Risks of Endowment Style Investing for Personal Finances: Lessons from a Catastrophic 2020

The Endowment model of investing is a very interesting one. It’s been popularized by Yale and Harvard University, where they have been able to generate higher than average returns every year.

“Between 1985 and 2008, Harvard University’s endowment generated 15.23% returns, while Yale pulled in 16.62%. Both endowments handily outperformed the S&P 500, which only grew 12% during that same time period.

In the decades leading up to the economic crisis, from 1985 to 2008, endowments with assets of US$1 billion and above generally invested a small portion of funds in traditional stocks and bonds and a larger portion in alternative assets such as hedge funds, private equity, venture capital, and real assets like oil and natural resources. Many of these alternative investments outperform traditional stocks and bonds, but typically have longer gestation periods and impose higher minimum investments — especially in highly illiquid markets.”

Source: How To Invest Like An Endowment

Basically it’s a portfolio with both liquid assets (like equity, bonds & cash) balanced by higher return but more illiquid alternative assets (ie. hedge funds, VC, PE & even art & timber).

So using my own personal example: when you have a portfolio stuffed with mainly illiquid assets like venture capital (LP & Carried Interest), angel investments in early stage startups, Investment Rental properties. (Ie. real estate), stocks in 401K and some crypto (thankfully the last bit is liquid). I found myself in a very enviable position of being relatively “Asset Rich, Liquidity Poor.”

On paper & in the long term I should be fine, but it is the short term surprise squeezes which wreck you. I did not follow the lesson from math & the ecology: “Always Account for Variable Change”

So, for example during the pandemic in 2020, I found myself facing non-paying tenants with the addition of a local government mandated eviction ban. You just have to eat this. Add to this, some delayed accounts receivable payments for some loans and advisory work, I ended up facing a VERY painful cash crunch during the summer. Added to this, the ongoing government mandated lockdown, the BLM movement and consequent riots, Forest Fires & oh yeah, the raging Covid 19 Pandemic that started all this. And then there was chaos of the larger government mismanagement and the lead up to a zany contentious election in the USA. It was a really tough couple of months.

I barely got through it and it was only from a combo of borrowing money from family (much to my embarrassment) and selling some assets at a discount. (Yes, i know #Firstworldproblems, thankfully i had some assets to begin with)

As the famous investor Howard Marks states: Every investment move has to be defensive and offensive. This is why a thoughtful portfolio approach that accounts for all situations makes sense. Something I did not do.

I’ve thought a lot about this. In retrospect there were many things I should have done.

So learn some lessons from my own mistakes. Here are some key takeaways:

1. I should have taken a Barbell Approach to my investments. It should have been balanced with more liquid assets like stocks & crypto.
2. I was over-geared. You should always try to keep 9–12 months emergency liquid funds in your bank ie. cash. Yes, I know this is basic stuff but how many people actually do this (or can actually do this). I was a bit too aggressive with only a few months of liquid cash. Probably overly optimistic here going into 2020. Having some liquid reserves allows you to survive the cash crunch and hold on to your assets. I had to sell a rental property at a less than optimal price to get through the crunch. I still came out ahead fortunately but it was at a substantial discount to optimize for selling fast.
3. Keep personal cost structure as low as possible. Thankfully I tend to be pretty frugal. BUT your own personal budget needs to be evaluated and trimmed on a regular basis. I’d recommend doing this exercise once a quarter, and the minute a financial crisis hits, don’t hesitate and cut right away. I screwed up majorly. I did not start cutting until 3 months into the pandemic, wasting precious cash when I needed it later.
4. As a continuation of Point 3. Geo-arbitrage is a smart & enjoyable way to cut down your personal costs structure. My family is lucky enough that we can spend a good part of the year in Canada or Taiwan, where the US Dollar goes much further.

By doing this, you can reduce your living expenses in very pricey San Francisco (or wherever you live) by a very large percentage. This is also something I should have executed on earlier in the pandemic. Like many people in America, I did not expect a lockdown lasting beyond 3 months, nor the gross governmental mismanagement that occured here.

5. Do a regular and personal accounting of your P&L for all of your business lines whether it is real estate, consulting, investing etc. regularly. At minimum once a quarter, although once a month is way better. This is the only way you can keep on top of things. In fact, i did not realize how much cash money i was losing in my real estate holdings until August, 6 months after the lockdowns started.

6. Make sure you follow up on personal accounts payables collections. This turned into a major issue for me by June/July 2020.

I share all this because I don’t want you to make my mistakes. Yet, as i write this I know this is the path everyone needs to figure out for themselves. These mistakes were painful, self inflicted & caused a lot of personal stress which I would not want to wish on anyone.

But at the same time, it was really personally instructive. You learn what you are made of. Once you get through something like this, you really become far stronger, more confident and feel capable of handling almost anything. As the African proverb states: “Smooth seas do not make for skillful sailors.”

This is especially if they value having more personal freedom in their lives. 2020 made it very clear to me that you cannot have personal freedom without some form of financial freedom. But as I paraphrase ex-Navy SEAL and leadership coach, Jocko Willink, you can’t have Freedom without Discipline. This will not be lost on me going forward.

Listen to this Newsletter: https://listencat.com/the-hard-fork-by-marvin-liao-podcast/