Influencing your own risk tolerance.
It was almost nine years ago and I was just starting out in real estate investing. I was driving to a local club to hear a speaker on buy-and-hold properties. I was considering getting a rental property in my area of Los Angeles, and didn’t understand how people were making rentals cashflow locally. During the meeting, we were broken down into groups of four to talk about what geographical areas we were investing in. Of the four of us, one had no investments, one was investing locally (an inherited property free and clear), one was investing out of state and one was investing out of the country. Wow, out of the country! How do you manage that? Totally crazy. That was the thought I had at the time.
That night I drove home thinking about what felt like a comfortable investment and out of my comfort zone. Basically, I was evaluating my own risk tolerance. I knew that if I couldn’t get the returns I wanted for rentals in Los Angeles I was going to have to change my investment criteria. Maybe get out of the comfort of my own area and invest somewhere that the numbers made more sense. I started to wonder: what would I need to make investing in another state work for me? What would it take for me to feel like the risk I was taking was mitigated?
I was once told that the single biggest threat to my financial well-being will be my own brain! I recently read that neuroscientists have found that the parts of the brain that process financial loss are the same parts that respond to mortal threats. Think about that, when we are faced with financial loss we respond as if our very own life is being threatened! And we don’t even need to be faced with a real financial loss…but the thought of a loss will keep us out of the game. It’s no wonder that for some it takes blood, sweat and tears to take any kind of risk at all.
Here’s the thing, risk tolerance is influenced by three things: information, resources, and experience.
It might seem overly simplistic, but all that’s really required is a simple system to neutralize the harmful effects of our brains’ faulty wiring. A different way to respond to taking risks.
Let’s explore these three:
Do the numbers work? And does it meet your investment criteria? It’s more than just making the numbers work, but it is also about what investment is right for you. Make sure you run numbers on the perspective property and taking all income and expenses into consideration. Then you need to ask yourself if it meets your personal investment philosophy. This covers several different criteria. Property profile, is it an A, B, or C class property? (Warzone to Pride of ownership). What about the time horizon? Real estate isn’t a very liquid asset, how long are you comfortable having your investment money in a project? Property type? Single family, multifamily, commerical?
An important component to figuring out your investment philosophy is deciding in advance how you’re going to diversify your investments. I allocate a specific percentage of my portfolio to low-, moderate- and high-risk deals. As my investment experience has increased and I’ve entered different phases of my life, these percentages have shifted. This way when feeling too exposed in a particular area you don’t have to back out of investing altogether but instead rebalance your portfolio.
Once you are clear on the information you have, the more certain you will feel about the investment.
Do you have the right team? Yes, you’ve heard it several times, real estate is a team sport. A lot of times people are trying to figure out HOW to do something, when in reality you might just need to find the right WHO, because the right WHO already knows HOW to do it. When you put yourself in the same space as successful entrepreneurs and real estate investors, you have a greater chance to become just like them. Proximity is indeed power. When you’re around people who have been there and done it, they can give you business strategies and knowledge making the risk ahead more manageable.
Yep, you gotta just do it! I think we all know this one. After you’ve done something once, it becomes easier to do it again because we are more familiar with the process. You gain knowledge through direct participation in deals. If you are purchasing buy and hold property on your tenth property do you think you will be as nervous as the first one? Of course not!
So in all honesty, it took me a year to buy my first out-of-state investment property, but once I understood and experienced the process, I bought two more within the next year. Yes, experience is key.
To sum it up, real estate investors need simple systems and guides to protect us from ourselves. Be assured that our risk tolerance will change as we learn, and grow our portfolio. Will you be perfect? No. Will you do better? Yes! Just think the difference this makes over a lifetime can amount to millions!