The First Thing You Need to Do Before Investing Your Money

A reader asks:

I am a 35 y/o about to have my first child. Born and raised around Grand Rapids, and moved to Boise after grad school 10 years ago and bought a small house in a desirable neighborhood shortly thereafter. The Boise housing market has boomed. I have been slowly purchasing real estate, and have two cash-flow properties in Michigan, as well as two in the Boise area. I would love to continue to invest in rentals or venture out into something bigger like storage units or an apartment complex in the future. I am currently close to closing on a cash-out refinance on my personal home, and this brings me to my question.

I owe just north of $100k (bought for $176k in 2012), and my appraisal came in at $822k (4.5x!!), which allows me to acquire up to $375k in cash at 60% LTV, with the idea to reinvest the vast majority of the cash. Our incomes have increased enough that the increase in the mortgage payment is not an issue. I feel that I’m on track for my goal of retiring early (hopefully in my 50s).

What would you recommend putting the money into? I will certainly be funding a 529 with some of it, as well as continuing to look at local real estate, but don’t want to waste this very unique opportunity.

This is a pretty great financial position to be in for someone in their mid-30s (must be that West Michigan upbringing).

Sitting on a big pile of cash is a good problem to have but it can also be stressful.

What if I screw this up?

What if I invest it all right before a huge crash?

What if I don’t invest it wisely?

What if I wait too long to put the money to work?

First-world problems but problems nonetheless.

The exciting answer would be to offer you a list of potential investments that will offer superior rates of return that will allow you to get rich.

This is the answer many people would like to hear.

The problem is the exciting answer is essentially useless until you have an investment policy in place.

A number of years ago my investment office was in a meeting with a well-known institutional investment consultant. After some name-dropping, the lead guy didn’t waste much time, immediately telling us exactly how we needed to invest:

First of all, you need to have at least 15% of your portfolio invested in timber. And if you’re not overweight in middle market mezzanine private equity funds and underweight large market LBOs you’re going to be out of luck over the next decade. Who are your hedge fund managers? We have access to the best long/short manager in the business right now. How long will it take you to shift your portfolio to our platform?

It was like a doctor prescribing medication before asking what’s wrong with you. Sure, that medicine can work on patients with certain ailments. But how can you possibly prescribe a solution before diagnosing what ails you?

He didn’t take the time to ask us any questions about our organization — risk profile, time horizon, funding needs, asset allocation, goals and expectations. He also failed to ask about our investment policy.

Charley Ellis gave a speech to a group of institutional investors back in the 1980s about the importance of investment policy and being a good client:

Investment policy does not enjoy much popularity. Almost everyone agrees that it is a “good” thing, but almost no one does anything about it.

If you are not able to sit down and write out in an hour’s time what you are trying to do with your portfolio and how you intend to do it in such a way that a competent and able professional could take those instructions and fulfill them-you should at least consider making a serious study of your objectives, your risk aversion, the nature of the capital markets, your cash inflow and outflows, and the design of an investment policy that is truly right for the long term, for you. Being a superior client is not easy. It means taking an important responsibility and doing the work. But this is one investment that is guaranteed to pay off. I urge you to make the investment.

Basically, know thyself and create a plan around your circumstances.

Creating an investment policy looks something like this:

  • Defining your long-term goals.
  • Knowing your strengths, and more importantly, your blind spots as an investor.
  • Understanding why you’re investing in the first place.
  • Stating your risk profile and time horizon.
  • Documenting your investment process.
  • Figuring out how you we align your investment plan with your stated goals.
  • Defining how you will measure the success of your investment plan.
  • And then benchmarking your progress along the way to ensure you’re on the right track?

Again, not the sexiest work you do as an investor. Most people would rather pick stocks or crypto tokens or specific real estate properties or whatever else you can invest in these days.

We get a lot of questions from people who say they have $5k, $10k, $100k or more in cash and don’t know what to do with it.

Unfortunately, it’s impossible to give investment advice to someone if you can’t tie it to their goals and circumstances.

Once you define what you’re looking to do with your money, what you hope to get out of your investments, your expectations for returns, your time horizon and how that fits within your overall plan, it’s much easier to deploy capital in a meaningful way.

But step one in the process should always involve looking at any opportunities through the lens of your overarching investment policy.

We talked about this question on this week’s Portfolio Rescue:

Bill Sweet joined me as well to discuss tax tips for young investors, UTMAs vs 529s, HSAs, when to refinance and much more.

Here’s this episode as a podcast:

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