What to Ask Before Investing: My Litmus Tests for Investments
Wondering how you can trust an investment? In this episode of the podcast, I share my personal “litmus test” for evaluating alternative investments and private placements.
If you’re exploring real estate, private funds, or other non-traditional opportunities, here are my top three takeaways to keep in mind:
Do they have real skin in the game?
Always ask if the managers are investing their own money, not just raising funds and charging fees. When their money is on the line, their interests are better aligned with yours.
Are there useful tax benefits?
Some investment strategies, like Roth conversion options, can give you substantial tax benefits.Is the rate of return fair?
Compare promised returns to similar opportunities and industry standards. If returns (or communication!) seem subpar, dig deeper or rethink your choice.
Links:
Take the quiz - How Alternative Assets Can Fit in Your Portfolio
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Introduction to the Unconventional Investor Podcast
Welcome to the Unconventional Investor Podcast. I'm your host, Michelle Moses, certified financial planner, licensed realtor, and founder of Me Financial. If you're an accredited investor feeling overwhelmed by managing your portfolio and looking for alternative investment strategies that go beyond the traditional stock market, you're in the right place.
Let's head into today's episode so you can start taking control of your financial future. Hello everyone, and thank you so much for tuning in.
Today's Topic: Litmus Tests for Investments
Today we are going to be talking about my litmus tests for investments. And this is specifically for alternative investments, but I think that you could attach this to real estate investments also.
This is, and not to say that with this litmus test that if they fail all of these that I necessarily say, Nope, I'm never gonna look at you, but the ones I really love have certain things in common. And the first thing, let's just dive right into it because it is so important, and I know I'm not the only one out there that thinks it's so important is, when you, people are asking you to invest in their fund, right?
They're in, they're asking for you to invest with them because they're the manager, all right? So even if you're doing real estate or they're flipping a house or anything like that. You are investing in this person is what you're doing, right? You're investing in this company or the people that are leading it and you wanna be able to trust them for, that's first and foremost.
Like when you're talking to 'em, you wanna be able to trust them that what they say is right, but.
Litmus Test 1: Skin in the Game
My first litmus test is do they have skin in the game? Do they have their own money in the deal? Because I have seen some of these investments where they just wanna raise money from all these people and then they wanna make an income from that on a monthly or a quarterly basis, but they're not putting any of their own money in.
And I don't see how your entrance. Your interests can align with the investor if you don't have your own money in, if you're only, having all of this big pool of money so that you can then make a, like a wage or that you can invest. The way that you want. That's great, but it's other people's money, so you just are not going to care the same way as if you had your own money in the deal.
And I want to reiterate that it is their own money in the deal and it's not a loan because sometimes you'll see people and they'll say, yes, oh yeah, we're giving a loan to get this thing started at 6% and then after two years we're gonna take it back. Once you know there's enough money in the loan, in the investment.
No, that's a way to make fees. To me that is a way that you can loan money and make fees on a fund, and then you get your own money back, and then everybody else's money is still in there. And then you're charging fees on that, right? You have a big pool of money of everybody else's money, and you're charging fees on top of that.
And so where is your interest at? Your interest is just at making fees and just trying to get that thing going as long as possible, right? Like drawing out. The fund as long as possible instead of having your own money in the deal and getting it back out so that you can do something else with it. So that is my number one litmus test.
And I would say most of the stuff that I invest in, that is a common denominator. It isn't always, because sometimes there are investments that have some tax advantages that you just can't ignore.
Litmus Test 2: Tax Strategies
there is one, I did an episode for Cedar Street, let's, for example, where you could do a Roth conversion strategy, which means you take your IRA money and you convert it to a Roth.
So that is like a, that's a tax benefit, a tax strategy, and. It's a good fund, but they didn't have tons of their own money in the fund. Like as much as I would've loved to maybe have seen, I don't remember what it is off the top of my head, but it's, that wasn't why I picked that fund. It was because of their track record of what they do.
But then they also have this Roth conversion strategy, and so that might supersede, whether they have their own money in the fund. Obviously it is better if they do just because you want, you wanna pile up the benefits, but these tax strategies might outweigh it because you're, you have a year where you're not making a lot of money and you want to convert your IRA to a Roth.
Doing one of the funds where, you know, you, I'm just gonna give a synopsis of what that, that episode was about if you put in a hundred thousand dollars into the fund. You invested a hundred thousand dollars in the land and the building isn't built yet. And so the real value of it is actually, I think, oh, $60,000.
So then. You take that $60,000 that your IRA now says it's worth and you convert it to a Roth, so you just save $40,000 on your Roth conversion. So those kinds of tax strategies, that's what we're looking for, that is like the number one. And then we're picking the best out of all of those funds and able to do that strategy.
So attack strategy is another litmus test that I would. Go for when I'm looking for a fund. And you might be able to transfer that over into real estate also, right? 'cause that's why people have rentals is so that they can the tax benefits, obviously the income, but the tax benefits with the depreciation of the homes or the commercial property.
Litmus Test 3: Fair Rate of Return
more other litmus tests that I go by is the, do they give a fair rate of return? And that is in comparison to the other vehicles that are out there. So if you're gonna lend money for a house that somebody is flipping, you're not gonna loan it for less than what they're gonna get at the bank, right?
You're probably gonna look up. What is hard money lending? Doing what, what are the other rates that they could get out there? And if your money is easier, quicker, doesn't have as many, as many hoops to jump through, you're gonna charge a higher rate of return. And then if if you're investing, you really want to, or the giving a fair rate of return to you.
And so when I'm talking about alternative investments and some of these private placements. Sometimes I think that, the investor is the one taking all of the risk and then it's guaranteed that the owner of the fund makes, 7% on their fees. And so those are paid no matter what, and then you are getting your, like 5% when all the other funds are paying more like 8%.
So those are the types of things you want to, compare and contrast. And I think it really helps. Having chat GPT and all these AI models that you can ask questions about these different types of funds, it will help tremendously. Whereas before you needed to know and you needed to read all of them, whereas now I think that you could ask the A whatever AI model that you're using and probably get a fairly good answer.
My first litmus test is do they have skin in the game? Do they invest their own money? The second one is there a tax strategy involved? And the third one is, do they give a fair rate of return in comparison to all the other investments out there in the same. Industry. So if you are in mobile homes, you wanna make sure that it's fair.
In mobile homes, if you're in self-storage, you wanna make sure that all the other self-storage, there's not another one that's paying 12% and you're gonna about to sign up for one that pays six. Why? Why are they only paying six? Is it structured differently? Are they taking more risk?
Are they putting more money in? There's usually a reason why, or it just might be that they just didn't want to give that much of return.
Importance of Client Communications
I think another one that often is overlooked is what are the client communications like? I have invested in some funds that are actually pretty good, but the client communications are so bad I would never invest with them again.
In a million years, they email me like once a year. I have to pound on their door to say, Hey, what's going on? Are you guys still there? Did you take our money and run? You know what? What is going on? The one the companies that I wanna work with are, when COVID happens, they lean in and they're doing more webinars, they're sending more emails, they're giving more updates about what's going on.
That is I think, a key to making sure that people feel good about where their money is. Because we're not talking about small amounts of money. This is not, I threw $5,000 at a stock. This is usually, I put a hundred thousand dollars into this investment. I wanna know what's going on with it and that you're legit.
And if you are legit, then you're sending me at least every six months an update about what is going on. Even if we're doing a building, you could take a couple pictures and put it in an email. But most of the time they have nice newsletters and. A portal that you can log in to see an update and what the value is of your investment.
So you wanna make sure that the client experience is good, unless you're doing something that's with your friend, and you guys are all pulling together to buy some real estate. That's a little bit different. You're not gonna have client updates. But if you're doing what I am, you know what I usually sell, which is like a private placement.
You're gonna want some client communications and some of the. Fund sponsors, they really fall short on this. And so it is one of the questions that I ask that I wanna see an example of it. I want to know how much they're, they are, how often they're sending it. And I wanna know what kind of portal that the clients can log into to see valuations.
I don't wanna just be emailing someone and then they can email it back to me. And I have no access to anything other than you know them emailing me because. Employees come and go, but if they have some sort of online access, then you can always log in and get your documentation and get your K ones and your tax documents.
That stuff is important, especially, as I said, the K one around tax time. And if you want to know what's going on with your stuff.
Additional Litmus Tests and Considerations
I would say some of these other ones I are less important. I wouldn't, I don't know if I wanna say less important. They're just at the bottom of my litmus test list, let's put it that way.
One thing I look at is exit strategy. And I only say this because I have looked at some funds where. They only have one exit strategy and it's where you, they have real estate and they go into what's called an upreit. And basically what that means is that you have invested in this one building or maybe five buildings, okay?
And then they wanna sell that and they wanna transfer this fund to like an institutional buyer. Okay? And that the institutional buyer basically wants to buy the fund. And if your only option to get out is to buy. Parts or is basically for your interest to transfer to this institutional investment so that basically you're going from owning five buildings to maybe owning 500 buildings inside of this, like probably publicly traded mutual fund or closed what's called a closed end fund.
That is a big deal because you are going from buying, owning five to eight properties and being able to ride off the depreciation and getting a K one, and then they're saying, okay, you can only go into the up, and I say this as it's. And I know this is getting like way more complicated.
Probably some of you guys are like, what the heck is this even? But you just wanna make sure that there's multiple ways to exit or that their only way is I'm gonna liquidate this and then you're gonna get your money back. Because there are some out there that will trick you and say, no, we're gonna, we're gonna do this.
And most of the time when it is. There's only this one option. It is with these very large conglomerates. And it is very difficult to read and understand some of it, but you just wanna make sure you know what the exit strategy is. And then some of the other stuff that you really wanna look at is obviously the fees you wanna look at, what kind of fees are they going to be generating on a yearly basis.
Without. So even if things go down they're still gonna be generating the fees based upon the amount that is in the fund. Are they egregious? Do they charge, 2% for getting the property and 2% for getting it, selling it and 3% for even doing due diligence. And you wanna add up all of those fees and see what those add up to and make sure that they are in alignment with what the industry standards are.
And again, I think with all the AI models, that is very easy to look all of that stuff up if you're going through an investment. So those are my. The big things that I even have a sheet where I have all of these things to make sure that I don't miss them when I am looking at a deal so that I can check off whether these are all true or not, and how I feel about the rate of return.
How do I feel about their fees, is there some sort of certain tax strategy that should go through? But I think these are all like a, I call it my litmus test. You can call it whatever you want, but this is my litmus test for looking at investments. And I hope it helps you, but I think the money in the game thing has made a, is in my experience that really separates people from.
There's just a huge, I don't even wanna say disconnect. It's just, it is just such a big difference in the funds and the returns. If they have money in the fund and if they're in alignment with the investors, like their interests are in alignment with the investors. They are not just in it to have a big pool of money and be making fees, because there are companies out there that.
That is literally what they're doing. They are raising money so that they can charge all these fees and loan the fund, money. And that's like how they make their livelihood is just having a big pool of money and being able to charge fees on it by doing all of these things. They are doing the real estate and they are doing the investments, but they're making a ton of fees in the process.
Anyway.
Conclusion and Contact Information
I hope some of that helps. If you, obviously if you have any questions, feel free to reach out. You can always schedule just a free 15 minute consultation with me on my website. If you have any quick questions or wanna explore some things further, I also have a quiz on my website that is about fitting alternatives into your portfolio and how you might do that.
So please let me know if you have any questions and thank you so much for listening. You guys have a great day. Thank you for listening to the Unconventional Investor Podcast. I hope you feel more confident in how you can grow your wealth using the strategies I shared in this episode. If you're ready to take the next step in diversifying your portfolio outside the stock market with alternative investments, head to me financial.net/contact us to book a 15 minute consult call with me.
Let's discuss how we can work together to achieve your financial goals. Until then, I'll see you on the next episode.
Disclaimer: The information provided in this podcast is for general informational purposes only and should not be construed as professional financial advice. Always consult with a qualified financial advisor or professional before making any financial decisions. The hosts and guests of this podcast are not responsible for any actions taken based on the information presented.