Thursday, May 29, 2008
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.
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
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.
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
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:
= the economy (inflationary)
If credit is cut off or the debt can't be repaid, the equation changes to this:
|= the economy (deflationary)|
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:
|= 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
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:
Table updated 3/21/07.
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
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.
Sunday, May 18, 2008
People often ask me, "How do you find great investments?" My standard reply is, "You have to train your brain to see them. Great investments are all around you."
I know that's not a very satisfying answer. Most people want something more specific and concrete. But my reply is as accurate as possible. If we could've seen all the great investments just in the past decade, we'd all be multibillionaires.
Missing Out on Millions
There have never been more opportunities to become rich than in the last 10 years. And there'll be even more opportunities in the next 10.
Let me explain. Like many investors, I didn't see the power of eBay almost a decade ago. If I had, I'd be a billionaire today. Nor did I see the power of YouTube, or Google, or MySpace. Being an old guy, my brain isn't trained to see investing opportunities in cyberspace. So I missed them.
Thirty years ago, when my business career was just starting at Xerox, I was introduced to a new type of computer. I wasn't tuned into computers at the time, so little did I know that I was looking at the early version of what was to become the Macintosh. So I also missed that billion-dollar opportunity, too. How many billion-dollar opportunities have I missed? Maybe millions.
If I've missed so many million- and billion-dollar opportunities, why am I writing this blog? That's a valid question, and the answer has to do with helping you find great investments.
Perseverance Pays Off
I took my first real estate investment course in 1974 in Honolulu. The cost was $385, and I believe it was two or three days long. Toward the end of the class, the instructor said something I've never forgotten: "Now you know the difference between good real estate investments and bad real estate investments. Now you all know what to look for."
He paused and then added, "The problem is, most people will tell you such investments don't exist. Your friends will tell you so, and so will real estate agents." Truer words were never spoken. For the next few months, I went from real estate office to real estate office, looking for investments. As promised, the real estate agents told me what I was looking for didn't exist. My friends and co-workers at Xerox told me the same thing, and said I was either dreaming or smoking funny cigarettes.
Finally, in a small, obscure real estate office in downtown Waikiki, I met a scruffy little broker who said, "I have what you want." The next weekend I was on a plane to Maui, where he'd found an entire condominium development that was in foreclosure.
I purchased my first piece of investment real estate for $18,000, putting the $2,000 down payment on my credit card. The one-bedroom/one-bath condo paid me a positive cash flow, even after all the expenses and mortgage payments. My investment career had begun. More important, I was training my brain to see what most people don't see. That $385 real estate course has made me millions of dollars over the years.
Keep an Open mind
From My last post called "Think Rich to Lower Your Taxes". It was about an investment strategy known as the "velocity of money," and how I use it to invest, make a lot of money, and then legally use the tax laws to minimize my own taxes. I suspected the column would spark some controversy, and it did.
For a couple of weeks, I kept track of the reader responses to it. Some of the less-complimentary comments reminded me of what those real estate agents and my friends at Xerox said to me back in 1974.
You see, our brains are either our greatest assets or our greatest liabilities. As I said, when it comes to investment opportunities in technology, my brain is a liability; I just don't get it. When it comes to investment opportunities in real estate, gold, oil, and silver I'm above average, but not great. And that's because I've trained my brain to see opportunities in those areas.
So, instead of criticizing the readers who were close-minded (or even mean-spirited) about my advice, I encourage them to keep an open mind and find their own way of seeing investments most people miss. That's how you get rich. People who refuse to open their minds to new strategies seldom become rich -- which I guess is why there are more critics in the world than rich people.
Finding Your Magic Formula
One of the most important things my rich dad taught me was to never say, "I can't do it" or "I can't afford it." Those thoughts are self-limiting, and it's hard to find great investments when you're basing your behavior on limitations. In today's world, there are more investing opportunities than ever before. Why would anyone want limited financial results in an unlimited world?
One of the reasons I write this Blog is to put forth ideas that challenge the way people think about investing. If you want the same old financial-planning dogma of "work hard, save money, live below your means, get out of debt, and invest in a well-diversified portfolio of mutual funds," then my column is obviously not for you.
My job is to stimulate your thinking, inform you about why rich people get richer, and encourage you to find the magic financial formula that works for you. I found mine, and I want you to find yours.
Why the sudden honesty? I'll tell you.
The Best Policy?
One of the things I loved most about the Marine Corps was that I never had to worry about what anyone was thinking. When I was preparing to be an officer, there was no sensitivity training. When superior officers spoke to you, they didn't have to wrap their words in ribbons and bows, and didn't worry about hurting anyone's feelings.
In fact, we often went out of our way to hurt others' feelings just to test their core toughness. (I'd repeat some of the more choice comments I've treasured over the years, but I'm not writing for a military audience.)
When I returned from the war and entered the civilized world of business, I was shocked by the phoniness, the covert hostility (disguised as caring), and the fake smiles that are rampant to this day. It's been over 30 years since I was discharged from the Marines, and I still haven't adjusted.
Today, I'm still hesitant to let my employees know exactly what I'm not satisfied with for fear of being sued, or to compliment a pretty woman for fear of being accused of sexual harassment.
But I'm happy to say that things are changing. We now have reality TV instead of Father Knows Best, a phony show about fake family harmony from my era. Today, commentators like Bill Maher and Jon Stewart rip into politicians under the guise of humor.
We also have Donald Trump, who has millions of people from all over the world tuning in just to hear him say the magic words "you're fired" to an apprentice wannabe. And of course there's Simon Cowell of American Idol, the critic of all critics, whose book of brutally honest dismissals I was recently tempted to buy.
An Honest Assessment
All of this overt honesty, while sometimes contrived, encourages me to be more honest about my favorite subject -- getting rich, and who's most likely to do so.
Most of you who follow my books and this column know how I make my money. First of all, I'm an entrepreneur. I've been starting companies since I was a kid. I never wanted to be an employee -- I always wanted to be in control. I didn't want someone like me telling me what to do. Consequently, I now have companies, agencies, or strategic partners all over the world.
Second, I love real estate. Not only do I think it's the best investment in the world, I can prove it. What other investment is there that has bankers lining up to lend you money? They won't lend you millions of dollars for years at a time to buy stocks, bonds, or mutual funds. And what other investment will your insurance company insure against losses? Surely not mutual funds or a 401(k).
Third, I love commodities like oil and gas. Why do I love them? Because they're in short supply and in great demand. Wars have been fought over oil and gas for years. What do you think the war in Iraq is about?
Finally, I've loved gold and silver for years. Why? Because I don't trust the U.S. government to be good stewards of money. As you may know, the Bush administration has printed more funny money -- over a trillion dollars' worth -- in six years than all past U.S. presidents combined.
Wars have been fought over gold and silver, too. Why do you think the Incas lost their empire to the Spaniards, or the American Indians lost their land to the European settlers? The conquerors may have said that they were acting in the name of God, but remember -- there's only a single letter's difference between "God" and "gold."
No More Political Correctness
The recent outbreak of honesty also inspires me to be more forthcoming in general, and less politically correct. This is the web, after all, where honesty is respected, not suppressed, censored, or forced to be "sensitive" like our old, more traditional forms of media.
You wouldn't be reading Yahoo! Finance if you weren't serious about being rich or becoming rich. So I owe it to you to be more truthful. And I'm not worried about offending the financial losers of the world, because financial losers don't read this column.
So, rather than tell you week after week about real estate, entrepreneurship, gold, silver, oil, and gas, I've decided to occasionally run a less-than-politically-correct column and tell you exactly what I think about the subject of getting rich.
The L Words
It's in this spirit that I opened by saying that lazy people don't get rich. I also said that the difference between "God" and "gold" is a simple "L" -- as in "lazy," or "looting." The conquistadors who looted the Inca Empire in the name of God weren't lazy. They were thugs with guns, but they had ambition.
Another word that begins with "L" is "loser." Over the years, I've met many losers who pray to God to give them gold. They'll never get it that way because, as the Sunday school I went to taught me, God helps those who help themselves. Again, the conquistadors may have been killers and thieves, but at least they knew how to help themselves.
I do, too. As some of you may be aware, I wasn't born rich. And I've written openly about my failures as an entrepreneur and my losses as an investor. I haven't hidden my horror stories. The reason I don't keep them secret is because my failures are the best learning experiences of my life. We learn by making mistakes -- except in school, where we're punished for making mistakes. This may be why most schoolteachers aren't rich.
I'm not recommending that you become an ambitious looter, as Ken Lay and Jeff Skilling were convicted of being. I only want to point out that if you're not a lazy loser, you may find yourself with more gold in your life without having to resort to looting.
Monday, May 12, 2008
Today, I'm predicting the next crash, what I believe will cause it, and why it'll be a severe blow to the global economy. The signs are already here.
Busts Beat Booms
First of all, it's no big deal to predict booms and busts. All markets boom and bust. It's just easier to predict a bust because the signs are so obvious -- like excess euphoria, easy access to money, huge profits, and scores of happy amateurs entering the market.
Booms are harder to predict. They start silently, like oak acorns buried in the ground -- you don't notice them until they're towering trees. For example, few people recognized Microsoft or Google for the giants they were until after they'd become major players and the big profits had been made.
Paradoxically, that means busts are better because we can see them coming. This gives us time to prepare, and makes it easier to capitalize on them.
The Year the Dollar Died
The coming bust started in 1971. That was the year Richard Nixon took the United States off the gold standard, thus converting the U.S. dollar from money to currency -- that is, from an asset to a liability, and an instrument of debt. That was the year the dollar died.
After Nixon was forced out of office, the U.S. economy went into a slump under presidents Ford and Carter. We had high inflation and low growth, otherwise known as "stagflation," before Ronald Reagan and his dedication to supply-side economics -- Reganonomics -- came along.
Reagan cut taxes and started borrowing money, increasing the national debt. As a nation and as a people, we began borrowing and spending to spur the economy. And the economy boomed until 2000.
A World of Debt
It began to sink after 9/11. We lowered interest rates and began printing more money. In 2003 and 2004, the Bank of Japan created 35 trillion yen to save the dollar and their economy. It was like a loan of $320 billion to the United States, and probably prevented a run on the dollar.
This loan kept interest rates low, which prolonged the boom with easy money from cheap debt. The problem is that interest rates are now beginning to rise, and the mountains of debt will have to be paid back. If interest rates rise and the economy slows, a severe crash could occur -- a crash caused by years of accumulating debt in order to spur the economy.
The world has never been in this position before -- and the whole world is involved. That's because Nixon's actions in 1971 made the United States into a virtual empire. As an empire, we began dictating the terms of world trade: If you wanted to do business with us, you had to accept our new dollar as gold. Unfortunately, the world complied.
The New Money
Today, China ships us products and we ship them dollars. The problem is that the Chinese can't spend those dollars. If they do, the price of their currency, the yuan, would go up. Why? It's simply a matter of supply and demand.
So instead of spending their U.S. dollars in China, the Chinese buy our assets, especially U.S. bonds, with them. Because they buy our bonds, interest rates in the U.S. remain low, and low interest rates encourage Americans to borrow more money. This causes bubbles in real estate and the stock market.
The problem is almost as bad in China. The Chinese are using U.S. debt as collateral in borrowing yuan to finance projects within their country. With the Chinese economy booming and in preparation for the 2008 Olympics, the Chinese have gone shopping -- they want to look good for the world.
Using Chinese debt collateralized by U.S. debt, they've been buying natural resources from all over the world. Consequently, countries that are rich in natural resources -- such as Canada and Australia -- are booming. Real estate and stock markets in those countries are hot.
But the global boom is clearly built on a mountain of debt.
A Familiar Cycle
This type of boom has happened before. In 1971, Japan was finally emerging from the effects of World War II and becoming a world economic power. The Japanese were exporting cars and televisions to the United States, and because we were importing more than we exported, the Japanese took payment in U.S. gold. In fact, one of the reasons President Nixon converted the dollar from money to a currency was to stop this hemorrhage of gold.
In the 1980s, instead of using gold to finance their economy, the Japanese used U.S. debt as collateral for Japanese debt. This caused the Japanese economy to boom just as the Chinese economy is booming today, and it made the Japanese look like geniuses. Business books and magazines trumpeted the magic of Japanese business management.
Then, in the early 1990s, the Japanese boom busted. Their stock market crashed and the most expensive real estate in the world became cheap. Today, the Japanese economy continues to struggle.
China Isn't Japan
China's advantage is that it learned from Japan's mistakes. That's why the Chinese stubbornly refuse to revalue their currency -- they don't want to make it more expensive the way the Japanese did theirs.
Currently, the Chinese yuan is pegged at 7.6 yuan to one U.S. dollar. This makes the United States accuse China of being unfair; we'd like to see the yuan float the way the Japanese let the yen float. This would make it easier for us to reduce our balance of trade, as well as pay back our debt with cheaper dollars.
The problem is that the Chinese know from the Japanese experience that we can talk tough but not act tough -- they simply hold too much of our debt for us to take measures. And if the Chinese started dumping U.S dollars and bonds on the world market, the world economy might well crumble, just as the Japanese economy crashed nearly 20 years ago.
Time for a New Standard
While it's tough to predict the future, one thing is for certain: The U.S. dollar will continue to go down in value, and savers will be losers. With people all over the world piling debt upon debt and spending like fools, it might be best to follow the Chinese.
They've never trusted banks, but have always trusted gold. Maybe it's time we started doing the same.
Sunday, May 11, 2008
While the piece was written in jest, Tom made valid points about why retirement plans filled with mutual funds are risky. As expected, the rader response was both positive and negative. Some people just didn't get the joke, or couldn't learn from its absurd extremism.
Obviously, the lottery is for losers, casinos are for gamblers -- and mutual funds are for dreamers. While there are some good funds, for the most part the only people getting rich from them are a few key employees of the mutual fund companies.
As you've no doubt read, Wall Street is paying out record bonuses to employees even though most funds perform marginally. In March of this year, the Wall Street Journal reported that Congress finally opened an investigation into the 401(k) and mutual fund industry. It's about time.
In my lottery column, Tom pointed out that tax laws are horrible for mutual fund investors. These people are being taken to the cleaners not only by the fund companies but also by the federal government. So to all of you who love mutual funds and hated the column, you may want to read it again to glean some of its not-so-humorous financial lessons.
The Investing Food Chain Explained
While I'm not a CPA, I am an investor. As such, there are a number of reasons why I don't care for mutual funds. One comes from a lesson my rich dad taught me. He said, "Humans are at the top of the food chain, and capitalists are at the top of the investing food chain."
To illustrate, he created the following diagram:
In the investing food chain, capitalists are at the top and workers are at the bottom. You'll notice that mutual fund investors are just above the bottom.
Professional investors often ask, "What position are you in?" That's another way of asking, "Where are you in the investing food chain?" Bankers, as a general rule, want to be in first position. If anything goes wrong with an asset, they want to get paid first. That's what being in the first position means -- you get paid first. So one of the reasons I don't care for mutual funds is simply because mutual fund investors are close to the last to get paid.
During the Enron debacle, it was workers who took the pounding, not bankers. Not only did Enron employees lose their jobs, many lost their retirement savings. That's because they were at the bottom of the investing food chain.
Still not convinced? Try asking your banker if he or she will lend you millions of dollars to invest in mutual funds or stocks to fund your retirement. I suspect the answer will be a polite, "No, thank you." Bankers want to be in the first position, not the last.
More Food Chain Lessons
There are other lessons to be learned from the investing food chain. One is the power of debt in contrast to equity. Debt holds a higher position than equity, and bankers and bondholders are in debt positions. Preferred stocks, stocks, and mutual funds are in equity positions.
The takeaway here is that most amateur investors try to get out of debt positions and into equity positions, where they invest with their own money or assets. Professional investors would rather be in a debt position -- investing with a banker's money, for instance -- simply because debt is less risky than equity.
Another term professional investors use is "subordinated debt." This is simply debt in a lower position on the chain than that of another claim on the asset. Many homeowners have it in the form of a second mortgage. If they fail to pay this subordinate debt, the banker in second place gets what's left after the banker holding the first mortgage gets paid.
Most homeowners have debt that's known as recourse financing, or full-recourse loans. As a professional real estate investor, I ask for non-recourse financing.
What's the difference? If a homeowner has recourse financing, that means the banker can go after the homeowner's other assets if the mortgage isn't paid. If the bank forecloses on the home and there's not enough money from the sale to cover the loan, the banker can sue for the homeowner's other assets, such as cars, stocks, bonds, and so on.
With a non-recourse loan, the banker can only get the property the loan was made against. The borrower's other assets are off-limits, although most bankers will try to get those as well.
Subprime Debt Feeds Off Workers
The subprime mess is another example of big fish eating little fish in the investing food chain. When interest rates dropped, mortgage brokers began calling people who had no business borrowing money and offering them loans they could never hope to repay. With low interest rates and consumer demand, the price of homes went up and caused a real estate bubble.
Now that the bubble has burst and home values are dropping, many little fish owe more on their homes than the home is worth. I suspect the real estate bubble will continue to deflate as more and more people are forced into foreclosure. People will lose everything because they can't pay their full-recourse loans. Not only will they lose their homes, but many will be forced to liquidate their other assets.
Here's the worst part: Much of the money for subprime mortgages came from the bottom of the food chain. Billions of dollars for these loans were drawn from workers' pension funds, where they were touted as "collateralized debt obligations," or CDOs (a few years ago they were called junk bonds).
Consequently, it's estimated that employee pensions could lose $75 billion dollars on bonds backed by subprime debt. Not only are workers losing on the value of their homes, their retirement plans have been poisoned, too.
Compare and Contrast
So what can you take away from such investing food chain behavior? This contrast might be useful:
My rich dad trained his son and me to be capitalists, and we become entrepreneurs and real estate investors. Instead of working at jobs and investing with equity, we create jobs and invest with debt with our bankers' money. My poor dad encouraged me to be an employee and trust my money to a pension plan.
Simply put, one dad pointed to the top of the investing food chain, the other to the bottom. My question to you, then, is, "Where are you on the food chain?"
Thursday, May 8, 2008
A few weeks ago I was talking with Tom Wheelwright, a CPA and business owner, about why people play the lottery. His comparison of the lottery to investing in mutual funds is worth sharing.
Even though he's not an investment advisor and never presents himself as one, clients continue to ask Tom what to do to prepare for retirement. "Should I max out my 401(k) contribution?" they ask. "Should I open an IRA? Or should I put more in my profit sharing or pension plan?"
According to Tom, and contrary to popular belief, none of these are wise investments. So here, in his own words, are his thoughts on the subject.
Games of Chance
Among other reasons, 401(k)s and IRAs involve putting money into an investment vehicle over which investors have little control. And since most people end up choosing mutual funds as their primary investment within these plans, playing the lottery would be a better way to go.
Gambling away your retirement funds in a government-sponsored game of chance that you have little hope of winning? Sounds crazy, right? Millions of people buy tickets with the same hope. How sensible is it to play the lottery when the chance that you'll lose the money you put in is so high?
But the same could be said of mutual funds. After all, it's also a government-sponsored program that you have little chance of winning. So your chances of retiring on mutual fund investments in your 401(k) or IRA aren't very high, either.
A Taxing Dilemma
I once heard a radio interviewer ask a representative of a large mutual fund about the fund's performance. The rep said it had risen in value by an average of 20 percent per year for the prior two years.
But when the interviewer asked about the average return to the average investor in the fund, the representative responded that the average investor had actually lost 2 percent per year. Why? Because the performance of the market is unpredictable. Compare that to the lottery, where the precise chances of winning and the exact amount of the jackpot are known quantities.
As for the great tax advantages of putting your money into a 401(k) or an IRA, how is it a good deal to get a tax deduction when you're young and in a relatively low tax bracket so you can pay taxes on the money you take out when you're old and retired -- and probably in a higher tax bracket?
Also, consider the difference in tax rates on capital gains and dividends if you're not in a 401(k) or IRA versus the ordinary income tax rates on the earnings when you pull them out of your 401(k) or IRA.
A Gamble Is a Gamble
So should you just invest in mutual funds outside your 401(k) or IRA? No again. Mutual funds result in capital gains taxes when the fund managers trade them, even though you don't see the money. You have to pay taxes even though the fund may actually have gone down in value.
Here's something else to consider: What about the lost opportunity cost of the money you pay in taxes, which you could've put into other investments? At least with the lottery, you know the exact amount of taxes you can expect to pay if you win, and you only have to pay taxes if you do win.
I can hear you saying, "But the lottery is gambling! And I have no control over whether I win or lose!" You're right -- the lottery is gambling. But so is a mutual fund. You have no control over the stock market and neither does the fund manager. If the market goes down, so does your fund.
No Big Payoff
At least when you play the lottery you recognize that you're gambling. And you don't have the government, financial institutions, and your employer telling you that the lottery is a good investment. And your employer doesn't go so far as to match the amount you put into the lottery like it might with your 401(k).
But isn't there a better chance of making money in a mutual fund than there is in the lottery? Hardly. There may be less of a chance of losing all the money you put into a mutual fund than there is of losing all the money you put into lottery tickets, but you're never going to win big in a mutual fund.
In fact, mutual funds are designed to minimize your returns by creating a "balanced portfolio." If they could minimize the risk of the market itself, that might be OK. But the problem is that nobody can minimize the risk of the market without sophisticated hedge strategies that aren't typically used in mutual funds.
If nothing else, the lottery gives you a chance to win big, and you can sleep at night because you aren't wondering if the chances of winning are going down overnight because of something that happens in Tokyo.
Retire for Real
If you don't like the idea that most of the money spent on lottery tickets supports government programs, you should know that most of the earnings from mutual funds support investment advisors' and mutual fund managers' retirement.
You take all of the risk, you put in all of the capital, but most of the money goes to the fund manager and your investment advisor. Lottery funds go to worthy causes like schools and the arts, so which is better?
Of course, I would never advise a client to rely on the lottery for their retirement, but neither would I advise them to rely on mutual fund investments. For my dollar, the lottery is a lot more fun -- and at least you know it's a gamble.
If you really want to retire, look at other investments and work with someone who's willing to put in the time to help you retire soon and retire rich. Financial freedom is available to those who learn about it and work for it. It's unlikely for those who want to rely on such risky investment strategies as mutual funds.
Having had many partners over the years, I can say that this statement holds true. So I thought I'd offer some personal experiences I've had with partners both good and bad.
All Play and No Pay
The first partner is a former CPA who does spectacular pro forma projections. His numbers on the future viability of a real estate project are always well laid out and convincing.
In fact, after first meeting him and his business partner, a Wall Street whiz kid, and looking at some photos of a property they were interested in and an architect's rendition of what it would look like upon completion, I was sold. I became their money partner.
So far I've done three deals with this pair, and to date, we haven't made a dime. The numbers still look neat and tidy every quarter, just the way a CPA should present the financials. The problem is in execution: The projects never finish on time or on budget. Something always goes wrong, and there's always some kind of drama -- problems with environmentalists, city planners, or banks.
Finally, after years of squabbling, his partner (the whiz kid) left the relationship. The projects of theirs that I invested in are still operating, but to date I haven't made any money on them.
A Complementary Relationship
The second partner is Ken McElroy, a writer and personal friend. My wife, Kim, and I have made the most money with Ken. There are several reasons why:
• We share the same investment philosophy.
We buy, improve, hold, and refinance. We generally don't like selling our properties.
• His expertise makes up for gaps in mine.
Ken owns the largest property management company in the Southwest, and his partner, Ross, is a real estate developer. Both men have nearly 20 years of experience in their respective fields.
Because of Ken's years as a property manager, he has the experience and skill to evaluate the value of an existing property. And Ross has the know-how to bring the reconstruction of properties in on time and often under budget.
• We adhere to the same strategy.
Ken, Ross, Kim, and I like to put our money in, improve a property, bring in better tenants at increased rents, reappraise the property, and then borrow our money out and move the equity on to the next property. We then repeat the process.
A Near-Infinite Return
For example, we put approximately $2.5 million into a $9 million, 300-unit apartment house, and secured a construction loan to improve the property. A year later, due to attracting better tenants at higher rents and a lower vacancy rate, the property was appraised at $14 million.
With the higher appraisal, we refinanced the property with a new loan at a better interest rate, and were able to take out $4 million tax-free. The money is tax-free because it's a loan, not profit. The debt service -- the monthly mortgage payment -- is paid for by the tenants.
With this investment strategy, our ROI is practically infinite. We have no money in the investment, yet we collect a monthly cash flow and still have control over the property. To me, this is better than buying a property, selling it, and having to pay taxes on our gains -- or be in a rush to buy a new property just to avoid capital gains taxes via a 1031 tax-deferred exchange.
(A 1031 tax-deferred exchange gives sellers a certain number of days to move money from a sale into another property and defer paying taxes on the gains. The process is more complicated than it sounds, which is why I strongly recommend using an exchange agent to guide and assist you in the process. Most real estate brokers can recommend an exchange agent if you live in the United States; other countries have different rules.)
Finding a great partner like Ken is similar to finding a great husband or wife -- you have to kiss a lot of frogs before you find the prince or princess of your dreams. I don't know of a magic formula other than to keep kissing.
My rich dad often said to me, "You need to be a good partner if you want to find a good partner." Obviously, this is as true in business as it is in love. In my opinion, the best way to begin is by looking in the mirror and asking yourself, "What do I bring to the table? Am I the kind of person I would want to do business with?" It's important to evaluate your strengths and weaknesses honestly.
One of the reasons Ken, Ross, Kim and I do so well together is because we all love real estate; we complement each other in terms of our individual strengths and weakness; and we're all adept at raising money. We make a good team because there's synergy between us, and synergy is money.
A Way Out
My most important partner is my wife, to whom I've been married for nearly 21 years. When Kim and I first met, I was deep in debt from a disastrous business partnership. Regardless, on our first date I asked her, "Do you have a problem with being rich?" It's tough to get rich if your partner doesn't share that goal, and I would never have become rich without her.
That brings me to my next point: All partnerships should have an exit strategy. My partner Donald Trump says that married couples should always have a prenuptial agreement. True, a prenuptial is important if one partner is much richer than the other before marriage, but Kim and I don't have one. Instead, we have our own corporations that we control independently.
Still, Donald is right: The best time to think of an exit strategy is before becoming partners -- that is, after you've kissed a few frogs and have found your ideal business companion. But remember: They sometimes turn back into frogs, and you can't do a good deal with a frog.
Sunday, May 4, 2008
Thinking Big is the Best Plan
Years ago, when I was just starting my real estate investing career, I came across a property with a for-sale sign on it. I called the broker and asked, "What can you tell me about the property, and how much does it cost?"
The broker politely and patiently said, "It's a commercial building with six tenants. There's a chiropractor, a dentist, a hairstylist, an accountant, and a bail bondsman. The price is two million dollars."
I almost choked. "Two million dollars?! That's way too expensive!"
Thirty years ago, $2 million was a lot of money. And instead of looking at the property, I let the price frighten me off. I never looked at the deal, and just assumed that the seller was crazy, greedy, and out of touch with the market.
Today, there's a luxury hotel on the same site. It's spectacular. I estimate the property to be worth at least $150 million, and maybe more.
Not seeing the potential of that deal taught me many lessons. Here are two important ones:
• Sometimes you learn more by being stupid and making mistakes.
• The person with the better plan wins.
In the above example, my plan was just too small. In fact, the only plan I had at the time was to collect the rent money from the tenants, cover my mortgage and expenses, and put a little in my pocket. And 30 years ago, I knew that the rent from six small tenants couldn't possibly pay for a $2 million property.
I later learned that the property's eventual owner bought it for full price -- with terms. He put $50,000 down as an option and asked for 180 days to put the rest of his plan together. During those 180 days, he gathered his investors, a builder, and his tenant, a major hotel chain.
If he hadn't been able to put his plan together, he would've lost his option money. Instead, before the 180 days were up, his investors paid the $2 million in cash, and he spent the next three years getting the project through the city planning commission and finally began construction. He won because he had a better plan.
Donald Trump often says to "think big." He definitely does so, but by nature, I don't. My excuse is that I come from a small town in Hawaii. My family wasn't rich, so when it comes to money, I tend to think err on the side of caution. Over time, my thinking has become medium-sized when it comes to spotting opportunities, but I'd still like to think bigger.
One of the reasons I enjoy doing business in New York and having Trump as a partner on different projects is that he makes me do just that -- because if you don't think big in New York, you get kicked out. If I thought small, I wouldn't be on television, cutting book deals with major publishers, or talking in front of tens of thousands of people in arenas like Madison Square Garden.
Currently, I'm working on a real estate project to present to Donald. Consequently, I find myself pushing my thinking, expanding my context, and thinking of luxury, not just price. Even if Donald doesn't like the project and we don't partner on it, just preparing to present the project to him has required me to think bigger and come up with a better plan.
A Blast from the Past
About a year ago, someone called to say that there was a spectacular condominium that had just come up for sale. She wanted to know if I was interested in looking at it. Of course I said, "Yes." I wanted to see what her definition of spectacular was, and trust me -- it was spectacular. She then said, "And the price is only twenty-eight million dollars. But I believe you can pick it up for twenty-four million. At that price, this condo is a steal."
Once again, I heard myself saying what I said so long ago: "That's too expensive." But, as I said, that lesson from 30 years back proved to be priceless: After hearing the think-small person in me comment on the condo price, I took a deep breath and asked myself, "What's my plan?" Then I asked myself, "What's wrong with my plan?"
I didn't buy the condo, but I did come up with a better plan. Over the next few days, I realized that the reason I couldn't afford the condo was because my business was too small. If I wanted to afford such a luxury residence, I needed to come up with a better plan for my business. Today, I'm working harder than ever to improve it -- not because I want the condo, but to be able afford such a condo if I someday decide I want one.
In many of my columns, I've written about my concern over the devaluation of the U.S. dollar. As the dollar drops in purchasing power, it often pushes up the prices of real assets -- quality real estate and equities. My fear is that many people may not be able to afford tangible assets and become poorer as the dollar declines. This drop in purchasing power also widens the gap between the rich and everyone else.
One method of staying ahead of rising asset prices and the declining dollar is to think bigger and come up with better plans. As important as financial and business planning is a plan for personal development and self-improvement. I'm often asked to invest in people's business plans, and one of the reasons I turn many of them down is because a big plan requires a big person who's spent time on personal development. In a lot of cases, a business plan is far bigger than the person with the plan -- that is, the dream is bigger than the dreamer.
Today, I'm glad I missed out on that $2 million property all those years ago. The best lesson I learned from it is that I can have a better life if I have a better plan -- and a plan to become better person. So what's your plan?
Friday, May 2, 2008
A Silver Lining for Nervous Investors
The subprime mess is widespread, and it seems to be getting worse. It's certainly worse if you're about to lose your home.
The stock market is schizoid -- up one day and down the next. If you're a, this volatility is pure heaven; if you're getting ready to retire, it's likely to give you a heart attack.
As for commercial real estate, it's a great market. I just bought a 350-unit apartment house in Tulsa with an assumable loan at a 4.9 percent interest rate. Rents are low, the oil business is creating jobs, and demand for apartments is high.
As with any market, the real estate business is terrible for some people and couldn't be better for others (like me).
But as much as I love real estate, I believe the biggest opportunity today is in silver. I think this precious metal is about to become the most spectacular investment in recent history -- bigger than oil, even bigger than
All That Glitters
Let me give you some reasons why:
• Silver is a consumable industrial commodity.
It's used in computers, cells phones, and electrical relays. This means that as countries like China, India, and Vietnam, and regions like Eastern Europe, become more modernized, the demand for silver will increase.
Silver is also applied in medicine. One little-known use is as a bactericide, a role silver has filled throughout history. Today, medical devices such as catheters and stethoscopes use silver, and every hospital in the western world uses silver sulfadiazine to prevent infections.
• Silver is scarcer than gold.
Gold is hoarded. It's estimated that 95 percent of all gold ever mined is still around. The exact opposite is true of silver: An estimated 95 percent of all silver ever mined has been consumed.
Forty-five percent of all silver mined is burned up in industrial uses. Jewelry accounts for 28 percent, and 20 percent has been consumed in photography. Only 5 percent is in coins.
• Silver supplies are down.
In 1900, it was estimated that the world had 12 billion ounces of silver. By 1990 it had dropped to 2.2 billion ounces. By 2007, the supply was down to 300 million ounces.
Some of the more pessimistic forecasts estimate that the world will be out of silver in about 10 years. This could be catastrophic to the world economy. In 10 years, silver might have as much of an impact on the world economy as $200-a-barrel oil.
A Safe Haven?
As a precious metal, silver is also money. And as the U.S. dollar drops, gold and silver are seen as a hedge against a loss of value. As more and more people wake up to the reality that their cash is trash, real estate is a gamble, and the stock market is too volatile, silver may be a great safe haven.
As I write, silver is approximately $13 an ounce. If industrial consumption continues and monetary panic sets in, who knows how high the price will go? Between 1979 and 1980, silver went to $48 an ounce. In today's dollars, that would be the same as $80 an ounce.
And recently, exchange traded funds in silver have been added as a way for investors to hold silver. The reason I find the silver ETF so intriguing is because an ETF represents real money -- not fake money like the U.S. dollar.
The ETF Solution
Prior to 1963, a U.S. dollar was real money that could conceivably be exchanged for silver. After 1963, it became a Federal Reserve note that was no longer backed by silver. A silver ETF is similar to old-time money, then, and as the U.S. dollar continues to drop in purchasing power these new ETFs may become the "new old money."
The significance of the new silver ETF is that it makes owning silver simple and convenient for the general public. Owning silver ETFs is easier than owning physical silver, which is heavy and requires security such as a safe. And owning silver ETFs is safer than buying a silver mining stock, which can be risky.
Silver ETFs are also pretty straightforward: If silver is $13 an ounce, you buy so many ounces at that price. If the price of silver goes up, you make money; if the price goes down, you lose money. The risk is minimized because you're buying physical silver -- you aren't buying a share of a silver company, which can go bust. As long as the ETF is honorable and protects your silver, your investment is secure. (A caveat: Silver ETFs haven't proven reliable yet, so use caution if you take this route.)
A Rich Find for Investors
My prediction is that the industrial demand for silver will continue to go up as the wider world becomes more modernized. At the same time, as the dollar drops in purchasing power, the average investor will wake up to the convenience of owning silver ETFs and start to buy them.
Consequently, the ETF side will dry up the silver supply for the industrial side. Someday in the near future, then -- maybe in two to five years from now -- these two forces will collide and the price of silver will go up faster than anything on the market today.
The Birth of a Silver Bug
I personally became interested in silver in 1957 as a 10-year-old boy, when I began collecting coins. I became a true silver bug when, in 1965, the federal government took silver coins out of circulation and reduced the silver content of a silver dollar from 90 percent to 40 percent. I immediately began getting bags of coins from my local bank and scratching through them looking for real silver coins.
Little did I know that I was simply behaving according to Gresham's Law, which states that good money goes into hiding when bad money enters the system. Today, I still have the silver coins I socked away as a kid.
While it's true that I could've profited more by putting my money into investments other than coins, my love of silver caused me to watch and understand the silver market. After five decades of doing so, I'm quite certain that silver will soon emerge as not just a good investment, but a spectacular one -- maybe even a once-in-a-lifetime investment. Of course, I've been saying that for 50 years now, so take my advice with a shot of tequila.
Anyway, there are three ways to play silver:
• Buy coins from a coin dealer
• Buy shares in silver mining companies
• Cautiously buy silver ETFs through your stockbroker
Thursday, May 1, 2008
Tax season always means a deluge of tax advice. Unfortunately, most of it is futile and lightweight.
I say that because most people work for their money rather than have their money work for them. The problem with working for your money is that you pay more in taxes as your income goes up. In fact, if your income passes $65,000 as a W-2 employee, you may find yourself being double-taxed with the
Working hard to earn more money and then giving it away in higher taxes isn't financially intelligent, even if you do put some of it into a retirement account. On the other hand, making your money work hard for you means your earnings are taxed less, if at all.
Better Financial Advice
Recently, on a popular morning TV show, a personal finance expert recommended putting half of your tax return into your IRA, which she claimed may yield (for the average person) a whopping $25,000 gain over 40 years.
The problem with this advice is the likely decline in the purchasing power of the dollar -- inflation -- over that 40 years. I estimate that in 40 years, $25,000 will probably have the equivalent purchasing power of $250 today. Try getting excited about living on $250 when you're old.
To me, it's better to inform people about who pays taxes and who (legally) doesn't pay taxes. If you can minimize taxes or avoid paying them altogether (again, legally), you can make a lot more money today instead of having to wait, with your fingers crossed, for 40 years.
Playing by the Rules of the Rich
Years ago, my rich dad told me, "When it comes to taxes, the rich make the rules." He also said, "If you want to be rich, you need to play by the rules of the rich." The rules of money are skewed in favor of the rich, and against the working and middle classes. After all, someone has to pay taxes.
There are many ways that the rich make a lot of money and pay little to no money in taxes, and anyone can use them. As an illustration, here's a real-life situation in which I played by the rules of the rich and minimized my taxes:
• 2004: My wife, Kim, and I put $100,000 down to purchase . The developer paid us $20,000 a year to use these 10 units as sales models. So we received a 20 percent cash-on-cash return, on which we paid very little in taxes because the income was offset by the depreciation of the building and the furniture used in the models. It looked like we were losing money when we were in fact making money.
• 2005: Since the real estate market was so hot, the 380-unit condo project sold out early. Our 10 models were the last to go. We made approximately $100,000 in capital gains per unit. We put the $1 million into a . We legally paid no taxes on our million dollars of capital gains.
• 2005: With that money, we purchased a 350-unit apartment house in . The building was poorly managed and filled with bad tenants who had driven out the good tenants. It also needed repairs. We took out a construction loan and shut the building down, which moved the bad tenants out. Once the rehab was complete, we moved good tenants in and raised the rents.
• 2007: With the increased rents, the property was reappraised and we borrowed against our equity, which was about $1.2 million tax-free, because it was a loan -- a loan which our new tenants pay for. Even with the loan, the property still pays us approximately $100,000 a year in positive cash flow.
Kim and I are currently investing the $1.2 million in another 350-unit apartment house in
Move Money, Don't Park It
This is an example of an investment strategy known as the velocity of money. As I've written before, moving your money makes more sense than parking it in cash, bonds, equities, or mutual funds -- the strategy most financial advisors recommend.
Kim and I have several such scenarios active at any one time. We have lots of monthly cash flow, which we reinvest, but we rarely have any liquid cash sitting around to be taxed.
In the above example, we started with $100,000 we earned tax-deferred from another investment. The $100,000 eventually allowed us to borrow over $20 million from banks, tax-free. How long would it take you to save $20 million by parking your money somewhere, as most financial advisors recommend?
Chipping Away at Taxes
Clearly, one of the reasons the rich get richer is because they earn a lot of money without paying much, if anything, in taxes. They know how to use banks' tax-free money to become richer.
Anyone can do the same. For instance, instead of paying Social Security or self-employment tax to pay, and the tax rate is further reduced by the depreciation of the property.
On the flip side, the poor and middle class toil away for their money, pay more in taxes the more they earn, and then park their earnings in savings and/or retirement accounts. In the meantime, they receive little or no cash flow on which to live while waiting for retirement -- when they'll live on their meager savings.
Doesn't it make more sense to play by the rules of the rich, and earn more while paying less in taxes?