Thursday, November 27, 2008

How the Financial Crisis Was Built Into the System

How did we get into the current financial mess? Great question.
Turmoil in the Making
In 1910, seven men held a secret meeting on Jekyll Island off the coast of Georgia. It's estimated that those seven men represented one-sixth of the world's wealth. Six were Americans representing J.P. Morgan, John D. Rockefeller, and the U.S. government. One was a European representing the Rothschilds and Warburgs.
In 1913, the U.S. Federal Reserve Bank was created as a direct result of that secret meeting. Interestingly, the U.S. Federal Reserve Bank isn't federal, there are no reserves, and it's not a bank. Those seven men, some American and some European, created this new entity, commonly referred to as the Fed, to take control of the banking system and the money supply of the United States.
In 1944, a meeting in Bretton Woods, N.H., led to the creation of the International Monetary Fund and the World Bank. While the stated purposes for the two new organizations initially sounded admirable, the IMF and the World Bank were created to do to the world what the Federal Reserve Bank does to the United States.
In 1971, President Richard Nixon signed an executive order declaring that the United States no longer had to redeem its paper dollars for gold. With that, the first phase of the takeover of the world banking system and money supply was complete.
In 2008, the world is in economic turmoil. The rich are getting richer, but most people are becoming poorer. Much of this turmoil is directly related to those meetings that took place decades ago. In other words, much of this turmoil is by design.
Power and Domination
Some people say these events are part of a grand conspiracy, and that might well be. Some people say they represent the struggle between capitalists, communists and socialists, and that might be, too.
I personally don't participate in the debate over a possible global conspiracy; it's a waste of time. To me, the wider struggle is for power and domination. And while this struggle has done a lot of good — and a lot of bad — I just want to know how to avoid becoming its victim. I see no reason to be a mouse trying to stop a herd of elephants from fighting.
Currently, many people are suffering due to high oil price, the slowdown in the economy, loss of jobs, declines in home values, increased bankruptcies and businesses closings, savings being wiped out, the plummeting stock market, and rising inflation. These realities are all direct results of this financial power struggle, and millions of people are its victims today.
An Extreme Example
I was in South Africa in July of this year. During my television and radio interviews there, I was often asked my opinion on the world economy. Speaking bluntly, I said that South Africans had a better opportunity of comprehending the global turmoil because they're neighbors to Zimbabwe, a country run by Robert Mugabe.
In my interviews, I said, "What Mugabe has done to Zimbabwe, the Federal Reserve Bank and the IMF are doing to the world." Obviously, my statements disturbed many of the journalists. I did my best to comfort them and assure them I was not an anarchist. I explained, as best I could, that Zimbabwe was an extreme example of an out of control power struggle.
After they were assured I was only using Zimbabwe to illustrate my point, I said, "If you want to understand the world economy, take a refugee from Zimbabwe to lunch." I advised them to ask the refugee these questions:
1. How fast did the economy turn?
2. When did you know that you were in financial trouble?
3. When did you finally decide to leave Zimbabwe?
4. If you could do things differently, what would you have done?
Three Approaches to a Crumbling Economy
I spoke to three young couples from Zimbabwe while I was in South Africa. Two couples were recent refugees now living in South Africa, and one couple still lives in Zimbabwe. All three couples had interesting stories to tell.
One couple said that they would have quit their jobs earlier. Instead, they hung on, hoping the economy would change. Then, virtually overnight, the value of the Zimbabwean dollar dropped and inflation went through the roof. Even though they received pay raises, the couple couldn't survive and soon depleted their savings. They left Zimbabwe by car with almost nothing. If they could've done something differently, they told me, they would have started a business in Zimbabwe and began exporting products to South Africa, so that they would have had South African currency and a bank account there before they fled.
The second couple that fled the country said they saved money and paid off their house and other debts even as the Zimbabwean dollar fell in value. Looking back, they say they would've saved nothing and gotten deeply in debt in Zimbabwe, allowing them to pay off their debt with the cheaper dollars. Instead, they fled after they lost their jobs, leaving behind their house and owning $200,000 in nearly worthless Zimbabwean dollars.
The third couple still lives in Zimbabwe. When they saw the writing on the wall, they set up a business in South Africa and, with the profits, began acquiring tangible assets in Zimbabwe. Often, they'll buy an asset in Zimbabwe and pay the seller in South African currency. They believe that once Mugabe is gone and order is restored, they'll be in a strong financial position.
Many Problems, Few Solutions
There are three major problems with the events of 1913, 1944, and 1971. The first is that the Fed, the World Bank, and the IMF are allowed to create money out of nothing. This is the primary cause of global inflation. Global inflation devalues our work and our savings by raising the prices of necessities.
For example, when gas prices soared, many people said that the price of oil was going up. In reality, the main cause of the high price of oil is the decreasing value of the dollar. The Fed, the World Bank, and the IMF, like Zimbabwe, are mass-producing funny money, thereby increasing prices and devaluing our quality of life.
The second problem is that our economic crises are getting bigger. In the 1970s, the Fed faced and solved million-dollar crises. In the 1980s, it was billion-dollar crises. Today, we have trillion-dollar crises. Unfortunately, these bigger crises mean more funny money entering the system.
Apocalypse Soon
The third problem is that in 1913, the Fed only protected the large commercial banks such as Bank of America. After 1944, the Fed, the World Bank, and the IMF began bailing out Third World nations such as Tanzania and Mexico. Then, in 2008, the Fed began bailing out investment banks such as Bear Sterns, and its role in the Fannie Mae and Freddie Mac debacle is well known. By 2020, the biggest of bailout of all will probably occur: Social Security and Medicare, which will cost at least a $100 trillion.
Even if we find more oil and produce more food, prices will continue to rise because the value of the dollar will continue to decline. The dollar has lost over 90 percent of its value since the Fed was created. The U.S. dollar will continue to decline because of those seven men on Jekyll Island in 1910.
Granted, the funny-money system has done a lot of good — it has improved the world and made a lot of people rich. But it's also done a lot of bad. I believe somewhere between today and 2020, the system will break. We're on the eve of financial destruction, and that's why it's in gold I trust. I'd rather be a victor than a victim.

Wednesday, September 24, 2008

As Capitalism Crumbles, U.S. Taxpayers Pick Up the Pieces

As Capitalism Crumbles, U.S. Taxpayers Pick Up the Pieces

As we all know, the world changed drastically on Sept. 11, 2001, when the twin towers of the World Trade Center fell.
This year, on the eve of Sept. 11, the twin towers of Fannie Mae and Freddie Mac crumbled. Then, on Sept. 15, Lehman Brothers and Merrill Lynch disappeared. Actually, that was a triple-tower collapse if you count AIG.
In a few years, the biggest pair of towers will collapse: Social Security and Medicare. Even today, they're looking shaky. How many ground zeros can we as people, a nation, and a world withstand before we admit something is very wrong with our global financial systems? What will it take to wake us up?
Government Can't Fix It
Personally, I believe the biggest it's a problem that so many Americans are looking to this year's presidential candidates, Barack Obama and John McCain, to save our financial system. How did we become so financially weak that we surrender our economic independence to politicians? Where does it say in the Constitution that the government should solve our financial problems?
And why have so many people throughout the world come to expect financial life-support from their political leaders? It seems most people will vote for anyone who promises a chicken in every pot and a guaranteed mortgage payment.
We're in the midst of a problem neither candidate can solve: A lack of comprehensive financial education in our school systems. What else explains the economic blunders committed by our political and financial leaders? Or why so many consumers are in debt up to their eyeballs? Or why millions of people expect a quick government fix of some kind?
Under Water
A few months ago, a friend of mine from Hawaii asked me if I wanted to buy his new powerboat with twin motors. Apparently, in late 2007, he purchased it brand new for approximately $85,000. His plan was to refinance his house when it appreciated in value and use the difference to pay for the boat.
Failing to obtain new financing, he called to ask me if I would buy the boat from him -- just take over the payments and it was mine. I passed, and the bank eventually repossessed his boat. Later, his wife called to tell me he's now having problems making his mortgage payments. Apparently, my friend planned to pay for his house the same way he planned on paying for the boat, by refinancing his debt.
I mention this story because it illustrates the problem Obama or McCain face: Limited financial education and diminished financial common sense. Apparently, my and the nation's business leaders all went to same school of finance.
A Cynical Aside
If you want to know why the towers of American capitalism are crumbling, I recommend reading "The Creature from Jekyll Island" by G. Edward Griffin. It's not an easy book to find, but once you start reading it's to put down. In fact, in many ways it's a murder mystery about the financial "murder" of the middle class.
A very important lesson in the book is how political leaders use financial spin to deceive the public. The very, very rich use the system to legally steal from the rest of us by appealing to our sense of patriotism. When our leaders say, "We're bailing out Fannie Mae and Freddie Mac because we want to protect the American people," they really mean "We're saving our rich friends."
All the bankers and politicians have to do is wave the red, white, and blue, play a few bars of "Yankee Doodle," and the masses get teary-eyed and pledge greater allegiance to legalized robbery. Yes, it's true that ignorance is bliss -- but ignorance is also expensive, and it cost us our freedom.
Freedom at Peril
A bailout can be different things. First, printing more money is a kind of bailout that leads to higher inflation. Rather than protecting people, it makes life for the poor and middle class more expensive. The other kind of bailout is protection for our rich and incompetent friends. If you or I fail at business, we fail. If we cheat and fail, we go to jail. But if you're rich and politically connected, your incompetence may be protected by a government bailout.
As a former Marine and a Vietnam War veteran, it saddens me to see some of the freedoms I thought I went to war to protect being stolen from us by bankers and politicians. Unfortunately, few Americans know the difference between the words "nationalize" and "socialize." Socialize means we turn more of our personal powers over to Big Brother, not free enterprise. It means we as a people grow weaker and need a higher power -- the same power that got us into this mess -- to protect us.
In short, when the towers of Fannie, Freddie, Merrill, Lehman, and AIG came crashing down, more came down than just money. What we're losing is the very freedom this country was founded on, and what most of the world yearns for.

Wednesday, July 23, 2008

When Pessimism Prevails, It's Time to Get Rich

When Pessimism Prevails, It's Time to Get Rich

If you're serious about getting rich, now is the time. We've entered a period of mass-produced pessimism, when bad news is everywhere, and the best time to invest is when optimists become pessimists.
The Weird Turn Pro
Journalist Hunter S. Thompson used to say, "When the going gets weird, the weird turn pro." That's true in investing, too: At the height of every market boom, the weird turn into professional investors. In 2000, millions of people became professional day traders or investors in dotcom companies. Mutual funds had a record net inflow of $309 billion that year, too.
In an earlier column, I stated that it was time to sell all nonperforming real estate. My market indicator? A checkout girl at the local supermarket, who handed me her real estate agent card. She was quitting her job to become a real estate professional.
As a bull market turns into a bear market, the new pros turn into optimists, hoping and praying the bear market will become a bull and save them. But as the market remains bearish, the optimists become pessimists, quit the profession, and return to their day jobs. This is when the real professional investors re-enter the market. That's what's happening now.
Pessimism vs. Realism
In 1987, the United States experienced one of the biggest stock market crashes in history. The savings and loan industry was wiped out. Real estate crashed and a federal bailout entity known as the Resolution Trust Corporation, or the RTC, was formed. The RTC took from the financially foolish and gave to the financially smart.
Right on schedule 20 years later, Dow Industrials and Transports struck their last highs together in July 2007. Since then, nothing but bad news has emerged. In August 2007 a new word surfaced in the world's vocabulary: subprime. That October, I appeared on a number of television shows and was asked when the market would turn and head back up. My reply was, "This is a bad one. The worst is yet to come."
Many of the optimistic TV hosts got angry with me, asking me why I was so pessimistic. I told them, "The difference between an optimist and a pessimist is that a pessimist is a realist. I'm just being realistic."
As we all know, things only got worse in early 2008, with the demise of Bear Stearns and the Federal Reserve stepping in to save investment bankers. In February, many of those optimistic TV (and print) reporters became pessimists -- and when journalists become pessimists, the public follows. By March, mutual funds had a net outflow of $45 billion as investors fled the market.
Surviving the Bad Times
Back in 1987, as savings and loans closed and investors' stock and real estate portfolios were wiped out, my wife, Kim, and I were living in Portland, Ore. Many people were depressed and hiding from the truth. The following year, I said to Kim, "Now is the time for you to begin investing."
In 1989, she purchased a two-bedroom, one-bathroom house for $45,000, putting $5,000 down and earning $25 a month in positive cash flow. Today, she owns over 1,400 units and -- because more people are renting than buying -- she earns hundreds of thousands a year in positive cash flow.
The period from 1987 to 1995 was a rough one, even for the rich. In his book "The Art of the Comeback," my friend Donald Trump writes about being a billion dollars down at the time. Rather than give up, he kept on fighting to survive. He and I often talk about how that period was great for character development.
Two-Year Warning
I believe we're through the worst of the current bust. I know there will be more aftershocks, and the news will continue to be pessimistic for at least two more years, possibly until the summer of 2010.
But the upside to this is that it gives us at least two years to do our market research and find the next big stock or real estate bargain. Before buying, I strongly suggest you study, read books, and take courses on your asset of choice. If your choice is stocks, take a course on stocks or options. If it's real estate, take a course on real estate. Now is the time to learn; not only will you know more than the average person and be in a good position when the market turns, but you'll also meet people with a similar mindset.
You have about two years to get into position. Opportunities this big don't come along often, so this is your time to get rich.
Climbing Bulls, Flying Bears
Am I optimistic for the long-term? Absolutely not. I still believe we're due for the mother of all market crashes, and that the U.S. economy is running on borrowed time -- and I do mean borrowed. I think most baby boomers are in serious financial trouble, and that oil will climb above $200 a barrel. Inflation will also increase, causing more pain for the poor and middle class.
The Fed is flooding the market with nearly a trillion dollars of liquidity, which is why I believe gold under $1,200 an ounce and silver under $30 an ounce are bargains. Gold and silver should peak and decline before 2020, completing two 20-year cycles. My exit is to sell silver around 2015. I plan to hold onto gold, income-producing real estate, oil wells, and stocks.
Most of us know the bull climbs slowly up the stairs, but the bear jumps out the window. I believe the bull is still climbing the stairs, and the bear hasn't jumped yet. But rest assured that it will.

Wednesday, July 2, 2008

Peace Through Prosperity

Peace Through Prosperity

In 1972, I was flying a helicopter just south of the DMZ (the demilitarized zone), a line that separated North and South Vietnam. On that mission, my aircraft was not configured as a gunship.

Instead, my assignment that day was not to fight, but to observe the battle below and report what I saw. Unfortunately, what I saw was tragic. The North Vietnamese kicked our butts. Not only did we lose a number of aircraft, but many men lost their lives.

Tough Questions Unanswered

Back in the pilots' ready-room aboard an aircraft carrier, the debriefing began. Most of us were shaken and our spirits were low. Seeing fellow pilots shot down and men dying leave memories that can never be forgotten.

Once the debriefing was over, my commanding officer asked if there were any questions. Raising my hand, I asked, "Sir, why do their Vietnamese fight harder than our Vietnamese?"

Without waiting for his reply, I continued, "We have the most powerful military on earth. We have B-52 bombers pounding the enemy with 1,000-pound bombs. We have fighter jets dropping napalm on them. We have tanks. We have Navy battleships with 16-inch guns pounding them. We have squadrons of Army and Marine Corps helicopters armed with rockets and machine guns providing close air support. The North Vietnamese don't have much, and yet they keep coming and keep fighting."

There was a long silence in the room. I suspect some of my fellow pilots had similar thoughts. Being Marine helicopter pilots, we had a bird's eye view of the war that few others had.

"We're the richest nation on earth," I continued, "North Vietnam is one of the poorest. We give the South Vietnamese the best military support in the world, yet they're losing."

The silence continued. My original question -- "Why do their Vietnamese fight harder than our Vietnamese?" -- was never answered.

Fighting Not to Lose

Back in 1972, we all knew the Vietnam War was over. We knew the U.S. was looking for a way out. We were no longer fighting to win -- we were fighting not to lose. That made it made it almost impossible to keep fighting.

You may notice similarities with what's going on in Iraq and Afghanistan today. There are three lessons from 1972 I believe are relevant to the world today. They are:

  • How powerful the human spirit is.

    Flying over the North Vietnamese in 1972, I was stunned at how fiercely they fought. We had all the modern weapons, but we couldn't beat them. Their spirit was unstoppable.

    Today, when I hear fellow Americans complaining about their own lack of money, or how they can't afford to invest, or how middle-class America is having a tough time, I'm reminded of the North Vietnamese soldiers taking on the richest country in the world. If you've lost your spirit, even living in the richest country in the world can't help you become rich.

  • It's tough to negotiate from a position of weakness.

    It was only after the U.S. recognized we had lost the Vietnam War that we agreed to sit down at the so-called "peace table." Today, as the wars in Iraq and Afghanistan still rage, we're doing the exact same thing. In war or in business, it's disastrous to negotiate from a position of weakness.

  • Don't let someone else run your life.

    During Vietnam, defense secretary Robert McNamara and President Lyndon Johnson called the shots from Washington rather than listening to the men on the front lines. In Iraq and Afghanistan, we have the same problem.

    President Bush, Vice President Cheney, and former defense secretary Rumsfeld, all men without combat experience, are calling the shots from Washington. They're not listening to their generals with Vietnam experience, generals such as Colin Powell. It appears that our leaders place little or no value on experience.

The Spirit to Succeed

The same sort of misguided leadership occurs in the world of investing. Today, there are millions of workers who put trillions of dollars in the hands of mutual fund companies even though many of these companies have horrible track records.

Many fund managers can't even beat the S&P Index. Yet, in spite of their poor investment record, many of these managers are paid billions of dollars in bonuses -- bonuses paid for with the sweat and toil and hopes and dreams of workers.

Personally, I would rather manage my own money than let strangers control it and my future.

In 1972, I saw many young soldiers lose their lives due to incompetent leadership in Washington. Today, millions of workers' retirements are at risk due to incompetent leadership on Wall Street.

But I also witnessed the power of the human spirit while flying over Vietnam -- a spirit stronger than the mightiest military power in the world, and one that beat the richest country in the world.

Today, I see the same spirit in the world of global business. America is still the richest country in the world, but countries like China and India are coming on strong. It's estimated that China holds nearly a trillion dollars of America's debt, which is more than enough to destroy our economy.

Play to Win

Financially, there are three classes of people. The rich are those who play to win. The middle class plays not to lose.

For the middle class, financial security is more important than financial opportunity. Ironically, today there's far more financial opportunity than financial security, yet the middle class still seeks security.

The third group, of course, is the poor, who often work very hard yet have lost the spirit to compete in the world of money. Without spirit, it's tough to win financially, even in the richest country in the world.

I resigned from the Marine Corps and flying in 1974, even though I loved them both. I quit because I no longer wanted to fight for peace. Instead, I believe we can build a more sustainable peace by working for prosperity. Instead of playing games of winners and losers militarily, why not work for solutions in which all sides win financially? After all, in business, it makes no sense to kill your customers.

In closing, I believe that as the scarcity of oil increases, so will the fighting. To me, scarcity in a world of abundance means opportunities for solutions. As the saying goes, "An eye for an eye makes us all blind." Instead, I ask we work for peace and prosperity -- for all sides.

Tuesday, July 1, 2008

Learning from the Best

Learning from the Best

Now that our book, Why We Want You to Be Rich, is out, I can tell you what working with Donald Trump has been like.

Millions of people know "the Donald" as the tough guy who says, "You're fired" at the end of The Apprentice. I've been asked often if he's that gruff in real life. The answer is yes. My experience with Donald is that he's being real whether he's on camera or off. He never pretends to be Donald Trump. He is Donald Trump.

Obviously, co-authoring a book with him has been a milestone for me -- as an author and as a businessman. Appearing on Larry King Live, The Big Idea with Donny Deutsch, The Today Show, The Early Show, and CNBC with Donald gave me more credibility in the business world.

An Unofficial Apprenticeship

Yet I gained more than just recognition and credibility. I also became a better businessman and a better person just from working with Donald over the years.

Here are a few of the ways that knowing Donald has enriched my life:

1. I got tougher.

I know many people don't like Donald because he comes across as a tough guy. That's their problem. In spending time with him, I realized that I wasn't as successful as I could be simply because I wasn't tough enough.

As a businessman, I often didn't say what I wanted to say because I was afraid of hurting someone's feelings, or of having my feelings hurt. Instead of being forthright, I would be polite. Because of my association with Donald, I took back control of my business in 2005 and 2006 and fired people who should have been let go a long time ago.

The employees I got rid of weren't bad people, they were just the wrong people for my company. Today, business is thriving and people are happier.

2. I became kinder and more respectful.

One of my problems is that I'm very impatient and get angry too quickly. I believe Donald can be the same. Yet I saw him be patient, kind, and respectful in many situations that would have caused me to lose my patience.

When I asked him about this trait, he simply said, "One of the most important lessons my parents taught me was to treat all people with respect, even if I'm angry with them." Today, in my dealings with people, I do my best to treat all people with respect -- especially if I'm angry at them. Although I haven't always been successful, I believe I've become a little kinder as a result.

3. I got richer.

My wife, Kim, and I have more than enough money. We consider ourselves rich. When we entered Donald's world, however, we saw a whole new level of rich.

There's a difference between being a millionaire and a billionaire. The Trump lifestyle -- the penthouse, mansion, limos, and 727 -- gave me a firsthand glimpse into his world, and I began to understand why he constantly talks about thinking big.

Just being around him, I began to think bigger and richer. I set my sights on becoming a billionaire and began redesigning my business to become a billion-dollar business. Today, I constantly remind my staff that my job is to make them millionaires -- and their job is to make me a billionaire.

4. I became less petty.

One day, during a meeting in Donald's office, I was complaining about someone we were doing business with. I didn't like the way we were being treated. When I asked Donald about this person and voiced my concerns, he simply said, "Don't be so petty. Sometimes you have to do business with people you don't like. It doesn't mean you have to be like them or like them."

From that, I learned to think bigger and, more important, to know the difference between paying attention to details and being petty.

5. I was reminded of the value of collaboration and partnership, as well as the value of loyalty.

I saw this repeatedly as we developed the concept for our book, discovered our shared concerns and our passion for teaching, and shared the stage for dozens of media interviews.

Getting on Larry King Live and The Today Show is easy for Donald, but in booking a few of these interviews he insisted that we get equal billing. And when a show host mispronounced my name, Donald jumped in to correct him on national television. These simple acts spoke volumes.

History in the Making

About the same time our book was released, a new book about Andrew Carnegie, the richest man in the world at the start of the 20th century, was also published. The timing is ironic. I believe that when history looks back at the start of the 21st century, Bill Gates, Warren Buffett, and Donald Trump will be seen as the Carnegies of the era.

Many historians view Carnegie as a ruthless man, and I know that many people also see these three in the same light. Yet if you study Carnegie's life, you find that he was extremely generous, and donated billions of dollars in support of building libraries and preserving world peace.

He even envisioned the League of Peace, a precursor to President Wilson's League of Nations. I trust that history will allow a space for the good that Gates, Buffett, and Trump have done, and not simply resent them for their wealth.

Donald and I got together to write our book as teachers, not just as rich men. We're both concerned about the lack of financial education in our schools. In the process of writing it, I not only became a richer person, I believe I also become a better human being. And for this, I feel privileged to have seen a side of Donald Trump that not many people see.

Keeping Your Business Ideas Fresh

Keeping Your Business Ideas Fresh

Sometimes life just isn't fair.

When I was growing up in the 1960s, my parents said to me, "Listen to your elders. You need to learn to respect their wisdom. Someday when you're older, young people will listen to you." So I listened to my parents and grew up respecting the wisdom of those older than I was.

But that notion has been turned upside down: Nowadays, people my age need to listen to and respect the wisdom of people who are younger than we are.

Ideas from an Earlier Age

In business, success often depends upon the relative age of your ideas. And today, people of all ages are in trouble because their ideas aren't just old, they're obsolete.

One example of an old idea is that of the traditional job. Jobs are a centuries-old concept created during the industrial revolution. Despite the reality that we're now deep in the Information Age, many people are studying for, or working at, or clinging to the Industrial Age idea of a safe, secure job.

Now people aren't just losing their jobs -- their jobs are migrating to foreign countries or disappearing altogether. As Alan Blinder, an economist and former vice chairman of the Board of Governors of the Federal Reserve System, says, "A new industrial revolution -- communication technology that allows services to be delivered electronically from afar -- will put as many as 40 million American jobs at risk of being shipped out of this country in the next decade or two." That's double the number of U.S. workers in manufacturing today.

In spite of such alarming figures, our schools still program kids to look for jobs. Advising people to go to school to learn to be an employee is as obsolete as advising young people to become peasants and work for a landlord. People need to be trained to be investors and entrepreneurs, not employees.

Obsolete Every 18 Months

My point is this: In a rapidly changing world, nothing is more dangerous than an idea whose time has come and gone. Just look at how has changed the world of brick-and-mortar booksellers such as Borders and Barnes & Noble, or how Skype is tearing down monster corporations like AT&T, or how Napster shot a torpedo into the record industry. Where do you think the people who work for those Industrial Age employers will be in 10 years?

As I said, people aren't losing their jobs -- jobs and companies are disappearing. I'm glad I listened to my rich dad and became an entrepreneur rather than the employee my poor dad wanted me to be.

Most people today realize that knowledge is doubling every 18 months. Does that mean that we now become obsolete every 18 months? Maybe so. Personally, it makes me feel like I need to assign an expiration date to my ideas, and update them regularly.

Many people my age are in serious financial trouble because they have old, Industrial Age ideas that they never update -- wanting job security, counting on a pension for life, relying on Social Security and Medicare -- while attempting to survive in the Information Age.

That's a mistake. Much of my company's revenue comes from the web, even though I remain a technophobe. My company survives because I've learned to respect the ideas of people younger than me, and recognize when my wisdom is obsolete.

Timeless Business Ideas

Although many business ideas go out of date every day, there are some that are timeless and essential regardless of the era we're in. Here are a few:

Be passionate about your products and what your brand stands for. Brands die if the leader's passion dies, or if the leader's passion is simply to make money.

Build a community. Good entrepreneurs are community builders, actively involved with their communities and dedicated to the community's well being. If you're dedicated to your community, it will be dedicated to you.

Communicate clearly. Speak in the language of your customers. Don't attempt to baffle them with jargon in an attempt to appear smarter than they are.

Tell it like it is, and don't be a phony. In business, there are too many people who will say anything to get their hands on your money.

Be human. Don't be afraid to say, "I don't know" or "Can you help me?" If you're a good leader, people will be more than happy to help you build your business.

Now more than ever, we all need to be careful about whom we listen to. Just because someone is older than you no longer means they're wiser. Their ideas may have been good yesterday, but tomorrow they might be obsolete.

Friday, June 20, 2008

Fear Can Cost You Money

Fear Can Cost You Money

Wall Street recently paid out billions in bonuses to its employees. Those bonuses came from investors who believe investing is risky. In other words, there's a giant industry built around investor fears. The more fear, the bigger the bonuses.

A recent Time magazine article called "How Americans Are Living Dangerously" makes a number of good points on this reality. I'll look at a few of them.

Illusory Control

We misjudge risk if we feel we have some control over it, even if it's an illusory sense of control. The article uses the example of people who drive rather than fly.

Even though the risks of death are higher driving than flying, many people would rather drive simply because they feel they have more control driving. The facts are that only a few hundred people die a year flying and 44,000 are killed a year driving. After Sept. 11, 2001, many people took to the roads rather than the skies. Not surprisingly, between October and December 2001, there were a 1,000 more deaths.

Today, many people feel they have more control if they have money in savings. Thus the saying, "Safe as money in the bank." But the fact is that savers are the biggest losers of all.

Between 1996 and 2006, the purchasing power of the dollar dropped by 50 percent compared to gold. In 1996, gold was approximately $275 an ounce; by 2006 it was over $600 an ounce. In 1996, oil was approximately $10 a barrel ; in 2006 it was over $60 dollars a barrel. Compare the price of real estate in your area between the same 10 years and you'll notice that the purchasing power of your dollar has slipped.

The point is, in spite of the facts, many people feel safer with money in the bank because they feel they have more control over it. They don't have control over the price of gold, oil, or real estate, so they think investing in these assets is risky.

The Biggest Risks of All

The second point the Time article makes is that when we're afraid, we tend to ignore the statistics and listen to our emotions. As I mentioned above, you're over 500 times more likely to die in a car than in an airplane. Yet cars are not the biggest of all killers.

Of the 2.5 million deaths annually in the United States, the No. 1 killer is heart disease. In 2003, there were 685,089 deaths due to heart attack. Auto accidents caused 44,000 deaths. Only 17,732 deaths by murder and 1 death by shark attack occurred in the same year.

Despite these statistics, more people are afraid of sharks and murderers than driving up to a fast food restaurant and saying, "Super-size it." French fries kill more people than guns and sharks, yet nobody's afraid of french fries.

The same is true in the investment world. Since many people believe investing is risky, they go for the second-riskiest investment, mutual funds. As my rich dad used to say, "Mutual funds are like french fries. They may fill you up, but they aren't good for you in the long run."

John C. Bogle, founder of the Vanguard Funds, states in his book The Battle for the Soul of Capitalism, "When we have strong managers, weak directors, and passive owners, it's only a matter of time until the looting begins." Bogle has spoken out this way because the mutual funds industry is legally looting money from investors.

To put it another way, since most people think investing is risky and full of sharks, they've turned their money over to some of the biggest sharks in the world -- the managers of mutual funds.

True Expertise Counts

One of the reasons people think investing is risky is because there's an entire industry that wants you to believe so. Trading on your fears is very profitable.

This leads to point number three in the Time piece. The magazine quotes the findings of a study in which a panel of 20 communications and finance experts were asked about the risk of human-to-human transmission of avian (bird) flu. These experts said the risk was 60 percent. When the same question was asked of medical experts, their answer was 10 percent.

The point is that you need to be critical of experts. Is the person you seek advice from able to give you a credible answer?

Qualified and Unqualified Advice

There are three experts who are often not qualified to give you sound investment advice. They are:

  • Non-investors

    I'm always surprised by the number of people who take investment advice from non-investors -- people such as friends, family, and co-workers. A few years ago, I found a spectacular little condominium for sale for $50,000 in Phoenix, Ariz. All I had to do was put down $6,000 and assume the loan.

    At the time, it was worth about $95,000. Today the units in the same complex sell for $195,000. Best of all, the monthly rent at the time was approximately $1,000 a month and today rents are around $1,500.

    A friend from Portland, Ore., asked if I would let her purchase it. My wife, Kim, and I agreed, thinking at the time that this unit would be a great start for our friend. A few months went by and we asked her how the purchase was coming along. She said, "Oh, I forgot to tell you. I didn't buy the unit." When we asked her why, she said, "My neighbor Marge said it was too risky."

    "How many investment properties does Marge own?"


    Clearly, taking advice from someone who doesn't know what they're talking about is the real risk.

  • Perceived experts, such as financial planners or stock or real estate brokers

    Most people take financial advice from salespeople, not rich people. Most stockbrokers are not rich nor do they invest in what they sell. The numbers are even worse for real estate brokers.

  • Investors themselves

    I've shown several great investments to an investor friend of mine. To this date, he hasn't purchased anything I've recommended. That's because he can always find something wrong with the investment. Instead of looking at what's good about them, he looks for what's wrong and then talks himself out of taking action.

    This is one reason why I invest as part of a team, so that I can consult with other investors rather than talk myself out of great deals.

The Time article made it clear that fear is normal. We all experience fear; I admit that I've let it hold me back. I probably would've been a lot richer a lot sooner if I flew more and drove less.

The important thing to remember is to pay attention to what we worry about -- and what we should be worrying about.

Wednesday, June 18, 2008

Reading, Writing, and Resisting Debt

Reading, Writing, and Resisting Debt

When I was young, people lived from paycheck to paycheck. Today, it seems like they live from credit card payment to credit card payment.

Most of us know that millions of People are deeply mired in credit card debt. Many financial experts have said repeatedly, "Get out your scissors and cut up your credit cards." While this may sound like good advice, to me it seems like a painful, short-sighted answer to a more complex problem.

That problem is a lack of financial education. Why don't we teach kids about money in school? Rich or poor, smart or not-so-smart, we all use money. Yet, while there are a few schools beginning to offer some financial education, it seems that most educators believe money isn't a subject worthy of the hallowed halls of our learning institutions.

A History of Credit

When I was a kid, there were no credit cards. Instead, retailers offered layaway plans. My mom would go to a store, such as a furniture outlet, choose the sofa she wanted, and put it on layaway. That meant she put a little money down to hold the sofa, and every payday she'd pay a little toward the purchase. When the sofa was paid for in full, she would bring it home.

At that time, stores also offered "buy now, pay later" plans. This meant my mom could buy the sofa, sign a payment agreement, and take the sofa home that day.

Today, while a few stores still offer such plans or even variations of them, most people simply put their purchases on a credit card. But credit has been a part of American life even before there were credit cards.

A Growth Industry

There are many reasons why credit cards have grown in popularity, including these:

Wall Street has turned debt into an asset.

Today, your friendly banker issues you a credit card. He then sells your debt to a Wall Street firm, which collects your monthly payments at high interest rates -- which is why it's an asset to them.

The minute a Wall Street firm purchases your debt, your bank no longer has it on its financial statement, which then allows the bank to look for more credit card customers. That's one reason why you get so many credit card offers.

The purchasing power of the dollar has dropped.

If you've followed these columns, you know that in 1971, President Nixon converted the U.S. dollar from money to a currency. That means the U.S. and other governments can print money faster than you can earn it -- or save it.

In terms of purchasing power, if you earned $50,000 in 1996, you would have to earn $100,000 in 2006 just to stay even. Many people aren't earning more even though prices are rising, so they make up the difference by using their credit cards for everyday purchases.

When wages go up, so do taxes.

Because the purchasing power of the dollar has dropped, many people work harder, ask for raises, or take on extra work (or a second job) to earn more money. And when they earn more money, they move into higher tax brackets.

Today, the alternative minimum tax (AMT) -- first levied in 1970 as a tax against the rich -- is penalizing the middle class. In many ways, the AMT is a form of double taxation. Many working people are now making more money but taking home less because they pay a higher percentage of taxes.

The cost of retirement has gone up.

When I was young, many people worked for a company with a pension plan that covered them for as long as they lived. If they didn't have a pension plan, they could count on Social Security and Medicare.

That's all changed. Today, millions of workers need to be able to afford their day-to-day living as well as put enough money aside for when they can no longer work.

I Love Credit Cards

Clearly, cutting up credit cards won't address these economic changes or solve America's debt problem.

In the real world, credit cards are essential. It would be extremely difficult to rent a car or make hotel and airline reservations without a credit card. It would also be tough to pick up the tab at a business lunch or shop online without a credit card.

Personally, I love my credit cards because of the financial freedom they allow me, and my life would come to a grinding halt without them.

Fight Debt with Debt

Whenever anyone asks me how to solve the credit card problem, I tell them to fight fire with fire -- and debt with debt. The way I solve my increasing needs for cash is to go deeper into debt -- good debt, not bad debt.

For example, I use debt -- which is essentially tax-free money -- to invest in real estate, which in turn increases my cash flow. Not only do I not pay taxes on my debt, I could also pay no taxes (or very little in taxes) on the income from the debt. Hence I earn more but pay less in taxes.

Obviously, in order to do this you need to know how to use debt wisely and responsibly, and must be able to find great investments that increase cash flow.

The Root of the Problem

Most financial experts will scoff at my "fight debt with debt" approach. They'll say my advice is based on flawed logic, and it may well be -- for most people. But I ask you to step back and take a look at the world of finance. As I stated earlier, Wall Street is able to take your debt and turn it into their asset. That's what financially smart people do, and it's one example of why rich people get richer.

Unfortunately, most people take bad debt and turn it into horrible debt. This is especially true of poor people and people with bad credit, who have access to only the worst forms of debt and pay the highest interest rates on it.

But their problem isn't credit cards -- it's a lack of financial know-how. And at the root of that lack of knowledge is our school system and its archaic curriculum, which is out of touch with the way people really live.

Clearly, advising people to cut up their credit cards won't solve the problem of excessive credit card debt. A pair of scissors won't make anyone financially smarter, but some financial education just might.

Wednesday, June 11, 2008

Educate Yourself into Riches

Many of Wall Street's elite firms were being required to pay tens of millions of dollars in fines to investors, according to media reports. The penalties are for alleged bad investment advice, courtesy of New York State Attorney General Eliot Spitzer.
This brings me to one of my favorite quotes from famed investor Warren Buffett goes: "Wall Street is the only place that people ride to work in a Rolls Royce to get advice from those who take the subway."
I have been highly critical of the standard financial planning advice -- "work hard, save money, get out of debt, invest for the long term, and diversify" -- for a long time. Such guidance is often more a financial advisor's (subway rider's) sales pitch than a solid investment guide.
But while I think it's courageous that Spitzer slaps millions in fines on a few Wall Street firms for their bad investment guidance, I believe the investors who accepted that unsound advice have some responsibility, too. Isn't knowing the difference between good and bad advice part of knowing what you're doing?
The Difference Between Investing and Shopping
The problem is, most investors don't know how bad the standard investment advice is. This mantra of "work hard, save money, get out of debt, invest for the long term, and diversify" is followed by millions of investors -- who lost $7 trillion to $9 trillion between 2000 and 2004. Many are still following this bad advice today.
Not only did millions of investors lose trillions of dollars, many also missed the boom in real estate, oil, gas, and previous metals. Furthermore, despite investors' huge losses, Wall Street paid out some of its biggest bonuses in history.
However, investors should realize it's "buyer beware." Investing is different from shopping. If I go to Sears and don't like the tool or shirt I purchased, I can generally get my money back. When we go shopping, we expect value for our money. But when we invest, we do so in the hopes of making more money -- and knowing that we risk making losses. What would happen to the financial industry if brokers were sued every time a client lost money? The wheels of world commerce would grind to a halt.
My point is: The world is filled with honest people handing out bad advice. An example of honest bad investment advice is the standard one of "work hard, save money, get out of debt, invest for the long term, and diversify".
The world is also filled with biased advice, which is why people say, "Never ask an insurance broker if you need insurance, or a mutual-fund sales person if they recommend mutual funds." Furthermore, there are many crooks and con artists as well, who intentionally promote dishonest ventures.
Spotting the Difference
So while it's imperative that we have the Securities and Exchange Commission and a brave Attorney General such as Spitzer to enforce the rules, we, as individual investors, still need to be vigilant and personally responsible for the advice we receive and what we do with our money.
In my opinion, that means each of us needs to be responsible for our own financial education so we can tell the difference between good advice, biased advice, and crooked advice. If you can educate yourself to know the differences between those three types of advice, getting rich is easy.
Or, if you take investing advice from a subway rider, don't be surprised if you wind up on the subway.

Thursday, June 5, 2008

Throwing Good Money After Bad

Throwing Good Money After Bad

All booms eventually go bust.
We all remember the stock market crash of 2000, and most of us remember the real estate crash after the implementation of the 1986 Tax Reform Act. Today, many people are anticipating another real estate crash.
Unfortunately, despite our understanding of booms and inevitable busts, it's always near the top of a boom that "dumb money" buys in. Currently, this has set the scene for a potential market bust of which few people are aware. I'll describe it today's column, and advise how best to prepare in my next column.
Express-Lane Inspiration
About a year ago, I wrote warning readers that the real estate boom was over. How did I forecast the end of the boom? I got my hot tip from the cashier at my local Safeway supermarket.
While she was tallying the cost of my apples, broccoli, and steaks, she handed me her new real estate agent's card and invited me to call her for my next real estate investment. Moments later, I was home writing that column. As my rich dad used to say, "When dumb money chases smart money, the party's over." Needless to say, many real estate agents and investors wrote me nasty notes.
I'm not a hundred-percent certain where things are going today. Most economists are forecasting a strong economy, but economists worry me more than newly minted real estate agents. Most seem to be happy that inflation is in check; when I hear that inflation is in check, I begin to think about deflation, and as most of us know, deflation is much, much, worse than inflation.
An Inconvenient Truth
In the simplest terms, inflation occurs when there' too much money in the system. On the flip side, deflation occurs when there are too few dollars in circulation. When that happens, prices start to fall. For example, in inflationary times, prices of houses go up. In deflationary times, prices of houses come down. If prices of houses begin to drop too fast right now, it could be 1986 all over again.
I wrote a colum years ago about how I love debt and my credit cards. The trouble is that most people do. Today, you can qualify for a loan to buy a house simply if you're alive and breathing.
The strong economy we've been experiencing for years has thus been built on dumb money -- in addition to smart money -- borrowing more and more. Even the U.S. government has had a field day borrowing money to do such things as fight a war and attempt to rebuild Iraq and Afghanistan rather than rebuild our country. And the inconvenient truth about debt is that it has to be paid back.
A Certain Ratio
For the next two years, I'm cautioning people to watch their ratios between good debt and bad debt, and keep liquid reserves such as cash, gold, or silver.
Good debt is debt that makes you rich. An example of good debt is the debt on the apartment houses I own. That debt is good only as long as there are tenants to pay my mortgages. If tenants stop paying their rent, my good debt turns into bad debt.
Most people don't have good debt -- all they have is bad debt. Bad debt is debt that makes you poorer. I count the mortgage on my home as bad debt, because I'm the one paying on it. Other forms of bad debt are car payments, credit card balances, or other consumer loans.
On our home, my wife, Kim, and I keep a 25 percent debt-to-equity ratio. In other words, our debt is 25 percent of the home's value. Unfortunately, many people have an 80 percent or higher debt-to-equity ratio. That means the debt on their home is 80 percent and their equity is only 20 percent.
On our investment properties, we carry a higher debt-to-equity ratio. To protect ourselves, we have cash reserves to cover the expenses of the properties. For example, in case all the tenants leave and no one is left to pay the mortgage and expenses, we have separate funds for each property, with enough liquidity -- i.e. cash, stocks, and bonds -- to carry the building for a year. Unfortunately, the dumb-money crowd has no reserve funds for their properties.
Where Deflation Does Its Damage
In a deflationary market, the value of your home can drop. If the value drops, the bank may call in your loan. Even if you've never missed a payment, and even if you're ahead on the payment schedule, the bank can call in your loan if they feel the value of the property is lower than the loan amount.
For example, say you buy a house for $100,000 and put 20 percent down and borrow $80,000. If the market deflates and the value of your home drops to $70,000 (because everyone else is selling their homes to get out of debt), the lender may ask you to pay the $80,000 you owe immediately.
If such deflation happens, cash will become king. There will be half-price sales on BMWs, expensive restaurants will close, and people will be out of work. And anybody who caters to people with dumb money will be in trouble. As I said before, deflation is much worse than inflation.
Smart Money, Bad Times
The good news is that during deflationary times, smart money reenters the market, so crashes are great for smart people with smart money. Instead of listening to the optimistic economists, then, you should eliminate bad debt and improve your debt-to-equity ratios on good debt.
Most important, study; if you want to be smart, you need to learn. I'll discuss what you should study in the second part of this column. For now, be aware that if deflation comes and there's a recession, it won't have much effect on the poor. Instead, it'll punish middle-class people who think they're rich because their houses and stocks have gone up in value.
I'll explain more in a couple of weeks.

Thursday, May 29, 2008

To Get Rich, Seek Out Rich Financial Advice

To Get Rich, Seek Out Rich Financial Advice

I've been on television recently discussing the U.S. financial crisis. These shows often feature a panel of so-called financial experts who rarely agree with each other. The reason their advice is different is simply because each expert speaks to a different segment of the population.
Giving Credit
For example, Suze Orman, Dave Ramsey, and Larry Winget speak to people who are deep in credit card debt. Their advice is excellent, direct, practical, and to the point. I should know -- in the late 1970s, I was one of the debt-ridden people they're speaking to. I was deeply in debt because my business was suffering and I was using credit cards to live on. Instead of paying off my credit card, I'd get a new credit card and use that one to pay off the old credit card. I, too, once used a home equity loan to invest in my business -- and lost it all.
At my lowest point, I was nearly $700,000 in debt. One evening, I attempted to check into a motel in upstate New York and my credit card was declined. I slept in the car that night. Many people might say that this was a horrible experience, but that isn't true -- it was a wake-up call. It was clearly time to look in the mirror and face who I really was. I realized that if I wasn't going to be tough on me, the world would take on the job.
Today, older and wiser, I have tremendous respect for the power of debt and the value of credit. Credit is another word for trustworthiness. I'm currently millions of dollars in debt, but it's good debt invested in income-producing real estate. While millions of homeowners are threatened with foreclosure, my investment real estate is doing very well. In fact, I'm doing even better because more people are renting than buying.
The Strata of Financial Advice
If you're deeply in debt like I was and want to get rich someday, I suggest you start by following the advice of Orman, Ramsey, and Winget. For a certain portion of the population, their advice is very rich indeed.
But there are other types of financial advice, some of it not nearly as beneficial. The lowest kind assures people that the government will take care of them. This is what the people who are counting on Social Security and Medicare have been led to believe. The problem is that the U.S. government is the biggest debtor in the world, and those depending on it to take care of them will only become poorer.
Another type of bad financial advice tells us to get a safe job, save money, live below our means, buy a house, get out of debt, and invest for the long term in a well-diversified portfolio of mutual funds. On those financial TV shows, I get into the most head-butting with the so-called financial experts who subscribe to this philosophy. That's because, according to the Census Bureau, in 1999 the average U.S. income was $49,244. By 2006, the average income declined to $48,201. This means that U.S. workers haven't had a pay raise for seven years. So much for the advice about getting a safe job -- it's the opposite of rich advice.
Diversify at Your Peril
Moreover, in January 2008 the Federal Reserve Board dropped the interest rate twice over a period of just eight days, by a record 1.25 percent. If my crystal ball is accurate, I expect another .5 percent drop sometime later this year. Savers are actually losers, then, because interest rates are low and inflation is high. So urging people to save money isn't rich advice, either.
Finally, the S&P stood at 1,352.99 in March 2008, which is below its mark of 1,362.80 in April of 1999. So much for the advice of investing for the long term in a well-diversified portfolio of mutual funds -- that's also not rich advice.
Warren Buffett has said that diversification is for people who don't know what they're doing. And my rich dad once told me, "Diversifying is like going to a horse race and betting on every horse. The only way you win is if the darkest of dark horses wins." So my concern is that people who follow this second type of financial advice may actually wind up poor in the long term.
Get Rich, Stay Rich
So there's different financial advice for different people, and the price of poor advice is that millions will be poor if they follow advice that isn't aimed at them.
To become rich, I recommend investing in your financial education. There's a difference between that and financial advice. A solid financial education allows you to know the difference between good advice and bad advice, rich advisers and poor advisers.
If you want to become rich -- and remain that way -- it's important to know what financial advice is best for you.

Tuesday, May 27, 2008

Mutual Funds Get Greedy

Mutual Funds Get Greedy

I was on a radio program not long ago. My host was a financial planner who was upset about the book Donald Trump and I wrote, "Why We Want You to Be Rich." In the book, Donald and I don't speak highly of mutual funds.

Rather than listening to what I had to say, the interviewer wanted to argue. His position was that Donald and I weren't experts on mutual funds, and had no right to criticize. I agreed that we weren't experts on mutual funds, and reminded the host that Donald I never claimed to be.

An On-Air Dustup

Instead, we were quoting John C. Bogle, a true expert and leader in the mutual fund industry whom I mentioned before. For those who may not know, John Bogle is the founder of the Vanguard family of funds.

Rather than consider my position -- that Donald and I were not experts, but John Bogle was -- the on-air financial planner defensively said, "John Bogle loves mutual funds."

Again agreeing with him, I replied, "Bogle does love mutual funds. That's why he's upset, because mutual fund investors are being ripped off by mutual fund managers."

Our on-air argument continued for approximately five more minutes. I asked the host if he'd read Bogle's book, "The Battle for the Soul of Capitalism." He admitted that he hadn't, and had no future plans to do so. His position was that I had misinterpreted the book and was taking Bogle's statements out of context.

Bogle on Funds

There's a saying that goes, "Minds are like parachutes. They only work when open." Since the radio-show host's mind was closed, and so was mine, I asked to end the interview early. Rather than continue arguing about a book the listening audience couldn't see and the host didn't plan on reading, I decided to make my case here, with Yahoo! Finance readers.

Essentially, John Bogle's position in "The Battle for the Soul of Capitalism" is that investors -- what he calls the true owners of major corporations and mutual funds -- are being robbed blind by corporation and mutual fund company managers. He refers to it as the shift from owner's capitalism to manager's capitalism.

Most of us have heard about the investors (and true owners) of Enron, WorldCom, and other corporations being fleeced by the likes of Ken Lay, Jeff Skilling, and Bernie Ebbers. Bogle contends that the same type of theft practiced by these men is going on in the mutual fund industry. He doesn't point to just a few bad apples, either -- he fingers the industry as a whole.

To quote Bogle, "Simply put, fund managers have arrogated to themselves an excessive share of the financial markets' returns, and left fund investors with too small a share." Elaborating on that point, Bogle writes, "With today's dividend yields on stocks at about 1.8 percent, a typical equity funds expense ratio consumes fully 80 percent of a fund's income."

As I put it on the air that day, "Eighty percent is a bit greedy."

A Money Vacuum

To illustrate his point, Bogle writes that "while $10,000 invested in the stock market [in 1985] earned a profit of $109,800 [over 20 years], the average mutual fund investor earned a profit of just $29,700. Together, the cost penalty, the timing penalty, and the selection penalty consumed an amazing 73 percent of the profit available simply by buying and holding the stock market itself, leaving the average fund stockholder with a mere 27 percent of the total."

In other words, if investors had invested in the stock market back in 1985, they would have made $109,800 dollars over 20 years. That's including the ups and downs of the market. During the same period, investors who put the same $10,000 in mutual funds made only $29,700.

That's what prompted me to tell the radio interviewer, "That's why mutual funds suck. Not only do they suck 80 percent of the dividends, in come cases they suck another 73 percent of other gains from investors."

I believe my comment was bleeped.

Caveat Emptor

Reading "The Battle for the Soul of Capitalism," you begin to understand Bogle's motivation for writing it. As the radio host accurately told me, "John Bogle loves mutual funds." If that financial planner had read the book, he'd understand that that's precisely why Bogle is so frustrated.

Mutual funds are a beautifully conceived investment vehicle designed to provide long-term wealth for passive investors. Sadly, over the years, fund managers have been both legally and illegally ripping off investors who count on their investments to provide a college education for their kids or retirement security for themselves. It seems that mutual fund managers, like the managers of our major corporations, have sold their souls for fast money, and have left the investors behind.

I agree with Bogle's call for more governance from fund managers. If the rip-off continues, it'll be harder to raise money from investors to fund our entrepreneurs and businesses. Many U.S. investors are already investing overseas rather than at home.

Yet regardless of whether or not our capital market leaders tighten the rules and fund managers regain their capitalistic souls, I remind you of a timeless bit of investing wisdom: "Let the buyer beware." Ultimately, it's your money, so be very careful about what you invest in and who you invest with.

Sunday, May 25, 2008

Rich Today, Poor Tomorrow

Rich Today, Poor Tomorrow

As promised in my former post, this week I'll explain why deflation will severely punish the upper middle class. These are the people who think they're rich because their houses and stocks have gone up in value -- that is, because of inflation.

What Goes Up...

People concerned about inflation today tend to buy big houses and nice cars. They believe that the purchasing power of the dollar is going down. But what happens if cash becomes king?

This cash squeeze is already affecting many people who thought they were rich. My wife, Kim, has a friend who's a successful architect. Her husband was a manager of a good sized advertising agency. They have three children, the oldest in high school, and earn about $350,000 a year in combined income.

Because they were flush with cash, this couple purchased two high-end vacation homes, one in the mountains and one at the beach. They live most of the year in a McMansion in Phoenix.

Things were going along fine until the husband lost his biggest client. Then he lost his job, and in less than three months their savings was depleted. They then tried to sell their vacation homes, but the values had dropped below the mortgage amount. Today, they continue to pay the mortgages on their houses and hope the price of real estate will go back up. They sold one of their BMWs at a loss.

In 2005, they were net-worth millionaires. In 2007, they're facing bankruptcy.

Follow the Arrows

People like this couple aren't concerned enough about is the credit bubble bursting, which could lead to deflation. Today, nationwide savings are low and debt per household is up. Most of us know the following equation from Economics 101:

cash + credit = the economy

Ever since 2000, there's been an oversupply of credit. When the Y2K threat loomed, the Federal Reserve flooded the market with credit. After the terrorist attacks of 9/11 and the stock market downturn in 2002, the market was again flooded with easy credit. Excessive credit and lower interest rates kept the economy afloat.

It was a smart move at the time. In the first five years of his presidency, President Bush borrowed nearly a trillion dollars, more money than all of our previous 43 presidents combined, and the resulting credit bubble helped keep the stock market from collapsing entirely and led to a boom in real estate.

The problem is that this debt must be repaid. So the trillion-dollar question is, can the government, businesses, and consumers keep the credit bubble inflated? Here's that equation:

cash +


= the economy (inflationary)

If credit is cut off or the debt can't be repaid, the equation changes to this:

cash +
= the economy (deflationary)

Fresh-Squeezed Stocks

If the credit bubble bursts, it could trigger a short squeeze.

"Short squeeze," a trader term, is when a stock's price is high and many traders short the stock. Shorting a stock means borrowing shares from an investment house, selling them, and hoping the price of the stock drops. When the price drops, a trader buys the stock back and returns it to the investment house he borrowed it from.

For example, say XYZ stock is selling for $100 a share. A trader borrows 10 shares from the investment house and sells them for $1,000. The stock drops to $60. Now the trader buys back 10 shares from the market for $600 and returns the 10 shares to the investment house. He now has a gross profit of $400 before paying interest and fees to the investment house.

A short squeeze occurs when the market goes the other way. In this example, instead of XYZ stock dropping to $60 a share, it rises from $100 to $150. The investment house issues a margin call, which means the trader needs to return the 10 shares he borrowed.

Suddenly, all the other traders who shorted the stock need to buy shares of XYZ in order to return them. As more short traders begin buying XYZ, the price of the stock goes up and up -- from $150 to $160 to $170, for instance. This is a short squeeze in stocks. The traders who thought the price of the stock would go down are squeezed into becoming the ones who drive the price up.

Putting the Squeeze on the Economy

A short squeeze could happen with the U.S. dollar if lenders suddenly forced debtors to pay in cash.

The couple I mentioned above is technically caught in a short squeeze, since they're short of cash and long on debt. They had to sell their luxury car at a huge loss because they were desperate. As time goes on and their savings dwindles, they may become desperate enough to sell their vacation homes at huge losses.

If the credit markets bust, there could be millions of couples just like this who seemed rich but are suddenly poor. This could send the lending rate of the dollar higher, making the value of the dollar higher as well -- essentially causing a deflation.

I don't want the U.S. economy to go into a short squeeze, and I hope the credit bubble doesn't burst. Deflation isn't good, and inflation is easier to cure than deflation.

Invest in Money Smarts

My concern about deflation is best represented by the following equation:

cash +
= the economy (recession)

If the credit bubble bursts, not only will credit disappear, but people will stop spending and start hoarding cash, and savings will increase. Money is fuel for the economy, so when credit is gone and money is in hiding, the economy slows and a recession -- or worse, a depression -- can occur. In this case, prices go down, not up, and cash becomes king.

I certainly don't want this to happen. Nonetheless, given the lack of a clear direction in markets today, a good investment for 2007 may be to pay off some high-interest debt, put a little extra cash aside, and wait for bargains. If there's a short squeeze on cash, I believe it will be short lived. Once the Fed pumps more money into the system, the dollar will continue its fall.

In conclusion, your best investment today may be in time, not money. That is, invest your time in studying, reading books, and going to seminars. I recommend you study the asset class that's high-priced today, and could be low-priced tomorrow. For example, if you want to acquire real estate, study real estate while prices are high.

And if and when the market crashes, be ready to buy.

The Slow-Motion Stock Market Crash

The Slow-Motion Stock Market Crash

When my book "Rich Dad's Prophecy" was released in 2002, most financial newspapers and magazines trashed it because I discussed a looming stock market crash. Ironically, much of what I predicted in the book is coming true earlier than I expected.

On Feb. 27 of this year, a 9 percent market sell-off in China sent ripples of fear through stocks markets across the world. In the United States, the Dow's one-day plunge of 416 points was the steepest decline since the market opened after Sept. 11, 2001.

So the question is: Should stock investors be worried? As you might expect, some say yes and some say no.

Correction or Crash?

Personally, if I were counting on the stock market for my retirement or to put my kids through college, I'd be worried. Why? Because from my perspective, even if the Dow were to miraculously soar through 15,000, the stock market has been experiencing a long, slow crash for years.

This February, investors witnessed a drop of $583 billion in U.S. market wealth. Many experts are quick to point out that this loss of wealth is a mere drop in the bucket when you take into account that the stock market has been going up for four years. Most market experts say that the market was due for a correction, which is true.

In fact, the recent 3.5 percent drop is miniscule when compared to the 21 percent drop of the S&P 500 back in 1987. By definition, such a small drop isn't even classified as a true correction. According to BusinessWeek, a full-fledged correction is defined as a 10 percent drop, and a bear market is defined as a 20 percent drop.

Comparing Apples to Oranges

So how can I say that the market is crashing even if it continues to go up? To see the true crash, educated investors need to compare apples to oranges, not apples to apples.

When you compare the Dow to the Dow, or the S&P 500 to the S&P 500, that's comparing apples to apples. The Dow at 12,000 appears better than the Dow at 9,000, just as an apple at $1 a pound looks better than at $1.50 a pound, even though it's still the same apple. All that's happened is the price per pound of the apple has gone up -- the apple hasn't changed.

Years ago, my rich dad taught me to be a comparison shopper, especially when it comes to investments. He said, "You need to understand value more than price. Just because the price of something goes up doesn't necessarily mean the value has gone up."

He also told me, "If prices go up without a corresponding increase in value, it means the value of the asset has actually gone down." This holds true for all assets, including stocks, bonds, and real estate.

For example, when the price of a house goes up it doesn't mean that the house is more valuable. And prices going up may mean that something else is going down in value. In today's global markets, what's going down is the purchasing power of the U.S. dollar.

The Dow vs. Gold

To get a truer picture of comparative values, compare the Dow to the price of gold. When the purchasing power of gold is compared to the purchasing power of the Dow, the Dow appears to be crashing.

That means the average investor will need at least a 15 percent annual return on their stocks or mutual funds just to stay ahead of the U.S. dollar's purchasing power erosion -- that is, just to break even.

In my earlier Yahoo! Finance columns, I used history to forecast the future by comparing the dollar to gold and oil over a 10-year period. Here's the data:

19962006Percent Increase

Table updated 3/21/07.

What Next?

What this means for you depends upon your bullish or bearish outlook, your financial education, and financial experience. For example, I hear many young people today saying that the price of real estate doesn't go down. This is a naive opinion due to lack of financial education and experience. I heard similar misguided opinions about stocks in the dotcom era, just before the market crashed.

Personally, I tend to heed former Federal Reserve Chairman Alan Greenspan's caution about a possible recession ahead. I predict that if there is a recession, current Fed chairman Ben Bernanke (and, in an attempt to hold onto the White House, the Republicans) will flood the market with more money at lower interest rates.

Then the purchasing power of the dollar will once again drop, asset prices may rise, and the financially naive will actually believe that the value of their assets -- houses, stocks, and mutual funds -- have gone up in value.

Thanks to Mike Maloney, my go-to guy for information on gold and silver.

Riding Out the Subprime Disaster

Riding Out the Subprime Disaster

You've no doubt heard about the subprime mess in the mortgage industry. That's the bad news.

But there's a flip side: Even though there's trouble in the subprime market, bankers haven't stopped lending money on good real estate to sound investors.

How Subprime Went Down the Drain

Instead of quivering in fear of a real estate crash, savvy investors need to ask what led to the subprime disaster and how they can profit from it. Here are some of the causes:

1. Early in 2001, the crashing stock market caused Alan Greenspan to drop short-term interest rates to 1 percent. Instead of the stock market roaring back, the residential real estate market took off.

2. Pension fund managers -- the people who collect your 401(k) money, for example -- needed to find returns that were higher than those in the stock or bond markets, so they began lending money to hedge funds, private equity funds, and large mortgage firms.

In other words, the people you entrusted your retirement savings to were willing to invest it in riskier ventures just to get you a higher return.

3. China and other foreign nations were willing to finance our national debt, our war, and our lifestyle. Foreigners loaned us money to invest or to use to buy their products.

4. This led to five types of foolish or unsophisticated investors, who drove up the price of real estate, which led to the boom in subprime loans and the eventual bursting of the bubble.

The Usual Suspects

Those five investor types are best illustrated by the following people (and although I've changed their names, they're actual people I met):

John and Sally: First-time homebuyers

With low interest rates and easy loan qualification, newlyweds John and Sally bought a new house in a bad neighborhood at an inflated price. They signed their future earnings away with a 125 percent loan. With the extra money, they put in a pool and bought all new furniture. Their first child arrived a year later -- and their home has dropped in value.

Joe and Suzy: Credit card abusers

These folks use their house like it's an ATM. Every time Joe and Suzy get into credit trouble, they refinance their home to pay off their credit card bills. That is, they substitute short-term credit for lifelong debt.

Ed and Mary: Empty nesters

Ed and Mary are baby boomers whose kids have left home for college. With their extra money, the couple bought a vacation home as an investment. They used the equity in their primary residence as a down payment on the vacation home, and now have two mortgage payments. They're wrongly convinced that the houses are assets, and that real estate always goes up in value.

Jack and Janice: Bigger is better

Jack and Janice, surprised by the escalation of prices in their neighborhood, sold their home and bought a bigger home in a more prestigious and expensive neighborhood. Today, they're having a tough time financing their (or rather their neighbors') standard of living.

Fred and Phyllis: The flippers

These are novice investors who think flipping real estate is the way to wealth. Fred and Phyllis have never been through a real estate downturn. Prior to the real estate bubble, they were day traders in dotcom stocks.

In 2003, they became real estate "experts." Believing that real estate always goes up in value, they found a mortgage broker who financed 10 properties with nothing down, with what are known as liar loans.

The problem is, the project Fred and Phyllis invested in wasn't built yet and then ran into construction delays. Rather than go through the pain of selling their 10 homes, the couple turned in the keys and walked away, returning to their day jobs.

A Silk Purse from a Sow's Ear

Does all this make real estate a bad investment? Obviously not, just as a stock market crash doesn't make stocks a bad investment. What it does do is underscore the foolishness of crowds and the mania of markets.

Actually, right now is a great time for real estate investors. Today, in many markets, the price of real estate is still coming down. On top of that, interest rates are low. So the subprime mortgage mess is bad news for sellers but good news for buyers.

As usual, there's an outcry that the government should intervene. But that raises the question of how laws against greed, stupidity, and foolishness are passed and enforced. The fact is that subprime lending will never end -- people with bad credit, or who are greedy and/or excessively foolish, will always find ways to get the credit they neither deserve nor can afford.

Think I'm wrong? This evening, right after a TV news story on the subprime disaster, a commercial appeared encouraging homeowners to buy furniture today and not make payments until 2009. I rest my case.

A Fender-Bender or a Train Wreck?

Last month, Alan Greenspan cautioned the world that a U.S. recession is possible in 2007. If the subprime mess continues to spread and credit dries up, his warning could come true. A recession, along with the ongoing Iraq war, the national debt, and baby boomers retiring in massive numbers, would deliver a severe blow to the U.S. and world economies.

So I recommend that you get into a cash position, and save as much as you can as quickly as possible. The good news is that there will be bargains galore. If you have cash you'll be able to purchase real assets and fancy liabilities such as jewelry, artwork, nice cars, and big homes at cut-rate prices.

Unfortunately, in a recession the people who suffer the most aren't the rich, but the wanna-be rich and the poor. The poor will find it harder than ever to get additional credit, even if they're hard-working, have a decent credit score, and have some cash. The wanna-be rich -- those who are rich in credit only -- will be the ones donating their homes and their bling to bankruptcy auctions, second-hand stores, garage sales, and swap meets.

Many experts and commentators say that the subprime debacle is just a fender-bender in the economic parking lot; others say it's the headlight of an oncoming train. Regardless of which one it is, it represents a great time for bargain hunters to become genuinely richer.