Long term investing is hard without discipline. One of the biggest problems I consistently observe is people's inability to control their spending once they start making money or a lot more money.
We all know someone who is making the big bucks, yet is just living paycheck to paycheck (see: Scraping By On $500,000 A Year). After three months of grueling work out of college, I decided to buy a new used car. Not only did I get a car that was parked several subway stops away for $200/month, I also got a brand new motorbike!
What kind of 23-year-old dumb ass idiot buys a car and a motorbike when the subway system in Manhattan is so efficient? My base salary was only $40,000 and I was trying to save money by living in a studio with my high school friend. But I couldn't help but buy the two things I always wanted since high school. Thankfully, I got a bonus which allowed me to max out my 401k and save something extra. But I could have saved much more.
After I left Manhattan for a competing firm in San Francisco two years later, I promised to start fresh and seriously clamp down on my spending. I got word my job was at risk due to the dotcom collapse, so I felt I had dodged a bullet by escaping the east coast.
After two years of working in banking, I knew I wouldn't be able to last for an entire career. Therefore, I saved like a madman. 100% of each bonus was invested. And my spending was kept to a minimum by living in a crappy 2 bedroom, 1 bathroom apartment at the edge of SF's Chinatown with a mentally disturbed person I met on Craigslist. I eventually got a car, but it was a seven-year-old Honda Civic I bought off my mom for $7,200.
Based on my consumption habits in Manhattan, I knew I wouldn't be able to properly control my spending once I started making more money as an Associate and beyond. Therefore, I began investing ~20% of my after 401k savings in 5-7 year CDs, ~50% in real estate, ~10% in private equity, and the remaining ~20% in stocks each year.
Because I worked in the financial services industry, it was important to diversify from just stocks given my career and compensation were closely linked to the performance of the stock market. But what I realized about my stock investments was that I didn't have the patience to hold onto securities long enough to make meaningful returns.
Instead, I would buy and sell stocks to the point where the department head called me into a meeting to ask whether I had a trading problem. Apparently, I racked up $12 million in trading volume one year compared to the next highest employee who traded $5 million in trading volume!
I apologized for my behavior, even though it was perfectly within the rules to day trade index ETFs, and promised to focus on my career instead. That meeting with the department head was the turning point to start investing everything outside of my 401k into private investments and real estate. If I had continued trading so aggressively, I probably would have been laid off.
As I look back on my investments, the biggest returns are those that I've held the longest. San Francisco real estate is up about 5-6% a year un-levered since I first invested in 2003. With a 20% downpayment, we're talking a 25% – 30% a year return. Then there was my 10-year investment in Bulldog Gin that has annualized an estimated 15% annual rate of return. Finally, there's a 7-year duration mortgage backed securities fund I was forced to invest in during the crisis that has annualized 24.5% a year.
The S&P 500 has annualized roughly 7% – 10% including dividends since the beginning. Not bad in comparison, but actually not as good as any of my real estate or private equity investments. Sure, investing in the S&P 500 has potentially less risk (still went down big in the crisis), with pure liquidity. But who knows, I may have panic sold during the downturn since it's so easy to click some buttons to get rid of a position. Plenty of people sold and never recovered!
Saving Yourself From Yourself
Investing in private funds, long-term CDs, and private companies basically saved me from myself. I still ended up hurting my net worth with my vacation property purchase in 2007, but it could have been much worse. When there is a 7 – 10 year duration for each investment you end up doing the following:
1) Tighten up spending.
The more you accumulate, the more tempted you will be to spend the money sitting in your bank account. When you lock money up in a long-term investment knowing there's a penalty for early withdrawal, you won't go blowing it on a ridiculously priced car, a crotch rocket, or other superfluous things you don't need. The feeling is similar to purposefully making yourself poor in order to stay disciplined. Compared to the typical consumer who spends most of what s/he makes, you're not only not spending, but you're also likely earning a return that will create a widening wealth gap over time.
2) Staying calm during a downturn.
When you're locked in, there's nothing you can do. As a landlord, your main concern is receiving a steady rent check. It's too hard to sell property in a cratering market. As a private equity investor, you're mainly concerned about whether your company makes it past the dip. Luckily for Bulldog Gin, they were able to raise another round of financing after the crisis. With CDs, you're just collecting your guaranteed income. When you know you can't sell with ease, the panic starts to disappear.
3) Experiencing windfall surprises.
Given your investments are so long ago, you tend to forget about them. When the funds finally expire or your private equity investment finally has a liquidity event, it's kind of like winning the lottery because you've been living without such funds all this time. In Feb 2014, I had a nice six figure windfall because of an expiring 5-year CD. I used $260,000 of it for a downpayment on my Golden Gate Heights fixer. If I didn't have that windfall, I don't think I could have afforded my current home, which would be a crying shame because I love the place so much.
The surprise windfall is a very similar feeling to getting a “surprise” tax refund. Even though the money has always been yours to begin with, it still feels nice when the money finally returns home. With long-term investing, the feeling is even better due to a return.
For those who are undisciplined with money, I highly suggest looking for investments where you can lock your money away for years. Not only will you quickly adapt to living without such funds, you'll also get motivated to earn more money to make up for your lower liquidity. When it's finally time to collect, you probably won't even need the money!
Here are some examples of long term investments I've held:
* Two Venture Debt funds expiring in 2020 – 2026.
* Various zero coupon municipal bonds expiring in 2021, 2022, 2023, 2024, 2025 with a 3% – 4% yield.
* 4.1% yielding, 7-year CD expiring in 2018.
* 3.75% yielding, 7-year CD expiring end of 2017.
* Looking for more ideas. Maybe the 5-year Fundrise Heartland eREIT or a venture capital fund to find the next Snapchat.
The goal is to consistently lock my money up each year to create a perpetual windfall machine. It's been years since I last went on a foolish spending spree. But as I enter my 40s, I'm afraid my old habits will return!
Invest In Private Growth Companies
Finally, consider diversifying into private growth companies through an open venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
Check out the Innovation Fund, which invests in the following five sectors:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI! Investing in private companies is all about long term investing.
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum.
You can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.