6 Questions to Ask Yourself Before Investing Your Money With Someone
How to make sure that you're not the sucker at the table......
A few weeks back, a friend of mine here in New York reached out to me. He had a big meeting coming up with a potential investor. His goal was to get this investor to put money into a real estate deal that my friend was trying to put together. My friend texted me the following question, “How do you approach these meetings?”
It was a really simple question. At the same time, it got me thinking a lot. There are a million directions you could go with a response. Oftentimes, when a question like this is presented, I try to work backward by flipping the script. “If I were the guy/gal on the other side of this meeting, what would make me want to invest with me?”
Here was my response: “Depends on your relationship with them. If they’ve known you a long time, trust you, and your numbers make sense, they will prob be interested.” Simple enough? If you dig into that response, there are two elements: Numbers, and TRUST. Numbers is the easy part. Trust? Not so much.
In 2024, there are countless places that you can invest your money. Everyone and their mother is raising money for a real estate deal, mutual fund, ETF, crypto project, Pokemon card backed NFT, Chinese theme park private investment (“Alts are the future, bro!”), etc. Every single one of them has a slick investor deck, “forward projections” that look fantastic, and probably a good looking smooth talking guy or gal with an entire marketing team backing them presenting it to you. The numbers look good. The story makes sense. That’s the whole point of marketing.
I would love to tell you that being honest and truthful always pays. It doesn’t. The market often rewards snake oil salesmen. The only qualifications for the job are charisma and a sociopathic lack of empathy for others. There’s a saying, “Lie to people who want to be lied to, and you’ll get rich. Tell the truth to those who want the truth, and you’ll make a living. Tell the truth to those who want to be lied to, and you’ll go broke.”
Humans are inherently gullible. We are hard wired to process information in a way that benefits us. “Wow that guy says I’m going to make 50% returns if I invest with him?! Well that sounds great! He must be right, because I’m great and I deserve 50%! Take my money!” On the other hand, if you’re the bearer of bad news (the one telling the truth to someone who wants to be lied to) you may end up broke.
One of my favorite financial books “The Smartest Guys in The Room” is the story of Enron In the late 1990s. Enron was, well…..The Smartest Guy in The Room. They had taken a boring (but profitable) energy company and turned it into a money printer through financial engineering and balance sheet manipulation. Everyone was making money, and not many were asking questions. Those that did ask questions were called some version of “haters” and were told they simply weren’t smart enough to understand the business. The NUMBERS looked great. The forward projections looked great. TRUST us. We’re smarter than you, you don’t need to understand how we make money! Just know that we make it!
You know how this ends. In 2001 the whole thing unraveled and was exposed for being the accounting fraud of all accounting frauds that it was. The beloved numbers were all fake. Arthur Andersen (at the time the biggest accounting firm in the country) was shut down. Enron filed for bankruptcy. People went to prison. Investors got wiped out. Enron went down as the biggest case of corporate fraud in history.
The point here is, everyone has numbers they can point to. In real estate, a deal often comes with what is called a “pro forma”, the latin word for “bullshit.” It breaks down how a particular property should perform in the future based on rents, expenses, etc. Everybody has one. They all look good. I use them too. They’re an important part of the business, but to me they are meaningless without that one key word: TRUST.
So what does trust mean to me? Let me provide you with an example. There’s a gentlemen (let’s call him Warren) who has handled my parents money for years now. Before that, he handled my parents parents money. Warren is a great guy. Warren has never done anything sketchy. He’s never caused their investments to blow up in a market down turn by taking unnecessary risks. He’s never lied, cheated or stole. The relationship goes back decades. I have no idea what his annual returns are. I have no clue what “alpha” he has generated over the years. I don’t care or need to know. What I do know is that he has been a true fiduciary for my family for decades. He’s kept his eyes on the road while everyone else was staring off at various shiny objects such as NFTs, non profitable tech, leveraged ETFs or whatever is the fad at that given time. I trust him. I’m sure the numbers are solid, but I don’t even need to see them. You can build a pro forma in 20 minutes, but it takes years to build trust.
In my time as a real estate investor, I’ve had many investors trust me with their money over the years. I don’t run a massive fund, but I do have people that I can generally go to for capital when I am looking to raise money for a deal. I did not start any of these relationships by “pitching” any of these people. Most of them came to me simply because they saw what I was doing (start using social media folks, people need to know what you’re doing) and have known me for years. They trust me and know I’m not a bullshitter.
As the quote I cited above says, you can make a lot of money by lying to people. I won’t do it. If anything, I will highlight EVERYTHING that can go wrong when I talk to an investor. I want to work with mature adults who understand that there is no reward without risk. I won’t take money from someone who I think is a risk to have a freakout if things don’t go perfectly. Spoiler alert, they never do. Everyone who has invested with me has done very well, but that doesn’t mean there aren’t speed bumps. These people trust me, and that trust is worth more than any “prospectus” or pro forma.
So how can you determine if someone is worthy of your trust? First off, it’s not easy. But here some questions that I ask myself before placing an investment:
-Am I even good at determining if someone I just met is trustworthy? Maybe. I do this for a living and like to think I have a pretty good bullshit radar. I still won’t give money to somebody I don’t know, no matter what their numbers say.
-Does the investment seem overcomplicated? Think of our guys from Enron. If your head is spinning it’s probably by design. People complicate simple things in order to create the impression that they’ve discovered something special or proprietary. Think of SBF and his crypto business, FTX. Others can’t understand it because they’re simply not smart enough! If you can’t understand it, it’s not because you’re dumb. It’s likely because it doesn’t make sense.
-Do they talk about risk? If anyone says that there is no risk, run for the hills. There is no such thing as reward without risk. That is one of the few hard and fast laws of finance.
-Are they promising outsized returns? For perspective, the S & P 500 has a historical average return of around 10% per year. If someone is promising you 50%, why isn’t everyone doing it? This goes for real estate, stocks, or any other investment. Does this mean it’s impossible for an investment to return 50% in a given year? Of course not. But can anyone promise those returns? That’s a hard no.
-Are they pointing to past performance? “Past performance is no guarantee of future results” is a disclaimer that can be found in pretty much any investment disclosure/legalese. They have to include it, but it’s usually at the end. This doesn’t stop them from pitching the exact opposite to you in the bulk of their marketing. Exceptional past performance is not only no guarantee of future results, it’s actually often times the opposite. Due to the way markets work, recent under performers often outperform in the future (and vice versa). Enron was one of the top performers on the 90s. Fund managers everywhere were pitching them as a blue chip in 1999……
-What is their track record? Trust has to be earned, not bought or pitched. I care more about doing my homework on the person than I do on the investment. Has this individual been a good custodian of others money in the past? Can anyone you trust vouch for them? Remember, they can lie about their own track record in a prospectus or presentation.
You work your ass off for your money. You live in a capitalist society. Whether we like it or not, money plays a factor in nearly everything that we do. You and your families future quality of life depends largely on your ability to be responsible with money. Remember, not everyone who comes around with an “opportunity” is worthy of your attention. Numbers can be made up. Trust has to be earned. Make sure that yours doesn’t come cheaply.
Perfect quote about truth and lying!
Great article and information! Thanks!