A strategy to reallocate a percentage of one’s stock portfolio seems to be both timely and prudent when considering the effects of volatility and inflation can have on the stock and bond market. The extreme volatility that the traditional stock markets (the Dow and S&P) have experienced over the past 100 years, which seems to be increasing in frequency in the 21st century, should be of paramount concern to investors with long stock market positions yet more short-term investment horizons. Furthermore, inflation has increased over the years due to the expansive monetary policies in place by the Federal Reserve and its reactions to economic and geopolitical events. Inflation has not only triggered bear markets which can take decades to fully recover, but also exacerbated the decline in real purchasing power of stock portfolios. Preserving net worth against volatility, inflation, and bear markets demands a strategy of portfolio reallocation to hedge exposure to these risks through wider diversification to less volatile assets that are a natural hedge against inflation.
Endowments and major pension funds have already implemented such a strategy since the financial crises of 2008 with between 19 percent to 50 percent allocation to alternatives. The alternative real estate private placement offerings that have been developed over the past 20 years now allow the private investor to access equivalent institutional quality real estate at low investment minimums. Furthermore, since the 2017 Tax Cuts and Jobs Act, investors have the ability to reallocate out of appreciated stocks into alternative real estate investments on a tax-sheltered basis by deferring the capital gains tax using qualified opportunity zone investments.
As stock and bond markets are often resilient and provide excellent liquidity, a majority of an investor’s overall portfolio should remain in traditional stocks and bonds with at least 20 percent reallocated to alternative real estate investments on a tax-sheltered basis. The combined diversification in equities, bonds, and real estate is an effective way to minimize the risk of volatility, inflation, and bear markets under a full implementation of modern portfolio theory.
One reason people flock to Berkshire’s annual meeting is to hear the “Oracle of Omaha” (Warren Buffett) offer wisdom on living life well. At the 2023 annual shareholder’s meeting he did not disappoint. “You should write your obituary and then try to figure out how to live up to it,” he said. Buffett also stressed the importance of kindness, saying he knows rich people who’ve died without friends.
A strategic reallocation plan should be forward looking and highly personalized to not only preserve capital but also build wealth over many decades. The plan should not only be insightful by anticipating the private investor’s essential needs but also be an aid that helps propel the investor to reach ambitious lifetime goals and dreams. Accordingly, the plan should approximate the investor’s cash flow needs, anticipate future liquidity events, provide for legacy philanthropy, and accommodate the investor’s estate plan. By doing so, the implementation of the plan over time will help to empower the private investor to not only live well but finish life well. Lastly and most importantly, integral within every aspect of the plan, professional care must be exercised to ensure that specific investments are suitable for the unique investor given his or her individual risk tolerance, time horizons, investment income or growth objectives, and aversion to tax exposure.
How much cash flow will the private investor need to live well and preserve a thriving lifestyle? One method is the reverse engineer the amount of cash flow the private investor would like to receive either on a monthly or yearly basis. Based on the estimated monthly or annual cash flow needs, the plan may extrapolate the amount of the required real estate equity that will need to be invested given current CAP rates, interest rates, and future cash flow projections. Detailed year-by-year cash flow projections may be found in the private placement memorandum (PPM) documents for each real estate investment offering. It may be prudent to provide for an additional margin of income to account for possible variations in the cash flows generated by the properties due to various market forces.
Building upon the alternative real estate investments that have been selected to support the quantified cash flow, additional investments may be carefully selected and added to the portfolio that provide additional future liquidity events. Based on the business plan presented within the PPM, future liquidity events may be timed to provide funding for specific life goals and legacy aspirations. In addition, certain types of real estate offerings may be used to help aid in implementing and facilitating of the investor’s estate plan.