As this error has cost my family (big) money, I’m going to share a case study that illustrates the point.
One of my jobs is to manage a small portfolio of local real estate. From time-to-time items come up that need to be sorted. Each of those items represents a small dose of unexpected pain.
In most years, there will be a dozen items that require action. Total cost of these items is on the order of one-month’s living expenses.
To give an idea on scale of the “pain”, the portfolio is worth ten-year’s living expenses and, annually, it generates cash equivalent to seven-month’s living expenses.
Combining the above, you could calculate that the portfolio has a cash yield of ~5% on net realizable value.
When compared to all of the alternatives, this investment is one of the best places to invest.
But the random, little bits of pain hurt — jammed sewer lines, flooded basements, six-foot high marijuana plants, missing tenants, leaking toilets… none of this is unusual, or unexpected.
The small doses of pain hurt so much I’ve been considering selling the portfolio and switching into a less attractive investment.
To escape the small and random pain, I am willing to accept certain, large and immediate pain! A discount on market value and payment of significant tax liabilities. The total cost would be more than two-year’s living expenses.
In a fantastic investment, with less attractive alternatives, I’m willing to pay 25x more than the cost of the pain to make it go away.
Rather than pay two-years living expenses to make the pain go away, I’ve hired a property management company to insulate me from the pain.
Annual cost is 0.6% of net realizable value and less than a month’s living expenses.
Beware of quick reactions triggered by small, negative surprises.
They are often irrational.