Although you personally may have never invested in crypto currency, there are some universal investing lessons that the sudden collapse of the FTX Crypto Currency Exchange can teach, or remind, all of us. Whether you are investing in a hard asset like real estate or speculating in the latest technological innovation, these 5 tried and true, rules of thumb are applicable:
1. NEVER BUY INTO HYPE - Marquee venture capital firms made some of the largest investments in FTX. Samuel Bankman-Fried aka SBF was considered to be a crypto wunderkind. FTX bought the naming rights to the home court of the Miami Heat and with that exposure, they were able to garner endorsements from some of the biggest names in sports and Hollywood, driving investment in FTX products. Hype and exposure don’t guarantee financial success. The venture capital firms and high-profile investors will come through this disaster just fine as their investment in FTX, relative to their vast portfolios, is miniscule (Temasek Holdings wrote off its $275 million FTX investment which represented only 0.09% of its $273 billion portfolio). Unfortunately, many small investors allocated a significant amount of their savings into FTX, buying into the hype and hoping for massive returns. Those are catastrophic losses.
2. DIVERSIFY YOUR PORTFOLIO - If you decide to make speculative investments, never allocate more than 10%-15% of your portfolio in that space. There's a reason they're called "speculative." More often than not, speculative investments become worthless. The big boys in Silicon Valley have the capital to invest in multiples of speculative startups in the hopes of finding the next FAANG Stock (Acronym for the top tier tech stocks; Facebook (now Meta), Amazon, Apple, Netflix and Google (now Alphabet)). That one big hit can wipe out all of the losses in their other losing investments. The problem for the typical investor is that they invest thinking about the FAANG stocks and neglect to think about the thousands of startups that fall by the wayside and don't even get the courtesy of a moniker.
3. UNDERSTAND THE INVESTMENT – One of Warren Buffet’s many famous adages is; “Invest in what you know.” He famously avoids investments he doesn't understand well. That's the main reason you won't find many high growth technology companies or biotech stocks in Berkshire Hathaway's portfolio. He terms it as "operating within your circle of competence." Competency means educating yourself about the business or stock before committing your hard-earned dollars to it. How has it performed in the last 3 years? How is it performing relative to competitors? Is the company transparent about it's finances? How will outside economic factors impact the performance of the business? These are just some basic questions to think about before committing to a particular investment. At Delarosa, we ask new borrowers a battery of questions relative to their ability to complete their project. We want to know that they have the operating competency and in some situations, we partner them with one of our experienced investors to guide them through the process, protecting our investment.
4. BE CAREFUL USING DEBT - Leverage is your best friend when things are going well. On the downside leverage is your enemy and can wipe you out and cost you much more than your original investment. Using real estate as an example; housing prices have plateaued in the last 6 months and most metro areas are beginning to see a housing price decline. Many homeowners and investors were able to buy properties with very little money down (sometimes only 1%-3%) and borrowed the balance. As home prices came crashing down (as much as 50% in some areas), the debt on highly leveraged properties became greater than the value of the properties. Many homeowners and investors simply walked away from these homes knowing that the debt owed to lenders was now greater than the value. As a result, these people lost not only the potential profits but their equity investment. Had they not taken on so much leverage, they might still be renting out or owning those properties today. This is why when Delarosa makes a hard money loan, we never invest at more than 70% LTV and our borrowers put up 20% or more. This not only protects our investment against the hard asset, but protects our borrowers from getting into a situation where they don't have the capital to finish and lose the property. We want successful borrower/investors who come back to us over and over with a track record of successful investments.
5. SLOW AND STEADY GETS YOU TO THE FINISH LINE - After years of investing, the one lesson I've learned is that when something sounds too good to be true, it is! Stay away from investments that promise above average returns. Stay away from technologies or concepts that are too new and have yet to prove themselves. The odds are that your investment will not be profitable. Look for solid sustainable businesses with proven track records to invest your money. It may not be sexy, but either is an empty bank account!
Often the best lessons are learned from our mistakes and failures but it is just as easy to learn from other peoples’ mistakes. Knowing what to avoid is often so much more valuable than hearing the success stories. You may miss out on one or two genuinely great opportunities over your lifetime, but one bad opportunity, which are infinitely more prevalent, could take a chunk lifetime to recover from.