INVESTING AND RELATIONSHIPS

Welcome to this fifth blog in our six-part series on investment. The first four parts have covered having an Investor’s Perspective, how to Develop a Sound Investment Strategy, and some of my key Investment Learnings. If you haven’t read them yet, I encourage you to start with them and then return here.

I’ve learned many lessons in my years of investing. The majority have been from the various deals and opportunities. I have also learned essential ones concerning relationships – especially close ones. I would like to share with you some areas you may want to consider when it comes to relationships and investing.

DEFINING YOUR RELATIONSHIP WITH YOUR INVESTMENT MANAGER

Based on how much time you have for investments and your expertise, you may find that sometimes you need a professional to oversee and manage your investments, whilst other times you can do direct investing yourself. There are a variety of factors however that would impact this decision. When it comes to selecting an investment manager, team or organization, ensure you do extensive due diligence. Review their history and track record, seek those that have outperformed the benchmarks and monitor them against other managers you use.

For purposes of diversification, I have three investment managers. I learn a lot from all three and they all offer different perspectives on the market. Annually I enjoy meeting with them, hearing their investment worldview and learning about new strategies and goals. 

When selecting professional investment managers for our liquid assets, we ensure we provide the overall target return and risk level that we are striving for; we then let the manager construct, manage and report the performance against an agreed upon benchmark. Benchmarks are a useful tool to compare how the market performance compares to your portfolio performance. You can come up with your own internal benchmark for an investment you’re making or compare how that investment is doing relative to benchmarks in the field. 

From there, my team holds them accountable. We don’t micro-manage them but allow them to make all the decisions. It wouldn’t be fair to them if we made decisions and then held them accountable. Our quarterly discussions then focus on deviations of performance – based on our target return and risk profile.  

Looking at your managers performance once a year is also important. Know what fees you are paying both direct and indirect. I also have a report that summarizes all the assets each manager is managing and compares their performance with other managers. Be ready to change managers if they change strategy too often, or if the manager is going through material organizational change. Find the right experts and let them do the job for you. If we don’t like their performance over time, we let them go as a manager or organization and replace them. 

When you get to the point where your investments have grown and there is need to look at reports monthly, consider hiring someone who can perform this work for you and knows the details of each investment intimately. Even then however, I recommend you personally do a quarterly review of your investment portfolio.

INVESTING WITH FAMILY AND FRIENDS

From experience, I don’t recommend doing investments with friends. Generally, if you bring an investment to friends and it does well, everything is just okay. If it doesn’t go well however, your friendship can be hurt. With friends – the downsides far outweigh the upsides. The rare times I have shared an opportunity and gone into a deal with friends, I always make sure to invest more than them. If it goes down, I’m going to lose more than they will – and they’re aware of that. When you invest with friends it’s important to recognize you’re not only risking your money, you are also risking your relationship. Some friendships can handle it – while others can’t.

LENDING TO FAMILY AND FRIENDS

When it comes to lending to family, my general rule of thumb is not to expect to be paid back. Go into it with that mindset and only loan what you are comfortable not receiving back. It helps protect the relationship. There are some situations with lending to friends where I will make a loan and expect to be paid back. In those cases, I always document our agreement in writing for both parties to read and agree to. Rarely will I do a deal on a handshake. It may be a solid relationship, but I’ve learned that putting it in writing protects the relationship. I think I remember the details, but over time perspectives change and we don’t always remember things clearly. But when it’s in writing you can refer back to it with clarity. 

Always obtain collateral for a loan you are making, especially to friends. Every time I have made a loan to a friend where there is collateral (preferably real estate) the loan has been repaid and there has been a positive outcome. I generally will not take someone’s home as collateral, but other investment real estate instead. When there is no collateral, the repayment has been less assured and when a friend defaults on a loan it almost always damages your relationship. Protect the relationship and require collateral. I always include a default interest rate provision where the interest rate rises measurably under a default situation.  Although I don’t always collect default interest, it is a motivator for the borrower to fulfill the obligations they have agreed to.

A point to note: what you put in writing, be prepared to stick with. Sometimes with family, friends and business relationships you’ve got to take the hard position because it’s what’s best for everyone involved. 

TEACHING CHILDREN ABOUT INVESTING

When our children were young teenagers, I began to introduce them to the concept of investing. I would bring home a one-page summary of a few of our investments. We would go through them together, they would ask questions, learn about them, and decide which ones they wanted to invest their own money in. Initially they would start by investing between $100 to $500.  Twice a year we would review their investments and talk about new opportunities. As teens they easily each made over twenty investments. I would keep track of each investment in a ledger and whatever return I received from the investment they received the same return. They learned a lot through this process – making and even losing money along the journey.

A note on taxes on our children’s investments: Considering that the children are not actually directly linked to my investments, and their investment only shows up on an inhouse ledger, there are no direct income or capital gains consequences for their investments.  All K1 forms appear in my name, and I pay all income and capital gains tax.  Therefore, when an investment pays off, I reduce the amount of their return capital and gain by the combined state and federal capital gains tax rate.  The children pay their share of the capital gains tax based on the amount of gain they personally benefitted from, and I am reimbursed the approximate amount of capital gains tax I paid on their behalf.  Therefore, netting everything out to zero in the most fair and simplest way possible.

Teaching them was a rewarding experience and a great way as a dad to connect with them on something. When they each graduated from college, my wife Kathy and I gifted them a larger amount to add to their investment portfolio. Over the next few years, they began to make meaningful investments and their portfolios sizably grew. We did this to increase the stakes and keep them focused on growing their investment portfolio.

There are many things about investing that I have had to learn the hard way. Teaching our children about the investment world with smaller investments allows for lessons to be learned that aren’t too expensive. Each of them has made at least one investment that went bad, and they lost their entire investment. These are lessons they will never forget and details they will pay attention to as they make their own investments as adults. Start early teaching them these important strategies.

ACTION STEPS

Relationships are important and should be protected. These strategies shared have allowed me to maintain and grow them.

From the steps listed above, identify any areas you need to re-visit and re-define. It may require a conversation, or it could be a point of growth for you. Purpose as you move forward in investing to bear these relationships in mind.

If you have any questions or comments, please do share them in the comments section.