3 mistakes entrepreneurs make by investing in “Sexy” Investments.
Eternal optimism is a common thread for most entrepreneurs. Naturally, most entrepreneurs are optimists; after all, if they weren’t, why would they constantly take the risks that business throws at them on a daily basis, in exchange for a greater reward? As an optimist myself, I had to learn the art of becoming a realist when it came to managing money and investing. Early on in my career as an entrepreneur, I recall investing my profits both in growth and personal investments in a rather emotional way. I, like most entrepreneurs, was hoping for “the big one.” The one big investment, the great idea, the person who had the deal of a lifetime, the sexy deal that would change my financial life forever. And I was determined to be a part of it…
In the end, I did succeed at a very early age in making millions. But I made them slow and steady, one good deal at a time. Along the way, however, I learned some important lessons through the school of hard knocks, and in the process, also lost millions.
Investing is as much about psychology as it is stock markets, real estate deals, or startups. Even the stock market moves on a day to day basis are more about perception of value and desire to take on risk than it is about daily changes in the value of a company. People get optimistic, they get pessimistic, and somewhere in between, the markets move. We all have our own motivations, goals, and tolerance for risk versus reward. However, aggressive entrepreneurs typically have an above average tolerance for risk in exchange for greater reward. Naturally, that is built into our DNA. And as such, we are also susceptible to making extremely poor decisions based on our appetite for growth and gain. That in of itself is not necessarily a bad thing, but it can lead to very bad things if not kept in check.
Entrepreneurs typically work to become wealthy, but 99% of the time, they end up working for higher incomes and for those of you who don’t know, income is not wealth. Wealth is a net worth which is not relied upon for your lifestyle. Income, on the other hand, is most often used exclusively for creating lifestyle.
Entrepreneurs typically think in multiples. For example, if a business was started with $5,000 and now you are making $100,000/year from the business, that is a multiple of 20 on your original investment! That’s great…The problem is that now anything less seems “boring”. The idea of that same entrepreneur taking 10% of his/her income and investing in a mutual fund for a 5% return seems silly and meaningless. An aggressive business owner will think, “if I take $10,000 and invest it at 5%, I could make $500 per year. Big deal! But if I take that same $10,000 and invest it into my business, I could make another $100,000/year, and double my business. THAT is a great investment!” That line of thinking is actually not bad. If the math works and the risk versus reward meet your expectations, then for the sake of business growth, that makes all the sense in the world.
Where entrepreneurs get in trouble, however, is when they’ve saved a substantial sum of money relative to their net worth, and decide to invest it in a highly speculative, risky investment in a “win all or lose all” kind of deal. Over the years, I’ve saved relatively substantial amounts of money, and invested them in ideas or businesses with people that I trusted explicitly, and almost every time I’ve lost money. And sometimes, I’ve lost “big” money…Life changing money…Even amounts of money that most people would consider retiring off of. How did a smart, handsome, brilliant guy like myself get talked into investing into a total loser of a deal? Well, there are three common elements that are associated entrepreneurs making silly investments.
1. Entrepreneurs often like investing in things that appear to be “sexy”. We all have a different idea of what “sexy” looks like. Maybe you fantasize about investing in big high rise hotel projects. Or maybe you fantasize about investing in the next Facebook, Twitter, or Instagram. Some people look at the oil business and dream of owning part of a big oil company that drilled a hole into the center of a massive oil reserve. Whatever your idea of “sexy” is, whatever you might fantasize about investing in that you know little about, is something generally worth staying away from. Sexy investments, in sexy industries, with big names behind them are never sure things. We’ve all heard the adage, “invest in people, not products.” Well, yes, but really to be successful in any investment, you need both the people and the product. You need intelligence combined with the right timing, product, and execution.
Recently, I was asked to join the board of a technology company, and further asked to become a co-CEO to help turn the start up around. The other people on the board and the other investors in the deal were big…In fact, big enough to be in a top executive position of a multi-multibillion dollar technology company. They wanted me to invest a modest amount of a few hundred thousand dollars, and to get involved to take the company to the finish line to be acquired. To me, this was a “sexy” investment. It had big names with it, other big investors who were, arguably, smarter than I. So, I took the opportunity seriously, and vetted it out very thoroughly. But ultimately I came to an appropriate conclusion: I knew nothing about the technology, nor did I know too much about exiting through a sale of intellectual property to another company. Moreover, I wasn’t impressed with the other day-to-day leadership of the business, and I didn’t want to battle for control which would have substantially distracted me from my main business. Truly, I had little to offer except my deal making and business skills, and of course the money they wanted me to invest. I chose to gracefully decline the offer to get involved. Although the potential was to quadruple my investment in a matter of months, and it would be a great opportunity to hob-knob with big technology firms and executives, I knew that just because it was sexy, that didn’t mean it was a good investment.
Several short months later, I was proven correct. The company has all but folded. Out of money with an aging set of technology which may not even be relevant in the next generation of hardware, I probably saved myself several hundred thousand dollars and a lot of time, heartache, and anguish over lost money.
2. The second element in making a poor investment decision is the idea that complexity means legitimacy, and the fact that complexity gives a false impression of sophistication. Often times, the simplest investments with the least amount of complexity are the ones that turn out the best.
“Only invest in products and companies that you can explain to a six-year old.” ~ Unknown
Entrepreneurs are often enamored with complex ideas and solutions because we love the challenge of figuring it all out. We also buy into the idea that for something to be seriously profitable, it also must be seriously complex. That couldn’t be further from the truth.
Investing in ideas, people, or products that you don’t fully understand can spell disaster. More often than not, big ideas even with big people behind them, don’t get off the ground. Sticking to your core competency and investing in things you know and understand is key to keeping and building wealth. This is one of the reasons why I am not a fan of complex financial instruments and securities like mutual funds, annuities, or other products that take 300 page prospectuses to explain how they work.
Simpler is better. Period. If you can’t understand it, if you can’t fix something that goes wrong with it, don’t invest in it.
3. The last, and perhaps trickiest of the sexy investment pitfalls, is investing in something because someone else, perhaps richer, wealthier, or smarter than you is doing it too. Back in late 2007, I happened to be friends with a member of one of the wealthiest families in the world. The wealthy family had a big investment deal that they were doing, and they were very excited about it. So, me being the aggressive entrepreneur that I am, I tried to find a way to tag along, and I did. Less than a year later, I was looking at a personal loss of about $800,000. Combine that loss along with the perfect storm in the real estate business of 2008 and beyond, I was really taking a beating.
What went wrong?
Well, first I broke rule #1. I invested in something that was sexy, big, and interesting to me. Second, I broke rule #2 by investing because it was complex, and even though I didn’t understand the business or the value of what I was investing in, I knew that the fact that it was complex of course meant that it was going to be a home run. Last, I broke rule #3, I invested because other people, “far smarter and more successful than I,” were investing in it too. I literally broke all three of my own rules, and lost close to a million dollars because of it.
At the time that I made the investment, I didn’t really think about my investment in the proper context. Of course I was following much bigger and smarter guys in, but they also had much bigger pockets than I did, and could afford to sit and wait out the financial storm a lot longer than I could. Being a “follower investor” is a silly, novice mistake. A mistake that cost me a lot of money.
Sexy investments aren’t always the best investments. Invest in the practical, simple, easy to understand things that you can take control of if needed. Hence, why I almost exclusively stick to real estate and real estate related businesses, because not only to I understand it well, but I can touch it, feel it, and when something goes wrong, I usually know how to fix it.
As an entrepreneur, you take a massive amount of risk on a daily basis already. Business is inherently risky. You don’t need to take your hard earned profits and invest in a sexy investment that gets you excited, but that also has the ability to bankrupt you or set you back years and years from your ultimate goal of being wealthy. Don’t compare yourself to Steve Jobs, Bill Gates, Warren Buffet, or anyone else…Don’t fall into the trap of saying, “but they did it and it worked for them.” The truth is, they were entrepreneurs just like you and I, and they were one in a billion. They grew their entrepreneurship skills in an area of expertise that they knew and understood, and as a result of their core competency, they made it big. Be your own entrepreneur, and be your own investor. Be smart, and don’t fall into the trap of investing in “sexy” deals.