How to Hedge Against Volatile Markets

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here is a lot of talk out there today about what's happening in the economy and the markets. People are concerned…

We're seeing rising interest rates and higher inflation. It’s an arena that we haven't seen or experienced in this country for over 40 years, since the late 1970’s and early 1980’s.

What's happening here? How are people adjusting? What do we do going forward? What about investing for practice professionals? There are different aspects of this that people need to be concerned about, but one of the keys is positioning. 

I've been fortunate to have some gray hair, which means I've gone through some of these cycles. In fact, quite a few, starting from the 1980’s. I’ve seen the ups and downs of these cycles and I've learned not to be fearful, but certainly still have some concern. It’s all about positioning yourself – your personal life, your business, and your investments – to navigate the choppy waters ahead.

You can't just keep doing the same thing you've been doing. You can't just hope for a better day or hope that the Federal Reserve will keep printing helicopter money like they've done the last several years (actually for the last 12-13 years). Those days are coming to an end. 

That's why we've seen the rise in interest rates and inflation. Even though the dollar is the reserve currency of the world, it doesn't give us a blank check. We’ve operated like we’ve had a blank check for many years, but that's coming to an end.

You can't just keep piling up debt and not expect to have to pay the piper at some point. What the government has really been doing is stealing from the future. When we steal from the future there comes a time when you have to pay that price.

So how do we deal with it? 

In one’s personal life, you have to make sure your lifestyle is not out of hand. You can’t live on credit. The credit markets have offered cheap money, low interest rate money, across the board. Whether you're using personal lines of credit, business lines of credit, investing in stocks or even investing in real estate today, the cheap money has over-inflated assets across the board. It’s made everybody feel like they're a lot richer than they are.

During the coronavirus pandemic, stimulus monies, in the forms of loans and unemployment benefits, were inefficiently thrown into the marketplace. People that didn't need it, got it. And people who did need it, didn't get it.

It's a very distorted market.

The government can't do a very good job with it. It's a lot of waste, but that waste ends up bloating the markets. So now we're starting to have to pay all that back, and it's not going to be pretty for a lot of people. But you can better position yourself, if you're careful about what your budgets and lines of credit look like, and the kinds of interest rates and credit you're floating.

I would stay away from open-ended variable rate loans right now. If you have those, I would either pay them off as fast as possible, or get them on a fixed rate, amortization schedule (a regular pay down). Don't let those float because those kinds of loans can be called, even if you have good credit. The rates can also go up and cause great harm to the margin in your cash flow, no matter if it’s a personal or business loan.

In your businesses, you may be running a tight ship today and you've had great results in the last two years. A lot of it, understandably, is from the stimulus money that consumers have had, but that money has been taken away. They don't have it anymore. So, you have to think about who your consumers are.

Who are your clients, your customers, your patients? What's going to affect them as we hit the skids and have a market correction/downturn and, ultimately, a recession.

I believe we're going to have some kind of recession. How long will it last? Nobody knows.

But a recession affects everybody, including the people who buy from you, who buy your products or services. It even affects investing for practice professionals.

A recession affects people who rent properties from those of us who invest in real estate. It affects the entire economy. 70% of the GDP in this country, the gross domestic product, is based on consumption by consumers – that is, people who are able and willing to spend money.

When we have a recession and when we have higher interest rates, people start to pull back. They pull back on their spending. They pull back on their plans. They pull back on their expansion ideas.

In the last few years people were not able to travel and do the leisure activities they would do before the pandemic, and with all the extra money given to them, people have been spending money on cars, homes, and massive renovation projects to their houses. They’ve been spending that money because they didn't know where else to put it. Now, that money has gone away. That desire to expand is also diminishing.

That means the demand for what you provide, whether services or products, is probably starting to go down. To what extent will demand go down? We don't know, but you've got to be ready for that.

You have to tighten your margins in your business. Make sure you're running as lean and mean of an operation as possible. Work on all those KPI metrics.

Let’s discuss the investment side of things because that's what we do in Freedom Founders. We invest our capital and position ourselves in the capital markets for security (preservation of capital first), growth, and cash flow (what sustains our lifestyle).

I love to invest in real estate because it's an inefficient market, which means we have opportunities that you don't have in the stock market or on Wall Street overall. The stock market (Wall Street) is run, primarily, by robots today. They use high-frequency trading algorithms which means that we, as individuals, have very little chance to profit from it. We basically end up buying the market.

Higher interest rates and higher inflation, overall, is not good for the stock market. 

Certainly there have been great runs in the last 8-10 years and that's great if you've been a part of that. But I think you've got to shift at least some of that (not keeping all of your capital in one place) because higher interest rates and higher inflation means higher costs to the businesses that are in the stock market. 

Businesses have had super high margins in the last 10 years and super high valuations. Now they’re likely to go down, considerably. Warren Buffett, Charlie Munger, even the late Jack Bogle have all stated that the future decade of the stock market is likely to return far less than it's returned over the last 10 years. We've had around 8 to 10% returns, and they said, “Expect more like 4 or 5%.”

I think that's realistic. If you look in the stock market today, most companies' price-to-earnings ratio, their valuations, are extraordinary. It's like taking a house you might’ve bought a year ago which was worth $250,000, and somehow that house today is stated to be worth $750,000. 

Prices have gone up – but not to that extent.

People investing in the stock market, index funds, or ETFs have no idea what those valuations are. They just like it because they keep going up. It's like investing in that house and thinking that it's worth more, simply because the market or someone says it's worth more. How much air can and will come out of that balloon to drop it down back to what it’s actually worth? That’s the risk that people don’t understand.

When we invest in real estate, we're able to invest based on fundamentals. I will not purchase or invest in a property that doesn't have strong cash flow fundamentals. I just won't play that game. I won't buy equities (ownership) when the market pushes the prices so high.

Where will I go? I'll lend money. When lending money or “being the bank”, I can decide how much money I want to lend based on the value I think the property is worth. I'm not going to lend at 100%. I may lend 70% of what I think the value is and if I can't put my money there, I'll just sit in cash. I'll just sit in cash for a while.

Someone may say, “Well David, you can't sit in cash because inflation is eating up your money.” Yes, they're right. Inflation will eat up my money, but I'd rather take a known loss than an unknown loss and risk putting my money in investments that are not in the right places. 

Fortunately in Freedom Founders, we are able to curate highly vetted, highly underwritten real estate opportunities. Whether it's equities or debt investments (debt as an asset, i.e. lending money), we're able to curate them and have a place to position our money where we believe it's safe, where we’re able to look at the fundamentals.

We stress test everything and you should be too. Do you know how to stress test? Do you know what that looks like for your business or for your investments? Most people have no idea.

This is a time where you really need to get educated and understand what stress testing means. 

By positioning yourself for the future and hedging, not only do you protect yourself defensively, but you can offensively or proactively be ready to pick up opportunities on the backside.

What do I mean by that? When we go through a correction, so many people, businesses, and investors will be pulled out of the market because they have no margin. They'll be gone. The competition will be gone and assets will go on sale, perhaps up to 40 or 50% of their recent values.

That's a real opportunity, whether you're buying businesses or buying real estate

It’s what we did after the 2008 downturn. Positioning was everything. Having access to capital was key, and I don't mean just banks – I mean access to retirement accounts or other people's money who want to be involved in what you do.

There's going to be a great search for preservation of capital, safe places to invest money. A lot of cash is on the sidelines today. It's going to want to come back into the market. If you're in a good position and have the ability to put money to work (knowing how to do it, or having access to that), it's a great opportunity. Don't miss this.

Now is the time to be positioning yourself, and attaining the skill sets and education you need to understand how the markets work. It's not rocket science, but you can't stick your head in the sand and just hope that it's going to work itself out. That's a bad plan. That's only based on hope, and hope alone is never a good plan.

Do what you need to do to gain the market insights and the positioning you need so that you can be proactive in this market, and you will come out a winner, where unfortunately so many won't. I've seen this before many, many times. I'm ready for it again, and so are the amazing practitioners I work with.

The question is, are you? 

To your freedom!

– David

P.S. Whenever you’re ready, here are some other ways I can help fast track you to your Freedom goal (you’re closer than you think) :

1. Schedule a Call with My Team:

If you’d like to replace your active practice income with passive investment income within 2-3 years, and you have at least $1M in available capital (can include residential/practice equity or practice sale), then schedule a call with my team. If it looks like there is a mutual fit, you’ll have the opportunity to attend one of our upcoming member events as a guest. www.freedomfounders.com/schedule

2. Become a Full-Cycle Investor:

There are many self-proclaimed genius investors today who think everything they touch turns to gold. But they’re about to learn the hard way what others have gained through “expensive” experience. I’m offering a free report on how to become a full-cycle investor, who knows how to preserve and grow capital in Up and Down markets. Will you be prepared when the inevitable recession hits? Get your free report here.

3. Get Your Free Retirement Scorecard:

Benchmark your retirement and wealth-building against hundreds of other practice professionals, and get personalized feedback on your biggest opportunities and leverage points. Click here to take the 3 minute assessment and get your scorecard.

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