Robert Kiyosaki, author of Rich Dad Poor Dad and CASHFLOW Quadrant: Rich Dad’s Guide to Financial Freedom among other books, has emphasized the power of investing in private markets to build wealth. He was interviewed recently and spoke with a “trance-like” voice the phrase that we frequently read or hear in advertisements…”create a diversified portfolio of stocks, bonds, mutual funds and ETFs.” It was funny because his voice was as if he was a zombie or possessed or brainwashed and just mindlessly repeating this. The implication with this “trance-like” state is that the brain is turned off.
“Create a diversified portfolio of stocks, bonds, mutual funds and ETFs. Create a diversified portfolio of stocks, bonds, mutual funds and ETFs.” This is the message to the masses…the middle class – the person who is typically an employee, pays their ordinary income taxes, saves for retirement, invests in their employer-sponsored 401k plan, and perhaps turns their money over to their financial advisor. 401k plans only allow for investments in the public markets, and most advisors from our experience do not provide exposure to private placement investments. Stocks, bonds, mutual funds and ETFs are investments in the public markets.
But what about the private capital markets? This market is actually much larger than you may realize. It is larger than I realized. It shocked me. Private offerings, which according to the SEC was $2.9 trillion in 2018, while public offerings accounted for only $1.4 trillion of new money in 2018…so more than double the size.
Most private capital investment opportunities (I.e., securities) are filed with the SEC as an exemption to Regulation D of the Securities Act, either as a 506b exemption or a 506c exemption. This allows the security to not be formally registered with the SEC (i.e., “unregistered”), yet in order to do so, the security offering must comply with the SEC requirements. For 506b, the security is limited to 35 sophisticated investors and the remaining investors have to be accredited. 506b offerings cannot be advertised and the investors must have a preexisting and substantive relationship with the sponsor group. I had one SEC attorney tell me to think of the letter “b” as “buddy”. 506c offerings can be advertised to the general public, yet all investors must be accredited.
An accredited investor is someone who either has an annual income of $200,000 (single) or $300,000 (married) for the prior two tax years with an expectation of earning that income in the future, or someone who has a minimum net worth (excluding their primary residence) of $1 million. A sophisticated investor is someone who doesn’t meet the accredited investor requirements but has suitable investing and business experience. This is someone who has invested in the past, who maybe is a business owner, and who is able to understand and appreciate the risk of a potential private capital investment. The SEC has made these stipulations on private investments to protect potential investors from investing all of their assets in a single investment. They figure that sophisticated investors have the financial intellect and accredited investors have the financial wherewithal to avoid this situation.
Green Bison considers private investments as potentially less risky than public investments. We make this statement with certain stipulations. All investments should be made only after the investor does his homework to understand the potential risks and the potential rewards of the investment opportunity. However, from our experience, this homework (“due diligence”) can more easily be completed with private investments (rather than public investments). Please know that our private investing experience has been with real estate assets. The result of you doing your homework should be you being able to “look behind the curtain.”
- Your homework should include investigating who is providing the opportunity. What’s their track record? Talk with them. Email with them. Go meet with them. Get referrals. Contact the referrals. Get referrals from the referrals, and contact them as well. The folks we invest with are very accessible and good communicators. They are happy to answer any questions and are forthcoming with information.
- Research the deal itself. Does it meet your investment criteria in terms of risk and reward? Are you okay with the liquidity or lack thereof of the investment?
- Is there an intrinsic value to the investment? Is the investment affected by the public markets or by general public perception/behavior?
We make the statement that doing your homework on an investment in the public market can be more difficult than a private investment. This seems counterintuitive because the opportunity is for the public, right? I mean – It’s out there. It’s not private or hidden?!? The issue with public offerings is that the “value” is typically exposed to the human behaviors of the masses. A tweet from the US president…a change in foreign trade policy of one of the G8 countries…The stock market is influenced by two primary human feelings: greed and fear. This brings up the field of behavioral finance and the science that goes behind trying to understand these motivations and their influence on public market valuations. External forces exist that can push and pull, for example, on a large publicly-traded company. Then take a grouping of individual stocks to form a mutual fund. The complexities can increase exponentially. As you can see, this topic is extremely complex which can make an investor’s due diligence difficult to complete.
Robert Kiyosaki said “Investing is not risky, but being uneducated is risky.” For these reasons, we include private investments in our overall investment portfolio as a means to grow wealth over the long term. Now go and do your homework!
