. So, you have to pick the right wood with the right grain. Shape the wood to match. Attach it to the rest of the chair appropriately. And apply a finish so that it all looks new to your wife, with very good eyes and excellent artistic and color sense. How to do that? As I grew up, Dad did exactly that! Did you learn that in high school or college?

          1. Adam Sher

            Thanks for explaining it.

    5. Pete Griffiths

      And real estate benefits from prudent use of leverage.

    6. someone

      Jlm went to business school? Color Me surprised.

  18. Frank W. Miller

    I went 80% into cash last week. I’ll probably keep the money out until after the first of the year.

  19. Thomas Luk

    Timeless advice on how to take out some risk and keeping the potential upside…

  20. Harry DeMott

    And here I thought I was the only Harry you knew.

  21. JLM

    .In considering diversification between VC and public stocks, there is an argument to be made that nothing much is accomplished by embracing high PE stocks which are dependent upon technology for their future.Both are tech based and, therefore, the comfort in diversification may be misplaced.There are a great number of high paying dividend stocks (XOM is a favorite of mine) which provide a nice current return to hold them while you wait for something to happen (like the price of oil to go up).I like the absolute absence of correlation between tech and energy as a means of diversification. We will see $100/bbl oil in the next 10 years.JLMwww.themusingsofthebigredca…

    1. Reddy_s

      How certain are you with $100/bbl in next 10 years ? can I guess as around 80%How certain are you with $85/bbl in next 10 years ? can I guess as around 96%Here is the tradable ‘Light sweet Crude’ Nymex Contract that expires in December 2025 for $64 ( see price at the bottom of the URL link )http://www.cmegroup.com/tra…you can buy one contract ( equal to 1000/bbl of oil ) for $5000 and keep additional $5000 in the account for margin money. If oil/bbl reach $85, your profit is $21,000 on $5000 investment.If somebody ( general population ) is 96% certain about an investment thesis, usually he will keep at least 40% of his net worth in that category .Talk is easy HARD : putting your money where your mouth is

      1. JLM

        .Or, you can own oil directly by taking exploration risk. It is cheaper to buy a good lease, contract to drill a well, and see what your luck looks like.I hit the last well I drilled.If I had it all to do over again, I think I would have been an oil man rather than a high rise office building developer.JLMwww.themusingsofthebigredca…

        1. Reddy_s

          Oil well drilling is topic diversion .I am talking about ‘How people though advice around, which they do not follow ‘ when there is a clear Actionable way to follow their OWN advice .Besides, drilling oil well and buying an OIL Future contract are a NOT comparable complexity .Anyway I am NOT advocating buying OIL future Contracts, I am ONLY pointing, How is easy it is for people NOT to follow their own advice .What is your ball profit numbers in $$ when you hit well drilled ? on what are the investment dollars for your oil drill project ?what is the industry average of . Hit/Miss ratio on oil Wells ?It seems your oil well Hit is not big enough for you to retire !!!!, in that case it is not called HIT, it is just oil well Drill .

          1. JLM

            .Well, I guess I retired at about 50. I was a real estate developer who liked to renovate properties.I was never a big oil investor, but I had some great opportunities when LLS was low in the mid-1990s.Most of the LLS deals were existing production which had bugs on it. The oil comes up with water and the water has to be boiled off and re-injected.It was a common problem that the re-injection wells deteriorated and were inadequate over the course of time to move all the water back underground. This required you to drill a new injection well while changing out the pumps on all the oil recovery wells. This was what I called a “turnaround.”In places like Portland, Texas, it was just as likely you’d hit oil when drilling the re-injection well as the depths were very shallow. You could not get permission to drill such a well because of minimum spacing rules in the field or as promulgated by the State of Texas.There is nothing that pisses off the Texas Railroad Commission (the oil regulator in the Lone Star State) like hitting oil when you’re supposed to be drilling an injection well.Often one would buy 200 barrels per day, redo the pumps and double production, drill a re-injection well, add to the production and get all your money back in 14-18 months. [You ran the numbers to get all your bait back in 24-28 months.]Many times you were consolidating the working interest and the royalty interest while buying the fee simple land ownership.You have to remember these were once 1-5,000 barrel per day wells which had been reduced to stripper status, but a few of these deals for an individual were a money maker.The LLS is the best oil in the world and while you often had a tank battery, the pickups were handled by the buyer.It was a sweet business. All of this was proven reserves and drilled long before 3-D seismic. There was not enough oil to be recovered to lure a major to do the re-work.JLMwww.themusingsofthebigredca…

          2. JLM

            .Calm down, Reddy, you’re going to give yourself a heart attack.There are lots of reasons why one would want to invest in oil through different methodologies than speculating in futures contracts.There is something called the “depletion allowance” which can be used (in much the same way that real estate uses depreciation and interest deductions) to reduce taxable income and thereby boost after tax returns.Believe me any well that strikes oil in the Oil Patch is a hit. There are plenty of dry holes out there. In developmental drilling, when there is a proven field, it can be singles and doubles, but very few strikeouts.Buying stripper wells and reworking them is the equivalent of renovating real estate. For an individual, it can be very lucrative. I’m just hoping for one more foray with $150 oil before I die.”Dear God, just one more oil boom and I promise not to piss this one away.”Please send me your audited, personal financial statement, six years of tax returns, and I will share my numbers with you.Right now there is a high probability that I will die before I am broke, but I am giving it a hard run.JLMwww.themusingsofthebigredca…

  22. Kai Turner

    Isn’t there a crypto solution for diversification? What about a fund (with the mix of investments you mentioned) that issued shares as crypto-tokens? Part of the reason for the volatility is that when people want to de-risk their exposure to cryptocurrency, they have to exit through fiat. If there was a safer way to keep your investment in crypto, presumably this would help stabilize the entire market.

  23. JaredMermey

    Will be interesting to see if this post moves the BTC/ETH prices down and, if so, how much.

  24. Daniel Olshansky

    As long as you invest rationally, intelligently, with a plan, and a margin of safety, you won’t really be able to blame yourself for losing money on an investment.There are many people who invest in ICOs without researching the tech, project, mission or team first. They’re simply hoping to for a “get rich quick scheme”. Provided that circumstances don’t change, just ask the following question:- Does this project really benefit from decentralized blockchain technology?- Who are the founders? How motivated are they by the project? (I really admire Luis and Jorge from Aragon on this point)- How will the token be used? Do I have any interest in the use case or value it’s creating?- What price do I want to get in at? What price do I want to get out at if it goes up? What price do I want to get out at if it goes down?Provided I answer all these question honestly, weighed the risk profile given my financial situation, and ultimately choose to hold a token that went down to zero, it’s hard to say that I made a bad investment decision.If someone invests 50% of their portfolio in an asset based on one article and loses everything, they only have themselves to blame. Simultaneously, they also shouldn’t deserve any praise if they 10x their investment.

  25. DJL

    Well said. And thanks for the honesty.Due to impeccable timing, I have “lived” through all three of the last major market crashes – starting in 1986. I started investing in the market in 1985. Truth be told, if I had just dollar-cost-averaged in, and put everything in some mix of safe assets that rose 5% a year (but never lost money) I would be 300% ahead. That compounding interest thing can be amazing over long periods. A painful lesson learned (way too late) by trying to hit home runs in a given sector. I hope my kids are more disciplined than I was.

  26. george

    Really impressed with your financial discipline; lessons learned and fully incorporated forward in your future investment criteria and policies.I often asked myself, what are my investments really worth? Often depends on cycles and runs – crypto has had a really nice run up…

  27. Jonathan Boutelle

    Commercial real estate is REALLY risky right now as the retail sector gets swallowed by Amazon. Residential is probably pretty safe long-term (unless driverless cars radically change preferences for where to live). Risk is everywhere.

  28. sigmaalgebra

    From your account, the 2000 crash was bigger than I knew and was more of a bubble than I appreciated.I wasn’t really trying to ride a wave or go up on a bubble or hot air but just trying to do business as usual. At the time, I was trying to do a startup based on my work in anomaly detection. I got an excited phone call from what looked like an eager investor, but then the crash hit. Then no more returned phone calls!I thought of buying a case of children’s liquid soap based bubble blowing bottles and adding some labels “Wonder Bubble” and sending them to all the better known firms on Sand Hill Road!My work in anomaly detection was and remains rock solid, the best solution available for zero day detection, and no bubble stuff. Still, when the bubble burst, it took down nearly all interest in startups.Maybe that’s when the LPs got together and agreed to tell their VCs to invest only in traction, significant and growing rapidly, with teams of several people.For how to balance a portfolio, we know that. H. Markowitz told us and got a Nobel prize for his little application of minimization with a non-negative, semi-definite quadratic objective function and linear constraints. Okay. W. Sharpe generalized that work a little and got another Nobel prize, and we know that work, too.Sure, in practice we don’t have the data we want, so we’d have to do some guessing. But then the math would give us a nice appraisal of the guesses! The results might give some insight and wisdom and justify some prudence!Since I have only one basket and my eggs don’t divide, I have all my eggs in one basket! Do I like that? Nope.I tried other things, and they didn’t work very well. E.g., I really do have the best work on zero day anomaly detection, but I accept that I could hold a meeting in a Boeing 737 washroom of everyone in the world who would value that work, no matter how many times Experian, Sony, Target, etc. get hacked.So, if my startup works, then, sure, I’ll take some cash off the table, hopefully with Trump’s new, much lower taxes, look up the list of places to spread the money around, maybe write a little code to do the Markowitz arithmetic, and pick some answers.One lesson I’ve learned is don’t try to make money by pushing on a jointed stick or a rope. Instead, be right at the interface where the money passes over. If the project is a loser, then improve it or pick another project. If the project is a winner, then get to keep the money. That is, be the owner of the business.Or, I try to do good work. If I do and own the business, then I make money. If I do and am just an employee, then I will get little or none of the money (e.g., I quite literally saved FedEx from going out of business twice, got a small raise, with my manager afraid and jealous and trying to fire me, the first time, got only scowls of fear and jealousy the second time, when my manager did write a letter firing me but the CEO Smith put me under SVP Basch and ignored the letter, and never got the long promised stock — my work was good, terrific, but I just didn’t get paid much for it). If my work is bad, I don’t expect to get paid. And if the business goes under from my bad work, then, sure I won’t get paid. So, to me, good work or bad, the better approach is just to own the business.But I’ve learned another lesson, right, straight from the 100% correct, as deep as reality goes, on target, children’s “The Little Red Hen” from Mother Goose: Outside of a bubble or some such, no one, and I mean zip, zilch, and zero, paid any attention at all to the Little Red Hen until she had hot, fragrant loaves freshly out of the oven with customers lining up eager to buy. So, all the work from the wheat seed, the plowing, sowing, cultivating, harvesting, threshing, milling, mixing, baking counted for zero. Okay. Thems is da rules; so, understand the rules (as taught to children) and then follow the rules.Then look on the flip side: The Little Red Hen, once she was selling loaves, anyone with just some wheat seeds had a very long way to go to compete with her and would get essentially no help! So, she stood to get good margins for her loaves! Then she could get some financial security and buy a nice hen house!For my progress with loaves of bread, I need to spend the rest of the day working with NTBACKUP and, in the words of Han Solo “do a switch over and hope I don’t get a burn out”. George Lucas got that just right! NTBACKUP SHOULD work. But I’ve been surprised, disappointed, and frustrated by such words before!

  29. Commander Crypto

    Mr. Wilson, your friend Harry is not nearly as smart nor successful as you. You’re a legend. Don’t worry about him.I predict no crypto crash, just scary volatility so hang tight guys. Buy low, and buy the next coin!

  30. Pete Griffiths

    Never a truer word.

  31. TeddyBeingTeddy

    Why little/no debt on cash flowing real estate?. It’s the most lender friendly of all buckets, for good reason.

    1. JLM

      .Debt is discipline. Discipline requires you to come to work every day and run the property. Private owners often don’t want the burden of doing that, so they do not use leverage.A bit of real property with a 1.5-1.75 DCR and a 70% LTV mortgage is considered a AA credit from an underwriting perspective. It qualifies for the best rates.Amongst sophisticated commercial real estate developers, one creates a matrix of their tenants, the length of their leases, their credit rating, and develops a pseudo synthetic credit rating for the property over a period of time.The ability to “whip out” money on a tax free basis through refinancing is what separates the amateurs from the pros.It is literally free, untaxable money. Free, untaxable money is a good thing.JLMwww.themusingsofthebigredca…

      1. TeddyBeingTeddy


  32. Douglas Crets

    Couldn’t there also be a risk allocation that allows for different types of crypto risk? I have about 30% of my PROFITS that I put into crypto, and that is spread across two risk buckets — the standards like ETH and LTC and BTC, and then the new edgier things like UKG, ALIS, OMG and several non-standard cryptos, just to see what they do.Then everything else is far less risky, in my view. Everything else I own is in real estate, gold, cash, and venture capital investments in a few companies in the US. I don’t even mess with equities. It’s not on my radar for now. It will be later. I don’t mind coming in on the market much later, after an equities dip or slide.It’s interesting to think of crypto as a long term investment category, even with frothy being the word of the day. Shows you that programmable money is something we have always wanted and didn’t know it till it arrived.

  33. HarryGreenhouse

    I’d be curious if anyone could give me a good rationale for holding physical real-estate rather than VNQ (Vanguard RET Index). I know there has to be a reason to do one instead of the other but I can’t figure out what it is, particularly because you can hold VNQ easily in a tax-advantaged account like a SEP-IRA etc. and while you might be able to do the same with physical real-estate any real investment would far exceed even the $50,000 ish a year you can put in a SEP-IRA if you are fortunate enough to be making $250,000/year. I presume the after-tax yield is far better — or there’s the fact that you actually own something after X years — but it seems like a major hassle to me as an asset class.Harry

    1. Mark Essel

      It’s the difference from being in the business of commercial development (buying land, construction , partnering with funds for co-ownership) or property management vs buying shares in a fund which may have many such deals. One is much more active, upstream and slow to liquidate, one is passive and at the end of the real estate funnel + liquid.Also as JLM mentions there are financial tools for direct ownership you can wield as leverage for loans, expansion and much better tax structures.

  34. Donna Brewington White

    As someone whose career is aligned with crypto at the moment given that my summer has been devoted to the Dash team and we have more hiring to do, I have been thinking a lot about the impending crash. Personally I think Dash is making some wise decisions to promote the sustainability of its ecosystem.What I have considered is that the internet survived the dot-com crash in spite of the devastation. Cryptocurrency as a “industry” will survive the crash as well but which cryptos are best positioned to do so?

  35. Pointsandfigures

    Oof. I know crashes. Painful

  36. sachmo

    I’d suggest adding one more thing to the mix of investments… Bonds.

  37. lingyong

    This is great! Thanks for sharing!

  38. Eliot

    Admittedly pretty ignorant on this topic, but I genuinely don’t understand how a crypto position serves to diversify – does anyone really understand how it has/will perform in relation to other asset classes under varying conditions? Related – 25% in the “risk” bucket strikes me as insanely high…

  39. PureLogic

    Agreed. When existing frameworks are not applied and PoC is validated in the market, it sets up belief that the wheel needs to be recreated. Which is not true, existing frameworks [legal, regulatory, investment] should be evaluated, adopted, and deployed.Frameworks exist for protections and best practice.Wrote this medium post back on March 3 on the current state and expected future state of the ecosystem. I believe majority of it still applies.https://medium.com/@PureLog

  40. Mike Carson

    My prediction: the lows of the “big crash,” if/when it happens, will be wayyyy above the current prices

    1. Donna Brewington White

      I hope you are right.

  41. hardaway

    Yes, Fred. I, like you, lost big in the dot com crash. And as a result, I have, like you, 5% of my net worth in crypto. I also own real estate (income producing free and clear). BUT in Arizona I have also lost in two real estate crashes (1989 and 2006) so I lack your faith in real estate.

  42. Salt Shaker

    I wish you success in whatever endeavors you pursue. We’re all wired differently. Risk tolerance is based on a number of variables, w/ a great deal of subjectivity w/ respect to those decisions considered rational and/or irrational. I like to sleep well at night. I don’t want the stress of thinking about what my next gig would be if things go belly up, particularly at the older, relatively speaking, life stage that I’m in. Again, only wish you the best in the choices you make.

  43. Dave Lee

    I haven’t hear about real.markets. Any links that give more info?