The Decision Tree: Moving From "I Want to Invest" to "Financial Freedom"

“Financial freedom is the exact moment your passive income eclipses your living expenses. Getting there isn't about finding a 'hot tip', it’s about building a framework for intentional decisions”

Retoro Capital Investments

Financial freedom is a simple math problem that still eludes most investors: it’s the moment your passive investment income covers your living expenses.

Getting to that answer requires a series of deliberate decisions. What to invest in, how to evaluate the options, how to ensure when we are ready to retire, either by choice or by necessity, that our bills are covered and our lifestyle of living well and giving well can be maintained.

Most investors treat investing like a hobby despite understanding how serious it is, with haphazard attention, decision making, organization, and reporting. Successful investors realize from the foundation that an investing portfolio must be managed like a small family business, because that's exactly what it is.

You are the CEO of your own investing business. You have board members (your family), professional service providers (financial advisors), even clients (your future selves).

High achievers are typically way past the starting line of "I want to invest," but we often doubt if we are doing enough, doing it right, especially if we weren't raised in an affluent family and didn't have the patterns modeled for us. You are not just looking to put more into set-and-forget index funds, which are arguably the best choice of investment in public markets, and you are not just looking for a good deal: you are looking for a path to follow and customize.

There are several decision points and forks in the road. The following is a framework you can use to start to guide your investing journey toward intentional financial freedom.

A well-diversified portfolio has elements of all of the following represented in varying proportions based on your unique goals and stage of life.

Decision 1: Which Arena (Public vs. Private)?

Public Markets

You have a lot of options in public markets. Large institutions like Fidelity or Vanguard provide easy access to stocks, bonds, mutual funds, and index funds. These are highly regulated with daily valuations, acid tests, and registration. They are very liquid, and a good set of index funds benchmarked as the highest averaged returns is a major part of a responsible investing strategy.

But only about 4,000 companies in the US are traded publicly, which leaves hundreds of thousands (including your buddy's "can't miss" tech startup) out of your reach unless you dig a little deeper into private markets. Not only that, but of the top 500 companies on the S&P 500, only 4-5 generate the bulk of the returns in a classic 80/20 example. Index funds are easy, set and forget investments that nearly always beat trading strategies, but despite being the "definition" of diversification, they're just often just a mask due to so few companies driving results.

We aren't talking about trading platforms here, either. Options, futures, trend following, wheel strategy, observational, all of these philosophies and more are entire books in themselves. You should have money in public markets, we do.

(I say, "You should," because that's the standard script, but let's be clear: I am not a financial advisor. Please, don't get investing advice from the internet. We're here for information only, not for specific decision making. Educate yourself and consult relevant professionals.)

If you want to get into more complicated public trading philosophies, by all means. Very few can beat total stock market and S&P 500 index funds, and it's possible you are one, but again to reference 80/20, allocate only a small portion to trading with the rest boring-ly tucked away in index funds, especially while you are learning.

Private Markets

Companies and assets not publicly traded is the world of so-called "alternative investments." Most alternative assets are the same as traded publicly in large companies; assets like real estate or art (real assets), company equity (stocks), and promissory notes (loans/bonds). Even publicly-traded Berkshire-Hathaway has about 60+% of its assets in private companies.

In private markets, you trade instant liquidity for a premium of higher potential returns that reward you for the extra work of networking and due diligence, the additional paperwork, monitoring, and the risk of being in less-regulated markets.

Private markets have historically provided better returns than public markets, 8-10% average versus 12-15% average, but in my opinion, as technology changed public market returns through index funds that regress returns to the mean, we are seeing the same happen in private markets. As the return delta starts to narrow, private markets offer true diversification, especially with the lower minimums we are seeing.

Private markets have also typically meant less volatility because assets are not valued frequently, and trading is restricted due to illiquid hard assets or private-trading discounts of 20-40% if an investor needs out before the investment matures to a liquidity event. This doesn't mean the assets are any less volatile than publicly-traded assets, but it's masked with less frequent data. It's kind of like being forced to not look at your stock portfolio every day to prevent panic selling.

One big temptation of private markets is "over diversification," adding to due diligence and tracking burdens. This is where good systems and technology allow more diversification than ever before with less time on our part. Dashboards, portals, single sign ons, and communication, all make private investing easier.

There is an added layer of access and paperwork many don't expect when they enter private markets. Be aware that networking to find private companies is critical through word of mouth, trade shows, angel groups, conferences, podcasts, and more as a way to learn about companies you can invest with. Also be aware that many private offerings are not allowed to advertise (Regulation 506(b)) so finding out about these takes some digging. Most private offerings only accept accredited investors (eg. net worth $1M+), and you'll need to certify that you are accredited through a letter from your CPA, a third-party verification system, or if investing $200k+ or into a 506(b) you can self certify.

In my experience, private markets have been more than worth the extra effort and risk as long as I kept my 80/20 investing "buckets" intact, focusing mostly on safe and boring with a bit of diversified experimentation and early company exposure.

Decision 2: Which Role (Debt vs. Equity)?

Once you choose an arena, you must decide your role. Are you the Lender or the Owner?

Credit (Be the Bank)

As a lender or private debt provider, you offer loans directly to borrowers, where they come to you or the debt fund you invest in, and not to a federally insured institution. These private loans or promissory notes are often secured by assets like real estate.

That's what we do at Retoro Capital Investments where we focus on senior, or first-lien, real estate debt, which places us with you as our investor in the priority position for payback. We pay our investors 10 or 12% on loans we make to our network of short-term real estate borrowers.

Private notes can be to anyone for any reason, but remember that most debt is still a security meaning you are a limited partner/LP, where you provide the money but not the operational input. Federal and state securities laws and regulations still apply to private notes.

Equity (The Landlord)

As an equity investor, you own the asset or a piece of the asset. You have a right to the profits, but you also share in any possible losses. Equity has a higher ceiling for returns, but it often lacks the stability and security of a debt position.

Equity means you are either a managing owner (general partner/GP), or an investor owner (limited partner/LP). Owners receive stocks in a company, just as with public companies. These stocks are in corporations such as an LLC. In a private company that owns real estate, LPs will have stocks in the entity that holds the title to the property, which means depreciation can be passed through to the LP, an advantage typically not available to publicly traded real estate companies like REITs.

Again, private companies require more due diligence, have less regulation, and more thoughtful placement of capital as minimums are still often $25k-50k and higher. In exchange, they offer more diversification, higher potential returns, and less volatility.

Decision 3: Which Goal (The Trilemma)?

Figuring out your goals and priorities is where you apply the Investor’s Trilemma discussed in more depth in our previous issue.

Every dollar in your portfolio must have a job description. You have three goals for the money working for you: to grow it, to protect it, and to provide a cash flow you can spend.

You'll use a combination approach to achieve all three, but typically you'll be more "forward" with one or the other depending on your stage in life. The pro move is to ensure you aren't over-weighted in one area while starving another.

Decision 4: The Vehicle (Taxable Cash vs. SDIRA)

You can hold your investments in any regular bank account, but if you are running your "family office" or investing business like a business, you'll want to think about legal and tax structures like creating an LLC and a bank account. We prefer a series LLC where each investment or small group of investments has its own child LLC off the main parent LLCs with its own bank account (community banks seem better at series LLC accounts than large national banks). In addition, you'll want to use various dashboard and bookkeeping tools to keep track of your investments.

You'll pay taxes on the money held in taxable cash accounts according to your tax bracket and situation, but those funds are more liquid than tax-advantaged accounts for living expenses you'll incur before you can make qualified withdrawals from tax-advantaged accounts. So again, you'll want some of each for different purposes.

Tax-Advantaged Account Custodians

Mainstream custodians allow only publicly-traded assets, whereas most passive or self-directed custodians allow only private-market assets. You'll want to choose more than one as they have different specialties, fee structures, and customer service profiles.

You can hold multiple tax-advantaged taxable accounts in both public and private markets. Any investable account can be self-directed, such as the most common IRA and Roth IRA, but don't forget Coverdell Education Savings Accounts, Health Savings Accounts, and others.

Your custodian cannot give investment or tax advice. They just ensure they only release funds directly to your chosen investment if your transactions are at arm's length to satisfy the IRS, but you'll still want to consult an accountant for the final word.

The Final Destination: Start Investing by Having Conversations

As mentioned above, Retoro Capital Investments specializes in private credit for short-term real estate loans in the Mountain West region, specializing in Salt Lake City. We'd be honored if you choose to diversify some of your investing budget with us after navigating this tree.

As you go through the decision steps, you will likely realize you are missing some specific components: the way to include these in your portfolio is the same way you'd invest with us, through research and scheduling an investor discovery call. Like most other private-market investment options, we maintain an investor portal where you can review and sign docs, upload your compliance docs, send and receive funds, and monitor progress.

Just remember, truly passive income is portfolio income where your money has a job, and you are the support to getting it to work for you.

Visit partnerwithrci.com to discuss investing together or any other topics we can help you with. Networking is how we make private markets effective together.