Making Sure Your Co-Investors’ Financial Health Is Great

If you co-invest or plan to co-invest, make sure your co-investor’s financial health is great.

Reasons? Simple:

  • Ability to track expenses means awareness of one’s financial situation
  • The will to save up cash worth months of expenses shows one’s discipline
  • Being able to afford emergencies increases one’s survivability
  • Having cash on hand during bear markets helps one keep their rationality

All these 4 reasons are for your co-investor and your best interests.

Think about it, the purpose of co-investing is to maximize returns for both your co-investor and you. The best way to maximize returns is to stick to an investment strategy through thick and thin, especially during bear markets where bargains are everywhere. To stick to an investment strategy through thick and thin, you will need to stay rational through the ordeal, you need to be able to survive the bear market so you don’t have to liquidate investments prematurely, you have to have the discipline to stick to the investment strategy and keep pumping money into it, and you need to be aware of how much money you need to pump, what returns you are expecting, and how long it will take to get to your financial goals.

If your potential or current co-investor can’t display attributes shown in the 4 reasons above, then you might want to consider not co-investing with them, since not being able to stick to an investment strategy through thick and thin will cause much trouble for all parties involved.

So what constitutes great financial health? I think it’s comparable to investing in great companies, thus the benchmark is 1.5 Current Ratio and 0.5 Debt:Equity Ratio, with 1.0 Current Ratio being the minimum and >0.5 Debt:Equity Ratio allowed if debt interest rate is below inflation rate.

Not only is this benchmark what Warren Buffett demands from his investments, it just makes a lot of sense personally.

1.5 Current Ratio in personal finance terms is having 1.5 years / 18 months worth of expenses in liquid assets. 18 months worth of expenses in liquid assets is ideal since by observation, on average, most of my college friends found a job within 1 year, but a minority could only find a job after around 1.5 years of job searching, while a few outliers are still without a job after more than 1.5 years of job searching. It would be crazy to prepare for all scenarios that happen within 6 standard deviations (99.99966% of all scenarios), but it’s not unrealistic to prepare for all scenarios that happen roughly within 3 standard deviations (99.7% of all scenarios) That’s why I prepare for the 1.5 year duration needed scenario.

The 1.0 Current Ratio being minimum is just because it’s the most cost-effective way to insure yourself of a job loss situation, since 1 year’s worth of expenses in liquid assets can help insure you roughly 2 standard deviations (95% of all scenarios). It is then better to build your way up to 1.5+ Current Ratio by having liquid assets be 25% of your Net Worth, so that as you build your Net Worth you build your Current Ratio as well.

The 0.5 Debt:Equity Ratio in personal finance terms is the ratio of Total Debt to your Net Worth (Total Assets – Total Debt). 0.5 Debt:Equity Ratio means that for every $1 Debt you have you have $3 in Assets (eg. if Net Worth is $100 and Debt:Equity Ratio is 0.5, then you have $50 Total Debt and $150 Total Assets), which is a good ratio since it means that if you were to pay off all your debt today, you can afford it comfortably, reducing your probability of going bankrupt.

The reason why >0.5 Debt:Equity Ratio can be tolerated when debt interest rate is below inflation rate is because your debt is basically free money by having inflation rate gobble up the real value of your debt interest rate. It makes sense to not rush paying off such debt to fully utilize this free money phenomenon, which is what I’m doing with my student debt interest rate at a mere 1.395%.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

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