Hey folks, today we are sharing a fantastic podcast featuring Morgan Housel, author of The Psychology of Money; a story of how I lost $15,000 of my own money AND owed the bank another $15,000. We finish with a discussion on the vagaries of investing in an illiquid asset class, that being Private Real Estate.

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Personal Finance

A reader recommended a solid podcast this week, featuring Morgan Housel, author of the Psychology of Money.

I’ve read his book and have recommended it here before—it’s one of the best on money and mindset you can find. What makes it unique is that it’s written in a way both teenagers and seasoned investment bankers can find value in.

If you prefer podcasts to reading, check out the episode The Best Financial Advice You’ll Ever Hear

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Stock Markets

What they tell you: I bought NVIDA in 2015 and I’m up 21,000%!

What they don’t tell you: along with my other 67 stocks and margin debt, I’m down 24% overall.

I have had only two ten bagger stock investments in my career. I’ve also had a few doubles and triples.

But I’ve also had some mega losers. One of these I alluded to in Issue #78. And I had borrowed money to invest, too..

Online language learning 10 years ago was still archaic, in need of an overhaul with the proliferation of the internet.

Along comes a business called Lingo Media. Micro cap, publicly traded on the TSX Venture Exchange.

LM had created a slick online learning platform and was growing revenues rapidly, showed very strong gross margins, operating margins, return on equity (in the high 25% ROE), no debt, and lots of cash (about 15% of its market cap). They had a “fortress” balance sheet and further margin of safety with a long term contract with a Chinese customer.

I built a detailed financial model, and went so far as to get on the horn with the CEO multiple times, who also owned a significant chunk of the business—usually good sign of skin in the game—and even demo’d the product.

By all financial accounts, this was a bullet proof investment, albeit risky, due to it’s micro cap size. It looked like the stock would easily double as they scaled the business.

I went all in with $15,000, a very large amount of money for me at the time. Stock went up from about 40c to 65c. I’m laughing.

And then I borrowed $15,000 from my bank on an unsecured line of credit to “enhance” my returns. Because now that it’s at 65c, it has to go to $1.00 right?

Guess what, it did! At this point I’m seriously thinking about buying a boat.

While I’m jeering on my gains, on paper that is, lo and behold, right as they start investing more money in product development, growth stalls. And then they lose the major contract from the Chinese customer. What’s more, Duolingo, a mobile-device based online learning company starts popping up everywhere.

A perfect storm of everything that could go wrong all at once. Financial performance suffers, investors lose confidence and the stock craters, something like 90% and never recovered.

I’ve lost my $15,000 AND I still owe $15,000 to the bank, plus interest!

Classic.

Absolutely fucking classic.

Took me a while to pay off that debt, it was crippling and felt shameful at the same time.

Some lessons I learned:

• The allure of making fast money is extremely dangerous.

• Position sizing is key—NEVER bet the farm.

• “Access to the CEO” is more often a bad thing than a good thing.

• When a stock is ripping, don’t rest on your laurels. No matter how good the numbers look, things can go wrong very fast.

• Be EXTREMELY careful when borrowing to invest in the stock market.

  • I’m going to do a future newsletter on the pros and cons of using margin debt in the stock market.

• Don’t trust someone else’s stock tip just because they’ve “done lots of research”. Handful of them will work out, but most will get crushed. Or maybe your friend that tipped you off today sells his position and forgets to tell you. A few years later you’re down 90% and ask him what he thinks—he says, oh dude, I sold that before it collapsed—you didn’t sell?

I’m lucky this happened in my 20s and not now. Couldn’t imagine how challenging this would be emotionally while supporting a growing family.

Some of my friends reading this will remember this story. They’d ask me, “Eddie, what are you buying?” I shared the idea. Some of them caught the koolaid I was drinking and bought some themselves; saw a nice green stock chart, and pressed buy. To all of you—I apologize for that—I should have been smarter not to share anything in the first place. Nothing good really ever comes from doing that. And I hope you didn’t bet the farm like I did!

To close, while I’ll always have an affinity for individual stocks, it’s been so liberating moving most of my liquid investments over to ultra low cost ETF land. Where average investors, with time, can have exceptional results.

Real Estate

Nicola Wealth was in the news last week as they halted redemptions on their real estate funds.

Nicola started as a wealth management shop and has quickly become one of the most prolific and well regarded institutions in Vancouver, with something like $13 Billion under management.

Much of their growth has been on the Real Estate side, with those funds now making up more than 1/3 of their investment holdings, including mortgage funds.

One of the challenging things about running a mutual fund product that invests in real estate is that it’s very logistically challenging to match up the liquidity requirements of mom-and-pop investors in the fund and the long term nature of real estate investments.

But investors clamored for “real estate” exposure as their recent memory showed them a 30 year bull run for pretty much all real estate asset classes (save for the 08’ calamity).

And so Nicola built their portfolio to an incredible size on the notion that everyone needed access to real estate in their retirement portfolios.

Unfortunately the last 5 years have seen many real estate projects get burned as higher inflation and interest rates have led to underperformance and bankruptcy in some cases.

But the last few years we’ve seen a disconnect between Private Mutual Fund values and their public REIT counterparts, where the Private Funds have seen continued growth while the Public REITs in many cases have seen significant declines in share prices over the past few years.

Doesn’t make sense right? Right.

This is because public stocks trade daily, so price discovery is instant. But in the private markets, annual appraisals are the norm and even appraisal values can be massaged to ones advantage.

Recently, we’ve heard about a number of large investment funds having to gate/lock up redemptions as investors are demanding their money back faster than the fund can sell assets: Blackrock, Centurion, Kingsett, to name a few. And if they can sell them, likely at lower values than the NAV implies.

All this is to say, when you are investing in private real estate, you must understand what you are getting into. It is truly long term investing. You are locked in for years, full stop. So be sure to recognize this important trait before you go piling 30% of your retirement account into an illiquid asset class.

A quick short story for you to finish:

I had a client come over to Richardson from Nicola. $130 million net worth. $100 million of which was in two buildings she owned personally.

Her advisor at Nicola had stuck her $15 million portfolio 40% into those real estate funds.

Once she realized, she was like, “hey Mr., I AM real estate. I don’t want those in my portfolio.”

The advisor kept the sales pitch going saying how great the funds were.

She didn’t like that pressure, so she left and came over to Richardson (was a nice win for young Eddie to be sure).

And then John Nicola himself called her to give the pitch and try to get her to stay.

She didn’t like that either!

1 Quote

“Everyone is jealous of what you’ve got. Nobody is jealous of how you got it.”

Jimmy Carr

A Question

Anyone else have an investment horror story they can share? If so, write it in a way that could feature it in an upcoming letter. We can all learn from it!

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