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 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?