Money Games People Play

A few years ago, I bought a building from a couple that specialized in acquiring and rehabbing old properties.

At the time of the sale, the building had a 6% cap rate, which subsequently went up to about 9% once I changed up the tenant mix and renegotiated a couple of leases.

Now, cap rates are EXTREMELY dependent on the specific market and the type of property in question.  But in that particular market, a 9% cap is considered a steal even in today’s environment, let alone the heyday of zero interest rates and plentiful financing.

In other words, I got myself a tremendous deal.  Which naturally begs the question – just what in the world were the sellers thinking?

Did they not make the mistake of a lifetime by selling me that building?

As it turns out, not at all.

You see, from their perspective, the math made total sense.

They bought the property for $350k, invested another $300k in renos, and sold it to me for $850k.  The whole process took them just under a year.

That business model yielded them a 30% annualized return ($200k gain divided by the total investment of $650k).  Why own an asset that generates a 9% return if you can put your money to work at 30% instead?

I, on the other hand, loved it.  At the time, the cash in my bank account yielded precisely 0%.  My stock market investments – about 8% over the long run.

More importantly, I had neither the time nor the skill set to actually find and rehab a property like that.  And so, adding a relatively passive investment to my portfolio and juicing that yield with some responsible leverage was a no-brainer.

In other words, the game I was playing (passive, long-term ownership) was very different from the game the sellers were playing (active, long-term ownership).

The investment decisions we made were diametrically opposite (buy vs sell), but they made perfect sense in the context of the respective games we were playing.

Smart vs Stupid?

In one of my all-time favorite books, Morgan Housel writes

“When it comes to money, no one is stupid.  People are simply playing different games.”

As much as I respect Morgan, I am going to have to disagree with him on this one.

Sadly, when it comes to money, some people ARE stupid.  Their stupidity manifests itself in many different ways and statements, like “401(k)s are a scam” and “The stock market is rigged”.

You want to ignore those people, or at the very least, ignore their “advice”.

But many others are indeed playing different games.

Let me give you a couple of examples.

Someone in their 20s and starting from scratch is likely to be playing a game of capital appreciation.  Bring on 100% equity portfolios with a strong focus on total returns.

By the time that same person turns 60, they are likely to be playing a game of capital preservation.  Cue in hefty cash balances and bonds.

Someone with a long and predictable career runway has no need for their portfolio to generate any immediate cash flow.

But consider that same person – only employed in a precarious industry or facing a potential health issue.  A portfolio of dividend-paying stocks makes a lot more sense in this scenario, even at the expense of total returns.

For someone living in a Western democracy, investing in real estate and the stock market is generally a no-brainer, a near-guaranteed path to generational wealth.

But put that same person in an emerging market, with volatile macro and limited property rights – and watch their strategy shift to shorter-term investments with higher ROI.

It’s tough to get excited about 8% annualized returns when your currency goes up and down by 50% in a matter of days.

In a similar vein, someone who is young, single, and dying to explore the world should probably hold off from buying a principal residence.

But that same person, with two kids, and a desire to settle down in a specific part of the country?  All of a sudden, home ownership makes a ton more sense, especially when you consider the non-financial benefits of owning the place you call home.

In the world of Facebook and Twitter, it’s easy to get offended by people who preach an investing concept that you perceive to be suboptimal.

It’s even easier to take certain statements as gospel, especially when they come from credible people with large followings.

But if you are truly serious about building wealth, the MOST important thing you can do before taking financial advice from anyone is to understand the specifics of the game they are playing.

Before long, you will understand that oftentimes, there are no rights or wrongs in personal finance.  But a strategy that’s 100% right for someone else might make zero sense for you – and vice versa.

As always, thank you for reading – and happy investing.