The news is officially in.
The Federal Reserve has spoken.
And, as predicted, there was nothing shocking about Jerome Powell’s Jackson Hole remarks on Friday.
We heard that “the time has come for policy to adjust” since the Fed does not “seek or welcome further cooling in labor market conditions.” That and “the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
In other words, he and his are still hedging their bets (which is somewhat understandable). But they’re nonetheless fairly certain the economy is ready for a course correction.
What Powell was absolutely certain about was a bit of back-patting:
Some argued [two years ago] that getting inflation under control would require a recession and a lengthy period of high unemployment. I expressed our unconditional commitment to fully restoring price stability and to keeping at it until the job is done.
The FOMC did not flinch from carrying out our responsibilities, and our actions forcefully demonstrated our commitment to restoring price stability…
All told, the healing from pandemic distortions, our efforts to moderate aggregate demand, and the anchoring of expectations have worked to put inflation on what increasingly appears to be a sustainable path to our 2% objective.
Fair enough.
Maybe.
I’ll take a page out of Powell’s playbook and say my final conclusions on the Fed’s efforts “will depend on incoming data.”
In the meantime, I do expect certain companies to reap the benefits of lowered rates. And, as always, I’ll call them as I see them.
Stay tuned!
But for today, considering the positive – even euphoric – attitude some investors now have, I want to offer a word of caution. Three of them, actually.
There are always potential risks to consider along with potential rewards… just like there are always ways to decrease those risks.
So here are three of the biggest lessons I’ve learned over the course of my investing career. I hope they benefit you every bit as much as I’ve profited from them since I let them sink in.
Lesson One: Don’t Knock Diversification
You’ve heard the saying, “Don’t put all your eggs in one basket,” and you probably agree with it.
In theory.
It’s easy to agree with good advice on an intellectual level. It’s much harder to put into practice.
For instance, I thought I was diversifying back in my commercial real estate development days. I owned more than one property. I built for more than one company. And I leased to an even wider range of businesses – every single one of which I researched before signing on.
I also considered myself an intelligent and responsible individual. So, while I knew I could fail, I didn’t actually expect that I would.
Yet I did. Twice.
First, it was because of my lousy business partner. He decided to use our mutual assets to cover personal ones that were underwater…
The result was both of us losing out. Enormously.
That catastrophe – which I’ll detail shortly – taught me to better evaluate who I made deals with. But I somehow still managed to miss the diversification memo. It wasn’t until the 2008 real estate market collapse that it finally hit home.
Then, after I lost almost everything (yet again), I realized the truth: that it wasn’t enough to be invested in multiple assets. Those assets also had to be spread out across numerous economic classifications.
That way, if one category hit a snag or even a catastrophe, the others could sustain me.
Which, for the record, is exactly what has happened ever since I put this revelation into practice.
Lesson Two: Think Twice About Your Debt
Debt, or leverage, isn’t a bad thing in and of itself.
Everyone knows the more money you have, the more money you can make. So if someone else is willing to “give” you more money, why not take it?
That’s not a stupid question. But the answer does come with strings attached since nothing ever comes free.
Most of us wouldn’t be able to buy a house without borrowing from a lender. In the same way, most businesses can’t grow without taking out loans.
Either way, however, it takes an equal amount of ownership from the “owner.” Homebuyers who don’t fulfill their monthly mortgage obligations can be foreclosed on. And businesses can collapse under the weight of unsustainable debt as well.
Between the principle that needs to be paid back, the interest that needs to be paid off, and every other unaffiliated expense that needs to be addressed…
Some people can handle it under some circumstances. Others can’t.
And the more leverage an individual or business takes on, the more likely they’ll fall into that latter category.
Once again, I learned this lesson the hard way. Going back to that partnership, we were both exposed to high levels of leverage as we took on project after project.
Considering how gangbusters real estate was going, I thought our operations were sustainable. But then he stopped paying the mortgages.
And then the banks came to me. Those financiers who were my best friends during the good times became my worst enemy when things went south.
I managed to not declare bankruptcy that time. Barely. But the ordeal was more than enough to teach me the value of watching how much I borrowed and under what conditions.
Lesson Three: Know Your Facts. All of Them.
Last but not least of my lessons learned (for today) is the need for transparency. And I can turn back to my former partner once again to illustrate this.
If I’d known what he was doing way back then, I would have stopped him. But I didn’t stop him because I didn’t know.
I didn’t know he took out loans on many of our assets.
I didn’t know he pocketed over $1 million in rent checks from one of our shopping centers.
I didn’t know he never paid the mortgage at all on that property.
I didn’t know he added four other mortgages to it that totaled another $2 million.
How did he get away with all of that? It was all due to our business contract, which had me operating the buildings and him handling the finances. I didn’t have access to the books, nor did I ask for a peek.
This arrangement made it very easy for him to take advantage of me. Exceptionally so.
Now, not every partner ends up being corrupt. But everyone – from individuals to businesses – can make mistakes. Moreover, they do make mistakes. Sometimes they’re small ones. Sometimes they’re big ones.
Sometimes they run into problems that weren’t their fault at all yet still end up affecting you.
Whatever happens – good or bad – I want to know about it. I need to know about it.
That’s why the stock market is such a great place to invest in. Publicly traded companies have to release a wide range of financial and finance-related data every single quarter.
Data I strongly suggest you utilize.
As with diversification and leverage, you have the choice to use it intelligently or foolishly. My advice is to choose the former.
Be like me today after I learned my lessons, not the me who had to learn them the hard way.
Regards,
Brad Thomas
Editor, Wide Moat Daily