Investing Education 102: Capital Deployment

Introduction

After 40 years in the investment world and listening to thousands of successful millionaires and entrepreneurs, I’ve developed my own understanding of what it takes to invest successfully. For newer investors, particularly those under 45, the process of putting together the trial and error experiences and identifying the key characteristics of sound investments can be challenging. This educational series aims to break down investment concepts in their simplest form.

This discussion focuses on one of the four key ingredients to successful investing: how much money you’re being asked to invest and what that looks like relative to your net worth.

The Capital Deployment Question

When someone approaches me with an investment opportunity, the first question I ask myself is whether I can afford the requested investment amount. If someone calls me today asking for a million-dollar investment, I have to immediately assess whether I have that liquidity available. Even if I do have the funds, a million-dollar investment requires a whole new level of seriousness, due diligence, and consideration.

The decision isn’t just about having the money—it’s about determining whether that level of investment makes sense given my current financial position and goals.

The Net Worth Perspective

Let me illustrate this with a practical example. Suppose I have a net worth of $5 million, and someone asks me to invest $25,000 in a particular opportunity. That represents just half of one percent of my net worth—a relatively easy decision to make. With a $5 million net worth, I should be generating somewhere between $250,000 to $1 million in passive income, active income, interest from CDs, money market accounts, and W-2 income annually. A $25,000 decision shouldn’t be overwhelming under these circumstances.

However, if that same person asks for $250,000, we’re now talking about 5% of my net worth. This shifts the conversation entirely and moves me up the risk scale significantly. The higher the investment amount relative to my net worth, the more significant the personal financial risk becomes.

Understanding Two Types of Risk

It’s crucial to understand that every investment decision involves two distinct types of risk:

Asset Risk

This is the risk inherent in the investment itself—the due diligence related to the asset, the investment strategy, the market conditions, and the potential for success or failure of the specific opportunity.

Net Worth Risk

This is the personal financial risk you’re taking relative to your total wealth. When I consider putting $1 million (20% of a $5 million net worth) into a particular asset, I’m not just evaluating the investment—I’m evaluating what that decision means for my overall financial security.

Calculating True Net Worth

Here’s where many people make a critical mistake. When I talk about net worth, I’m not referring to that inflated number you might share with friends at the golf club. I’m talking about your true, liquidation-value net worth.

Imagine you had to sell everything today—your house, car, jewelry, furniture, investments, everything you own. What would you actually receive after taxes and transaction costs? Many people who think they’re worth $5 million might actually be worth $3 million when they account for real-world selling conditions. Those who believe they’re worth $3 million might discover they’re closer to $1 million after discounting everything to fair market value.

This realistic assessment is crucial because it directly impacts how you should approach investment decisions.

Income Considerations

Your approach to investment risk should also factor in your income situation. If you’re earning $1-3 million annually from your profession or business, you can afford to take larger risks relative to your current net worth because you have substantial income replenishing your wealth. Whether you’re a doctor, lawyer, engineer, or entrepreneur with a growing business, knowing that your net worth will continue to expand gives you more flexibility in your investment decisions.

Conversely, if you’re later in your career or have limited income growth potential, your net worth becomes more finite. Without significant W-2 income or business income to replenish your wealth, you must be more conservative with your capital deployment decisions.

The Importance of Regular Assessment

One of the most critical aspects of successful investing is continuously evaluating your investment portfolio and adjusting your net worth calculations accordingly. Don’t kid yourself about the current value of your investments.

If you have money in syndications, multifamily properties, self-storage facilities, notes, or debt investments that are performing poorly, you need to adjust your net worth downward. That $300,000 note investment that’s in trouble? You might only recover 50 cents on the dollar. That self-storage deal that’s struggling due to rising capital costs? You might be lucky to get your principal back. That investment that was supposed to mature in 36 months but is now at 48 months with no end in sight? You might need to write it off entirely.

Making Sound Investment Decisions

Every new capital deployment decision you make is highly critical and should involve a two-step evaluation process:

1. Evaluate the asset and its inherent risks through proper due diligence
2. Assess the risk to your net worth based on the investment amount relative to your total wealth

This dual analysis ensures that you’re not just making good investment choices, but making investment choices that are appropriate for your personal financial situation.

Preservation of Capital

At the foundation of all investment decisions should be the principle of capital preservation. The goal is to deploy capital in ways that provide the returns you want, in the asset classes you prefer, while minimizing the chance of losing money. This requires diligent evaluation of every investment opportunity, regardless of size.

Conclusion

Successful investing requires understanding that every investment decision affects you in two different ways: through the inherent risk of the asset itself and through the impact on your overall net worth. By maintaining a realistic assessment of your true net worth, considering your income situation, and regularly evaluating your investment portfolio, you can make more informed decisions about capital deployment.

Remember, the amount someone is asking you to invest relative to your net worth determines the level of consideration and due diligence required. The higher the percentage, the more serious the evaluation process should be. This doesn’t mean you shouldn’t make larger investments—it means you should approach them with the appropriate level of analysis and consideration they deserve.