You’ve heard the saying “Pigs get fat, hogs get slaughtered.”
There’s great wisdom in that short phrase that can be applied to investing in turbulent times just like the one we’ve been living through these past six months.
There’s also a lesson in there about how to protect your wealth in a time of pandemic or any other disaster.
Up until February 12th of this year when the Dow hit an all-time high, the stock market had been on a roll. We were in the midst of the longest economic expansion in history (just one month shy of 11 years).
Many investors had gotten fat from this bull market in the aftermath of the Great Recession. Wall Street hogs thought the good times would last forever.
Then COVID-19 happened and the stock market went into free fall, hitting a low point on March 23, after having shed nearly a third of its value. Unfortunately, many hogs were slaughtered in that short period, with many witnessing their wealth evaporate overnight.
That dark period for the stock market served two important lessons about protecting your wealth in a time of economic disaster like a pandemic:
- Cash flowing assets are king.
- Wall Street diversification is worthless in a crash.
CASH FLOWING ASSETS AND CASH –
Savvy investors were too smart to think the economy would expand forever.
In fact, in two different surveys, one by UBS of family offices worldwide (average $1.1 B in investable assets) and the other by high-net-worth social network Tiger 21 of its members (average of $100M in investable assets), the ultra-rich had already started to take measures to protect their wealth beginning in the Spring of 2019.
They instinctively knew a downturn was around the corner. They just didn’t know how it was all going to play out.
What measures did smart investors take in 2019 to protect their wealth in 2020?
- The ultra-wealthy double-downed on cash flowing assets in 2019 in anticipation of a downturn in 2020.
- They minimized their exposure to public equities and reallocated significant assets to their already high allocations in cash-flowing businesses and commercial real estate through private equity, debt, and passive investment structures – with more than 50% of their investable assets allocated to these cash-flowing asset classes.
- They also stockpiled cash and expanded their investment windows to seven years and beyond.
Why Stockpile Cash?
No savvy investor is so naive as to think that all risks can be mitigated and that all negative consequences can be avoided in a downturn.
Even with the most recession-proof assets, there’s bound to be some decline. The key is to have enough cash on hand to compensate for any shortfalls and to ride out the storm.
Cash is key to protecting wealth because it prevents having to liquidate assets to meet financial obligations.
We saw what happened to Main Street investors who were heavily invested in the stock market. With no cash reserves, they liquidated their holdings when the market bottomed out just to make ends meet, and in the process, digging themselves a huge hole that will take years – not months – to climb out of.
Why Expand Investment Windows?
Savvy investors like to surround themselves with like-minded investors. They like to partner with investors who invest for the long haul just like them. Why?
Because long-term investments prevent investors from liquidating or redeeming their interests prematurely, which, in turn, prevents runs on capital that can derail an investment before it has a chance to mature and pay back investors.
Investing in stocks doesn’t afford investors this type of security. With instant liquidity, volatility rules the day on Wall Street.
WHY WALL STREET DIVERSIFICATION IS USELESS –
Wall Street’s concept of diversification through investing across several companies and industries to spread risk is useless if the entire market nosedives like it did in March. No company or industry was spared.
Contrast Wall Street diversification with the type of diversification adopted by smart investors. Smart investors don’t diversify to minimize risk (i.e., to minimize devaluation of their interests), they diversify to preserve cash flow.
Private cash flowing assets lend themselves to diversification across a variety of variables including:
- Asset Class.
- Asset Size.
- Stage of Development.
- Investment Structure.
- Compensation Structure.
- Lockup Period.
- Geographic Location.
All of these factors serve to preserve one thing – cash flow – essential for protecting wealth in turbulent times.
While Wall Street hogs got slaughtered when the market tanked in March and as people lost their jobs or fell victim to downsizing from COVID-19 lockdowns, investors with cash flowing assets and cash and who were diversified across multiple assets in multiple markets across other variables withstood the economic downturn better than any other segment of investors.
This serves as a lesson for all investors. If you want to protect wealth in a pandemic or any other economic disaster, seek to build a diversified portfolio of cash flowing assets.
Reinvest most of the cash earned from those investments to compound growth and stockpile just enough cash for future shortfalls.
