Is it Back to the Basics When it Comes to Making Money?

I can’t tell you how many times I have heard that the key to making money is “hard work” in the last six months. The new economy appears to have resulted in a 180 degree turn from the mindset of a little more than a year ago when it comes to investment decisions. The overall lack of stability across the board has really shaken the fundamentals of our investing philosophy.

As the credit markets are still very tightly guarded, and as a commercial banker friend of mine recently said, “we are really only loaning money to individuals that have enough money to cover the loan.” Many folks are going back to depression era thinking of it is time to tighten up the belts and hit the pavement, the key to making a good living is to hit the streets with hard work.

Overall, this may not be a terribly bad thing. Investment strategies were getting pretty crazy, like hedged derivative swaps, which if you don’t know what that is, that is okay because I just made it up; which isn’t much of a stretch from what was going on with our Wall Street friends. In a nutshell, investment strategies were being created to take advantage of the latest phenomenon in the market, and you just had to trust your broker knew what he was doing. This is somewhat reminiscent of Enron, however they couldn’t even explain what they were doing, but for a while there, they were printing money, or so it seemed, and all was right with the world.

Times have changed; investors now want to know what they are investing in, to the extent that CD’s and treasury bonds are popular again with, even with their low interest rates.

Just a little food for thought, but historically speaking the most wealth is made coming out of recessions and market adjustments. This wealth, is absolutely not made by individuals who believe that it is time to hit the streets and work harder, nor are these individuals pulling out of the market and investing in CD’s and treasury bonds.

The largest wealth is created in either emerging products/services or investing in significantly undervalued assets. There will always be a new greatest thing out on the market, however this is the more risky of the two substantial wealth building strategies, as there are countless failures for every new product success. There are businesses, like venture capital funds which take the Babe Ruth approach to investing, failing two thirds of the time, having a few base hits, but the occasional home run can make or break the company. Varying statistics show that these venture capital funds only work with less than 1% of the potential opportunities that cross their desk, so it is obvious that this is a full time, specialized endeavor best left to the professionals with DEEP pockets.

On the other hand, investing in undervalued assets, does not require you to be willing fail more than you succeed, it simply requires a little restraint and a brain. The restraint is required because the reason many fail with this type of strategy is because they jump on the bandwagon of the next best thing, or the get rich quick lure is simply too good to pass up. What is required here is a simplistic investing strategy centered on investments you understand.

For example, most investors and advisors preach diversification, don’t put all your eggs in one basket, however if you take a look at the wealthiest investors on the planet, you will find their strategy is the exact opposite. Take Warren Buffet for example, his entire strategy revolves around investing in a handful of companies that he knows and understands for the long haul. On a daily, weekly, monthly and yearly basis the stock market can appear to be pretty volatile, but no matter how volatile it may appear stretch the results over a long enough time line and the trend will emerge. Warren always sees the long-term view of the market and is able to pick out strong companies that, for some reason or another, the market, in the short term, has significantly undervalued. Additionally, where most investors buy stock, see the stock begin to slide even further then attempt to sell in a panic, Warren will simply buy more, knowing that he is continuing to buy stock as it approaches the bottom of the temporarily undervalued company. Once it turns around, he gets to ride the wave back up, and will continue to hold on to the stock as its value increases over time.

Another strategy, and my personal favorite, is investing in undervalued real estate. Like any type of investment, investing in real estate is similar to steering and airplane. Between any two points along any journey, an airplane is off course the vast majority of the time. Winds are constantly changing and pushing the plane off course, with the pilot having to constantly make corrections, sometimes undershooting (winds stronger than anticipated), sometimes overshooting, (winds less than expected), the course thus having to correct the corrections. The real estate market is the same way. At any given time, the estimated value of a property can be either over valued or undervalued based on the current market conditions.

Like Mr. Buffet, the key to knowing where the current market estimates are vs. the more accurate long-term view of a properties value is simply to take a long view of the market stretching far enough back in time to see where the general trend line is and compare it to the current value. When the current market conditions place a properties value significantly under the long term trend line, then you have a true candidate for a potential undervalued property. The next step is to understand the actual market conditions themselves to determine whether the local economic environment is simply over reacting to economic conditions, or if there is an underlying problem. For example, in Florida, real estate prices spiked through the roof, the so called bubble popped sending real estate values plummeting. In this example the market over reacted on both sides, market prices were too high to begin with, but the subsequent collapse has sent prices back almost 20 years in some areas, which is also an overreaction and an opportunity for a long-view investor to capitalize on significantly undervalued real estate. The scarcity principle works here as there is simply only so much coastal/warm weather real estate in the United States, and values will not stay depressed forever.

On the flip side if you are in a market that is propped up by one or two major employers that either are faltering or considering leaving the area, then the problem is a local one and an investment in this area would be unwise.

In short, if all else remains equal and the only change in the real estate market is the real estate prices adjusting to the macro economy, then look for over reactions for investing purposes. If the local economy is faltering due to micro economic conditions, then steer clear.

One of the key bonuses to investing in real estate is the principle of leverage, meaning banks will lend on real estate but not stocks. But we will cover this in another article. Stay tuned and smart investing.

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