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Entrepreneurship vs. Direct Investing

There is a subtle yet vital difference between direct investing and being an entrepreneur or business owner/operator. Direct investing is done with a specific investment goal in mind, and if that goal changes, you must adjust the direct investment, sell it, monetize it, etc., to ensure that it continues to align with what you are trying to accomplish.

The goals are generally of two types:

1)   A specific asset allocation goal – “I think that oil and gas in the ground to be produced will be a good hedge against inflation.”

2)   A specific return (or risk management) goal – “I want the portfolio construction benefits of fixed income (low risk of loss of principal, fixed payments over time, the ability to know what your return will be if you hold the instrument to payout), but I need more after-tax yield.” To accomplish this, we constructed a portfolio of multi-tenant office buildings with diversified tenants, lease terms and mortgage terms that over time yielded nearly 10% on an after-tax basis.

For the direct investor, it is the underlying characteristics of the investment that we are seeking for our portfolio, and we do not care what the wrapper looks like.

An entrepreneur, on the other hand, starts or buys a business for a variety of reasons, but seldom for a specific investment goal. The business is grown or built opportunistically. The successful ones have a strategy, but they still follow the opportunities. An entrepreneur or a business owner will rarely turn down an opportunity that is profitable or provides cash flow but is not consistent with the investment goal.

Entrepreneurs are typically dynamic individuals who are fun to be with and who often are pursuing all kinds of goals: getting rich, getting very rich, having fun, employing family members, having the status and recognition that comes from success. Direct investors, on the other hand, tend to be more focused and disciplined, and perhaps not as much the life of the party.

The bottom line is that we need both direct investors and entrepreneurs because they fuel different parts of our financial ecosystem. But it’s critical to understand the difference and know when each approach is most appropriate.

Investments and the Bell Curve

One of the biggest misconceptions in mainstream investment thinking is that the classic Gaussian bell curve can be used to predict the behavior of specific investments. While many try to apply this statistical tool to investment strategy, they do so at their own risk, because historical data clearly shows that it does not accurately predict investment behavior.

Why? The short answer is that investments are affected by a virtually unlimited number of variables, most of which are beyond the control of individuals or institutions managing the investments. One of the biggest uncontrollable factors is the economy itself. While my economist friends may take issue to some extent, it is simply impossible to accurately foresee how the economy will behave. Just ask the countless people, companies and organizations that lost half of their equity or more in the wake of the 2008 crash. Add in the uncertainty, and sometimes irrationality of governmental and individual behavior, and it becomes an inaccurate predictive model. That renders the traditional bell curve essentially useless in this application.

While we cannot accurately predict what investments will do based on a theoretical bell curve, we can learn about their behavior in specific situations based on historical data. We need to focus on the underlying assets and their characteristics to minimize the risks of losing the principal and maximize the probability of earning our targeted return.

The Right Investment Focus

People often ask, “What’s the best investment?” The answer is, “It depends on your objectives.” There are immense differences between investing for the long term to achieve solid portfolio growth with acceptable risk and investing to generate current, ongoing income with minimum risk of loss. Yet many, if not most, people are really asking, “How can I make the most money in the short term?” This can create disappointing and sometimes catastrophic results.

Focusing on the highest short-term gain is much like a gambling approach. You have a chance at a big payoff – maybe doubling your investment or more – but you also have a much greater probability of losing some or all of your investment. But most investors and investment advisors only focus on the “wins,” and conveniently forget the “losses.” Sure, a high-risk investor may show dramatic returns on 10% – 20% of their ventures, but how much are they losing on the other 80% – 90%? The big picture usually shows that their overall performance is unimpressive or in the red.

Going for singles and doubles is far more sustainable than trying to hit home runs all the time, and it produces much better results in the long run. Remember, the hardest thing to do is to re-earn lost capital. Your first investment goal should be to not lose what you start with. Gaining a reasonable, ongoing return comes next. That’s sustainable success.