Why Most Investors Misunderstand Risk | Ep. 14

In this episode of The Sage Investor, host Brian Spear challenges the fundamental academic dogma of investing: the idea that achieving higher returns inherently requires taking on higher risk. Drawing a sharp contrast between academic theory—which defines risk as volatility and plots it neatly on a spreadsheet—and real-world investing, Spear redefines risk as the actual probability of permanent capital loss. Through compelling historical narratives, including a multi-generational family office that nearly lost a $100M+ suburban office portfolio due to fragile debt structuring during the 2020 pandemic, Spear illustrates how risk quietly accumulates during stable bull markets, remaining completely invisible until market conditions shift.

The episode outlines a decision-making framework for limited partners to evaluate operators, explaining how to distinguish a genuinely skilled capital allocator from a “lucky idiot” who was simply lifted by favorable macroeconomic conditions. Spear presents historical asset class data spanning multiple market cycles, making a data-driven case for mobile home parks as an institutional real estate niche that achieves an optimal risk-adjusted return due to low supply growth and highly durable, non-discretionary demand. This briefing is designed for high-net-worth passive investors and business owners seeking to protect their hard-earned wealth. Listeners will learn how to shift their investment filters away from chasing nominal returns and toward evaluating structural stability, ensuring their portfolios can survive inevitable black swan events.

Key Takeaways

• Takeaway 1: True investment risk is not academic volatility or price fluctuations; it is the real-world probability of experiencing a permanent loss of capital.
• Takeaway 2: Risk is highly deceptive because it hides quietly inside the capital and debt structures of an investment during bull markets, only becoming visible when a crisis exposes it.
• Takeaway 3: A skilled investor is not defined by high nominal returns, but by the ability to either generate the same return with less risk or a higher return with the same risk.
• Takeaway 4: Mobile home parks historically offer an optimal risk-adjusted return in real estate because they combine highly durable, essential housing demand with virtually zero new annual supply growth.
• Takeaway 5: Black swan events do not generate new risks within a portfolio; they merely reveal the structural fragility and hidden leverage that were already present.

Key Topics Covered

• Redefining Investment Risk vs. Academic Volatility
• Structural Fragility and Debt Service Coverage Ratios (DSCR)
• Evaluating Operators: Skilled Allocators vs. Lucky Idiots
• Achieving Alpha and Superior Risk-Adjusted Returns
• The Deceptive Nature of Bull Markets and Asset Inflation
• Mobile Home Parks as a Defensive Real Estate Asset Class
• Supply and Demand Metrics in Manufactured Housing
• Black Swan Events and Portfolio Survival Strategies

Episode Chapters

00:00 Introduction

Brian introduces the core philosophy of the podcast based on a Warren Buffett quote: to succeed, you must first survive. He highlights why most investors mistakenly focus entirely on maximizing returns rather than designing portfolios that can withstand market uncertainty.

01:09 Dangerous “Risk” is Hidden

Brian shares a cautionary tale of a multi-generational, hundred-million-dollar real estate portfolio that almost collapsed during COVID-19. He explains how low loan-to-value metrics can mask dangerous structural fragility and thin cash flow cushions.

05:34 Risk Does NOT Mean Reward

This section breaks down the flaws of standard academic finance charts that claim higher risk automatically equals higher returns. Brian explains that true risk involves a widening distribution of potential outcomes, including severe downside and total capital loss.

09:53 Skilled Investor vs. Lucky Idiot

Using visual frameworks, Brian defines the concept of adding true “alpha” to a portfolio. He explains how limited partners can differentiate between an operator with actual risk-management skills and one who just looks good due to a rising market.

12:43 We Saw the Truth

Brian discusses how forty years of falling interest rates and rising asset values created a bull market deception where everyone looked smart. He explains how a sudden shift in macroeconomic conditions quickly exposes unearned investment success.

13:49 The Best Risk-Adjusted Return

Brian shares historical performance data showing why manufactured housing has outperformed other real estate sectors. He explains how the unique combination of low volatility, low supply growth, and non-discretionary demand creates superior risk-adjusted returns.

20:27 The Bull Run Deception

This section explores historical anecdotes from 2007 and various market cycles to show how retail euphoria signals market tops. Brian explains how risk builds up quietly inside the financial system when capital and credit become too abundant.

22:15 Black Swans Are Coming

Brian introduces Nassim Taleb’s concept of Black Swan events and explains that extreme market shocks do not create risk, but rather reveal it. He previews the next episode’s focus on building bulletproof portfolios to survive macro uncertainty.

Full Transcript

[Transcript begins]

Brian Spear: There’s a quote from Warren Buffett that I think about often. In order to succeed, you must first survive. It’s sound simple, it’s almost obvious, right? But in practice, very few investors actually build their investment strategy around that idea. Most investors spend the vast majority of their time just thinking about one thing, how to increase returns, how to squeeze out a few extra percentage points along the way. But very few investors, they spend time thinking about something much more important. How to design investments that survive uncertainty. Over the course of a long investment career, that difference quietly determines who compounds wealth and who eventually loses it.

Welcome back to the Sage Investor. My name is Brian Spear, and my mission is to help you generate cash flow and build legacy wealth in a tax-efficient manner, because that’s what I’m trying to do for my family, and I’m helping as many people as possible do just that along the way by sharing all the secrets I learn along that path. Today, we’re going to talk about one of the most important ideas in investing, and it is understanding risk. Because if you misunderstand risk, you will misunderstand investing. If you misunderstand investing, you’re eventually going to pay for it.

Earlier in my investment career, I met an investor who had built an extraordinary real estate portfolio. This was a family business that had been operating for decades, hundreds of millions of dollars of office properties, suburban office buildings in multiple different markets, and by almost any measure, this investor had done a fantastic job. The portfolio had grown steadily over time, the family had accumulated significant wealth. It was multiple generations in the business by this point, and importantly, the investor believed he’d been extremely conservative, because the portfolio only had about 50% leverage.

If you ask most investors what excessive leverage looks like, they’re going to say something like 85% LTV, 90% LTV, and that’s what people picture when they hear the phrase over leveraged real estate. But when we looked deeper into the portfolio, something else became clear. The loans were fully amortizing. The loan terms that were relatively short, and the debt payments were very heavy. Even though the loan to value looked conservative, the cash flow cushion was extremely thin. The portfolio was operating only at about 1.1 to 1.2 debt service coverage ratio, which meant that there was almost no margin for error.

For decades, everything worked fine. Tenants came in, they paid rent. Debt service got paid like clockwork. The portfolio kept on growing. But then in 2020, COVID hit, and the office tenants, they stopped paying. Collections dropped dramatically. And suddenly, this investor, who’d spent his entire life building this family’s wealth, was facing the possibility of losing the entire portfolio. Not because the assets were bad. Not because the leverage was extreme, but because the structure was fragile, and that experience illustrates something incredibly important about investing. Risk, it rarely is obvious when times are good. It just hides. It hides quietly inside the structure of an investment, until something unexpected exposes it.

If you went to business school or you took a finance course, you probably learned that risk is defined as volatility, as beta. But how much the price of an asset moves around, how much it goes up and down? If the price moves a lot, the asset is considered, quote unquote, risky, right? If the price moves very little, then the assets considered more safe, and that’s the academic definition of risk. And from a mathematical perspective, it’s unbelievably convenient. I feel like a lot of professors ultimately chose that because they could plug it into a spreadsheet. It’s easy to measure, right? That volatility, it is very easy to measure. You could plug it into formulas. You can calculate the sharp ratio. You can create really elegant financial models and put it into a pro forma. It’s nice. It’s convenient.

But here’s the problem. That definition of risk, it does not match how investors actually think in the real world. No investor has ever said, look, I don’t want to buy that asset because the price might go up and down really quickly. It might be volatile, right? What they actually say is something much more simple. They say, I don’t want to invest in that deal because I don’t want to lose my money. And that’s actually what risk is, right? It’s trying to avoid capital loss. It’s trying to avoid losing your money. And that distinction is incredibly important. An investment can be volatile without being risky. An investment can also be very stable while actually being extremely risky.

One of the investors who’s written most clearly about this is Howard Marx. I think he’s done a pretty good job of explaining risk very, very well and some things that are incredibly insightful along the way. He’s got this idea in this concept that risk cannot be measured precisely. It cannot be measured inside of a spreadsheet, the way that a professor would otherwise want. It cannot be reduced to a single number. And most importantly, risk is often invisible. When markets are really stable, when liquidity is abundant, when asset prices are rising, risk appears to disappear. But in reality, risk is often just quietly building underneath the surface. During those periods of rising inflated prices along the way, risk continues to go up and up and up. And it only becomes visible when something goes wrong.

I want to pause here and actually just share my screen for a moment because I think a picture is worth a thousand words right? And it can help explain this idea far more clearly than words alone. And for those of you who are just listening on an audio, I’m going to do my best to describe what I’m showing you here. If you took a finance course in college or in business school, this first chart will probably look very familiar for you. On the horizontal axis, the x axis, you’re going to have risk. And on the vertical axis, the y axis, you have return. It just slopes up and to the right, very simple chart. And the message is very straightforward. The more risk that you take, the more return that you should expect. And that’s the standard academic framework.

Now, on the next chart, it becomes a little bit more specific here. It plots various different asset classes along that same line. So you kind of on the very bottom left section, you have money markets. And then as you go up the risk spectrum, you go to treasuries and bonds and stocks and real estate and buyouts. And then ultimately at the top, in terms of the risk parameters, you’ve got venture capital with venture capital kind of sitting to the farthest up into the right on the highest risk, highest return part of the spectrum. And on the face of it, that sounds reasonable.

But here’s the problem. It is not a holistic view of risk. It is incomplete because the implication of this chart is just dangerously simplistic. The implication here, it implies that if you take more risk, that you will get more return. But obviously that is not true because if taking more risk automatically gave you a much higher return, then it wouldn’t be very risky at all with it. And that is the flaw. This chart leaves out one of the most important parts of investing, the range of possible outcomes. And that’s where the next charts coming a little bit more useful here.

So this next chart walks through something that the first chart is missing. It’s a widening distribution of outcomes as the risk increases. This is really what beta is. The higher you move along the risk spectrum, the wider the bell curve becomes. And it’s spelled out a little bit more clearly on this respective chart. Prospective higher return may increase with the added risk, but so does the variability of returns and also the prospect of loss. And this is a much much much much much better way to think about risk. Because now we’re no longer just pretending that a risky investment simply means higher expected return. We’re actually acknowledging reality that as the higher level of risk is taken, yes, the upside may be greater, but the downside also becomes much much much more severe. And that range of likely outcomes because becomes much wider.

And that’s what people are really doing, right? That’s really what we’re doing when we’re allocating capital. That’s what you’re dealing with. So when we try to make it a little bit more concrete here, and we’ll take venture capital as an example, you know, a venture capital pitch deck. What I can promise you is when they’re sharing you that that venture capital pitch deck, it’s going to have let’s call it a 30% internal rate of return projection fine. But what that pitch deck is not going to say is there’s very likely a massive significant chance you’re going to lose all your money. Probably that’s probably what’s going to actually occur, right? And yet, in venture capital, that is exactly what happens all the time. These deals do not become over. Most deals do not become Airbnb. Most deals do not become unicorns. Many, I would say, most ultimately go to zero.

So the problem with the original chart, the simplistic form, is that it presents a single expected return while hiding the violent spread of outcomes that actually comes with risk. That is the deeper meaning of beta and standard deviation. It’s not just some academic statistic. It’s telling you that the future range of outcomes is much, much less certain. And when you start to understand that, you start to realize why risk cannot be reduced to one neat, tidy number, which brings me to what I think is, you know, the most important practical takeaway from this whole discussion, okay?

If two different investors out in the marketplace generate the same exact return, two different investors generate the same exact 15% rate of return. How do you determine which is actually a better investor? And that’s where the next two charts come in. You know, I believe these two charts provide exorbitant amounts of information and a ton of value to limited partners out there in the marketplace. It’s the idea and the definition of determining the difference between a skilled investor and a lucky idiot. Let’s walk through these two things here.

So on this chart, what you’re going to see is an investor who earns the same exact rate of return as the benchmark, but does so while taking less risk. The portfolio sits to the left of the benchmark on the side of the risk axis and at the same exact rate of return. And the horizontal gap there is labeled value add. That’s value add to the marketplace. Let’s say two different investors, both the chief of 15% rate of return and one of them does so with significantly less risk. The guy who does so with massive significantly less risk is adding alpha. We’re actually adding value to the marketplace. This chart is a beautiful visual because if they’re both generating 15% returns while one of them generating significantly less risk, obviously the investor taking the less risk is clearly the superior capital allocator. That is not luck. That is skill. And ultimately, that’s what we try to do when we go into the marketplace. That’s our tactic.

In the next chart, we can show you kind of an opposite version of another way to add alpha. Another way to add value to the marketplace. Here the portfolio takes the same exact amount of risk as the benchmark but ultimately earns a higher rate of return that is yet another way to add value to the marketplace. The value added is vertical instead of horizontal. They take the same amount of risk but ultimately generate a better outcome. That is also alpha. That is also skill. So now we can finally say something much more intelligent than the original finance textbook chart. A skilled investor is not simply the one with the highest nominal rate of return. A skilled investor is the one who either generates the same return with less risk or generates a higher return with the same risk. And that is the difference between a skilled investor and a lucky idiot. And as a limited partner, your job is to find the people who actually add that kind of value to your portfolio.

Over the course of the last 15 years, there have been a lot of individuals that have gotten involved in this without exorbitant amounts of experience. And I will now say without exorbitant amounts of skill, but they still did pretty well. What we’ve been talking about here is this idea and this concept of risk adjusted returned and that’s where a lot of investors get confused during periods of falling interest rates, which we’ve been on a downward trajectory of interest rates for 40 years until the massive increase over the last couple of years, right? When you have those falling interest rates or rising asset prices, many investors appear to be extremely skilled because everybody’s making money. Businesses are compressing, asset values are rising, deals look brilliant. And sometimes the results of those individual transactions are not the result of skill. They were simply the result of favorable conditions. When the environment changes, the difference between skill and luck becomes way more obvious.

As Warren Buffett famously said, only one that tied goes out. Do you find out who’s been swimming naked, right? And that’s what we’ve seen in the syndication space. We’ve got a lot of different limited partners that ultimately invested, called $100,000 in a deal-specific syndication with a multifamily syndicator. And they did a fixed-and-flip business model from 2017 to 2020 and they doubled their money and they did great congratulations, moved to 100K to 200K. And they might have done it again from 200K to 400K, congratulations. But then unfortunately on the third fixed-and-flip, same-exact business model, same-exact operator, they assumed he was great because it was just favorable conditions. But then market conditions changed and you find out who’s swimming naked when the tide goes out. Now that $400,000, poof, oftentimes, unfortunately, you have paused distribution capital calls sometimes total loss of capital.

And to be honest with you, this is why we’ve loved the niche of mobile home parks for so long. I’m going to just give you some charts on this topic and why they produce, from my perspective, the best risk-adjusted returns. Here’s a chart that basically shares some data from 2018. So this data is a 10-year total return chart from 2008 through 2018, which basically shows that all sorts of different individual real estate niches from shopping centers, industrial, office, lodging, apartment, self-storage, mobile home parks, all these various different niches, mobile home parks are at the top of the list, nearly 20% annualized returns. And on the right side of the chart, you realize that that occurred the highest rate of return for mobile home parks while having also the lowest beta, the lowest risk. Those two things and the vast majority of other investments and sectors do not exist concurrently. But because we’re in a very unique, modest-sized, fragmented real estate market, you have the opportunity to generate really high-quality risk-adjusted returns. That’s why we love mobile home parks.

Let’s take another gander here at the top right portion of the chart for beta for risk, where you see lodging. Why is lodging at the top in terms of the beta? Because obviously, as the nation’s GDP ebbs and flows, whether you’re in a recession or a booming economy, there’s going to be a lot more disposable income in the pockets of consumers, and they’re going to be willing to spend more, they’re going to be willing to travel more, they have way more discretionary income, and that’s the result. So let’s see what happened after COVID, right? On COVID hit in the first quarter of 2020, fast forward a few different quarters, right? Now all of a sudden, this is data from September of 2020, and you could see what happened to the property values. You guys remember how it got absolutely crushed? Lodging is at the very bottom of the list when discretionary income dried up the value of lodging, i.e. hotels, 25% dip in the value of the portfolio immediately within nine months of this coming to fruition. People are out shopping significantly less across all different property types, down 10%, office was down nine, apartments were down 8%, mobile home parks, they were up, they were up 3% from pre-COVID, because let’s take a look at how long have a food, water, and shelter been in high demand since the the beginning of time, the most essential housing in the marketplace is always going to be in high demand, regardless, and this is why we just appreciate it so much, right?

What I’m trying to achieve from my family, I’m not trying to generate the highest returns, I’m personally trying to achieve the best risk-adjusted returns in the marketplace. I’m trying to achieve the best return that I can while taking an exceedingly nominal amount of risk along the way. Why? Because I’ve been so fortunate to already have one in the eyes of society. This is the old adage, you only need to get rich once. We’ve already done a pretty decent job of building some wealth along the way, and now my job is to ensure that we just never lose money, and we are living our version of the American dream. So I’m trying to generate the best return that I can while ensuring that I take exceedingly negligible amounts of risk.

In plain English, the asset class generated the best return in any real estate sector with the lowest volatility among all of the real estate sectors as well, and that is incredibly important. I’m personally not trying to generate the highest return possible. I’m trying to generate the best risk-adjusted return possible, and that is a very different objective. And mobile home parks have historically been compelling for exactly that reason, safe, predictable, durable demand. When the world gets punched in the mouth, some sectors are much more fragile than others.

Now this, you know, extends, this chart extends the idea over a longer time horizon. The Green Street Commercial Property Index, this is charted from 2016 through 2026, and it shows manufactured housing at the top of the group as well, ahead of industrial, while office in the malls are dramatically lower near the bottom. You know, I would add one more structural reason as to why this is the case. It’s the supply growth in mobile home parks. This chart shows manufactured housing with essentially no new annual supply growth through 2028, compared with much higher expected growth in data centers, self storage, industrial apartments, lodging every other real estate sector has a lot of additional growth in various different sectors in terms of supply, except for mobile home parks. So when you put all that together, you put durable demand, low new supply, lower volatility, strong long-term returns, you begin to understand why certain sectors can generate outsized risk-adjusted returns. And to me, that is the game. Not chasing the flashiest return. Not trying to hit home run after home run every single year, but generating the best return that I can while taking the least amount of risk necessary to get there. That is what thoughtful capital allocation looks like. And that is the difference between an investor who is actually skilled and one who simply got lucky in a favorable environment. And this is why bull markets are so deceptive, because in favorable environments, lucky idiots often look like skilled investors, which is exactly why risk gets misread for so long.

But during bull markets, something interesting happens. Risk begins to disappear, or at least it appears to disappear. Credit is abundant. Everything is easy, asset prices continue to rise, and leverage it begins to feel safe. Investors begin to believe that higher returns are simply the result of better opportunities, but in reality, something else is happening. Risk is accumulating quietly inside of the system, and history shows us that the periods of apparent stability are often the moments when fragility is building the fastest.

The minute that your Uber driver starts giving you stock tips is the minute that you need to sell. I remember being inside of a restaurant in 2007 when the waitress is telling me about the handful of condos that she’s been fixing and flipping in Miami. That’s when you should be selling condos. Back when I was in school, you had to use to make trades to buy and sell stocks through your broker. When I was in school, literally one of my teachers during the middle of our class, he had a phone in the room. We picked up, and he was telling the man to buy and sell shares of the latest tech fad. That is when you need to ultimately get out of the marketplace. When your literal teacher during school is ultimately buying and selling shares of Yahoo and the like, okay? When everyone is talking about a tip of this time to run for the hills. Same thing with Bitcoin. Oh my gosh. Can you believe it? Right? If you’re hearing about buying Bitcoin after it’s already had the thousands and thousands of percent run up, and somebody that has no idea what’s going on in the investment world in general is bringing that opportunity to you, oftentimes might need to take pause in advance of continuing to move forward.

This is where the idea and the concept of black swan events becomes very important. The term was popularized by Nassim Teleb, and a black swan event is something that is rare, it is unpredictable, and it has massive consequences. There’s many examples, including the 2008 financial crisis, the COVID shutdown, or just sudden credit market freezes, and one of Teleb’s most important insights is this. It’s that black swans do not usually create the risk. They reveal the risk that was already present, which leads to the most important question for all the investors that are out there. If extreme events are inevitable, and if risk is often invisible until those events occur, then how do great investors build portfolios that survive black swan events?

Successful investing requires two things, generating returns and controlling risk. And understanding that difference is the foundation of becoming a truly thoughtful capital allocator. I’m going to go deeper on how to plan for black swan events in the next one. We’re going to be answering how do great investors design portfolios to survive uncertainty. We appreciate you spending some time with us here today. Please share a comment or a question that you have down below, or give us a five star review. We appreciate you guys spending some time with us. Until next time, you’d be great.

[Transcript ends]