A few weeks ago, I was at a financial conference giving an investing talk. A hand from the audience shot up as I talked about returns on investments of 50 percent, 1,000 percent, and infinite returns. "That's a load of rubbish," shouted the person attached to the hand waving in the air.
I asked the participant to clarify what he thought was a load of rubbish.
"You can't get such high returns," he replied angrily. "I'm a financial planner, and I've never seen anyone achieve such returns."
"What kind of investments do you recommend for your clients?" I asked.
"I recommend a well-diversified portfolio of cash, stocks, bonds, and mutual funds," he replied indignantly. "That's why I ask you: How can you get such high returns from these investments?"
"Because I don't invest in those investments," was my reply.
No Honest Advantage
I don't think too highly of investments such as savings, stocks, bonds, and mutual funds, as my articles have made clear. I have written about the importance of having control over your investments -- how professional investors can invest with higher returns and less risk simply because they have more control. People who invest in paper assets -- such as savings, stocks, bonds, and mutual funds -- have very little control (see "Why Business Smarts Are Investing Smarts").
Beyond the issue of control, there's something else even more important for some professional investors. One of the problems I have with savings, stocks, bonds, and mutual funds is that I don't have an honest advantage over other investors. In this area, if I do become creative and find an advantage, I run the risk of going to jail or paying stiff fines, whereas finding an edge in other kinds of investment doesn't carry such legal risk. For example:
With registered securities, trading on insider information is illegal. When investing in a business or in real estate, insider information can give you a legal competitive advantage.
With paper assets, you have very little control over your greatest expense -- taxes. When investing in a business or real estate, you can gain a legal, competitive advantage by paying less in taxes, which increases your return on investment.
Creativity Puts You Ahead
When it comes to savings, stocks, bonds, and mutual funds, the government, via agencies such as the Securities & Exchange Commission, does its best to keep the playing field level and the rules fair. It's important they do this since so many amateur investors are involved.
At the same time, the SEC's tight rules tend to take away as much creativity as possible. With businesses and real estate, legal creativity is your advantage. The more legally creative you are, the greater your return on investment.
Recently, I bought 10 acres of land for $100,000. Since the land is already zoned for mobile homes, my plan is to simply subdivide the property into approximately 50 lots and sell each lot for $25,000. Do the math, and you'll see that the 10 acres are worth a gross of $1.25 million, which is not a bad return on a $100,000 initial investment. The legal advantage is the mobile-home zoning, an advantage all the other land in the area does not have.
Seeking an Edge
Another property recently came up for sale that's more complex and interesting -- a whole town for sale in Nevada for $12 million. We estimate the town's single family homes alone are worth $26 million. The remaining buildings and land, including a golf course, we estimate to be worth another $10 million.
Our plan is to raise the $12 million, plus an additional $2 million to fix up the single-family homes, and then sell those homes for $26 million. We then pay back the investors and split the potential $12 million dollars in gross profit. The rest of the town would belong to the five of us who put the deal together. That would be our real return on investment.
This all sounds easy in theory, but there's one serious problem, which is the reason the town's price is low. We suspect there are environmental problems, which the Environmental Protection Agency would pounce on, levying heavy fines, once we own the town. Before investing any money, a friend of mine who specializes in polluted properties will evaluate the risks. If the contamination is too high, we won't invest. If the contamination is low and we can solve the problem, we stand to make millions without putting a dime into the venture.
These are two examples of how a little skill and creativity can be used for legal advantages. So here are four lessons I want to leave you with:
Be careful about who gives you investment advice. If your advisor thinks an 8% return is a good return, you may want to look for another advisor.
Someone else's problem can be your opportunity.
Take the time to cultivate a stable of friends who know how to solve tough problems.
Learn to invest in investments where you can achieve an honest, legal advantage over other investors. When it comes to investing, why play on a level field?
Smart Investing Amidst Real Estate Mania
by Robert Kiyosaki
Tuesday, January 24, 2006
In early summer of 2005, I sent a warning to the Rich Dad community that the real estate market was cooling down. After all, we know that all booms go bust eventually, and every party comes to an end.
While many readers thanked me for the words of caution, many others sent me hate mail. An angry real estate broker called me and said, "Are you trying to ruin my business?"
The angry readers should draw insight from something Warren Buffett said: "For some reason, people take their cues from price action rather than from values. What doesn't work is when you start doing things that you don't understand or because they worked last week for someone else."
The sage of Omaha sums up pithily: "The dumbest reason in the world to buy a stock is because it's going up."
Personally, I would say, "The dumbest reason to buy anything is because the price is going up." Yet that's what people do when they invest. They generally don't buy high-priced things when they shop.
Fools Rush In
For example, if Safeway had a sale -- 25% off everything in the store -- the supermarket would be swamped. Yet, when the stock market or real estate market has big discounts (often called a crash or a burst bubble), that same shopper runs away from an asset sale. Instead, they wait until prices are high and other fools are bidding them up further to finally buy.
I estimate that 90% of all investors invest for price movement, not value. If prices begin to escalate, as they did in real estate from 2000 to 2004, amateurs turn pro and begin buying real estate to flip -- for example, buying a home for $200,000 and then selling it for $250,000 a few months later.
Most stock market investors do the same thing. In investor language, flipping is known as "the greater fool theory of investing" -- you're buying something not to own, but in the hope of selling it to someone who's a greater fool than you.
The Coming Crash
We all know a real estate crash is coming. The problem is we don't know when.
One of the more popular predictions floating around is that investors are now moving out of real estate and back into the stock market. Another prediction, which I think is valid, is that the real estate market is set to crash because of the high costs of building materials.
But such rumors only affect those investors who, as Buffett says, "take their cues from price action rather than from values." During such periods of high prices and volatility, it's even more important to pay attention to value, more than price.
Yet, it's one of the toughest things to do -- stop and focus on value -- especially when prices are volatile in either direction. It's difficult to resist the urge to sell when prices are dropping and buy when they're rising.
The Best Time to Buy
Take market crashes. I love them because that's the best time to buy -- finding true value is a lot easier during such periods. And since so many people are selling, they're more willing to negotiate and make you a better deal.
Although a crash is the best time to buy, the market's high pessimism also makes it a tough time to do so. I remember buying gold at $275 an ounce in the late 1990s. Although I knew it was a great value at that price, the so-called experts were calling gold a "dog" and advised that everyone should be in high-tech and dot-com stocks. Today, with gold above $500 an ounce, those same experts are now recommending gold as a percentage of a well-diversified portfolio. Talk about expensive advice.
My point is that this current period is a tough time to buy or sell. Real estate is high, interest rates are still relatively low, the stock market is rising, the U.S. dollar is low, gold is high, oil and gas are high, and there's a lot of money looking for a home.
So the lesson is: Now, more than ever, it's important to focus on value, not price. When prices are low, finding value is easy. When prices are high, value is a lot harder to find -- which means you need to be smarter, more cautious, and resist your knee-jerk reactions.
A final word from Warren Buffett: "It's only when the tide goes out that you learn who's been swimming naked." In my opinion, there are many naked swimmers, especially in the real estate market.