What I'm Doing with my Money Now
September 7, 2007

I'm not much of an investor. I am very conservative with stocks and bonds. I don't trade. And I don't leverage my investments except for real estate and only then with conventional mortgages.

My policy is buy quality at good prices and hold for the long term. That's an easy policy to maintain when your income is high and your nest egg is large enough to last. Most people don't have that luxury. They have heard the Warren Buffet story ad nauseum. But they don't feel like they can achieve their financial goals by investing in quality and holding. They want bigger profits, faster.

When I was in that position, I toyed with the idea of getting rich from stock investing but I had the fortune of working for a guy who knew a great deal about stock investing. My boss at that time, JN, had been a major player in the stock market in the late sixties and seventies. In fact, he had been the youngest person in the history of Wall Street at that time to have a seat on the exchange. He made millions in the stock market - but as a businessman, not as an investor. When the market tanked he got out and went into the travel business and made a fortune there. And when that industry faded he started a newsletter publishing business and that is how I came to work for him - as the editor of his publications.

About a year after I began working for him we decided to get into the financial newsletter publishing sector. In researching the industry, I was exposed for the first time to all the wonderful stories about people getting rich by investing in stocks.

I remember once talking to him excitedly about it. "You are a stock expert," I told him. "So why don't we use some of our cash flow to buy stocks and get rich fast instead of waiting years to build up these newsletters?"

The answer he gave me at first puzzled me and then changed the way I have thought about stocks ever since. He said, "Let me tell you something about making money, kid. You make money by selling things, not by buying them."

As I said, at first I didn't even know what he meant so I asked him a few very dumb questions. "Look. I made a ton of money on Wall Street. More money in a few short years than I expected to make in a lifetime. But I didn't make that money by investing in stocks. I made it by selling other people stock investments."

"We are not in the business of selling stocks," he went on to say. "We are in the business of selling newsletters. Focus your attention on doing that well and you'll have plenty of money for investing in stocks, if that's what you want to do. But your opportunity to get rich now lies in selling newsletters. Don't forget that."

I had enough sense to listen to his advice and our business grew quickly, from $100,000 in revenues to $135 million in 11 years. The business itself changed and expanded several times from selling publications to selling merchandise and finally to selling contests and sweepstakes.

For the first few years we reinvested every dollar we made in new businesses and that was the best way we could have invested it since we were seeing 505 to 100% growth year after year and seeing ROIs that were simply astronomical. Eventually the cash flow was larger than we needed - even with our aggressive expansion plans - and so we were forced, for the first time, to decide where to put that extra money.

We bought into a few start-up businesses that were outside of our field of knowledge and lost all our money on every one of those. We invested in rare coins and gold and stocks and did about as well as anyone else was doing - which is to say, not very well.

When I realized that JN was doing no better than I was, despite his superior knowledge and expertise, I decided I would drop the idea that I could outsmart the financial markets. I accepted the idea of long-term, fundamental investing and decided that I would invest my money in three ways only:

1. I'd put most of my money into start-up businesses in industries I knew so long as I had a reliable and competent partner to run them.
2. I'd invest half of what was left over in quality real estate deals - first by buying a more expensive house and then by buying undervalued properties and improving them and either renting or selling them, depending on the market. I did the first one myself and then, realizing that these had to be managed carefully, did the rest with partners.
3. The other half of what was left over would be invested in quality stocks and bonds at a 50/50 ratio.


I knew I wouldn't be successful with every business I invested in, but I also knew that I didn't need a perfect track record to succeed. If even one out of five succeeded, I could get rich because with a start-up business you have two things you don't have with a passive investment in a stock. You have intimate knowledge of the business and the industry. And you have power to change what the business is doing, if you don't like it.

Since I happened to be employed in the publishing business at the time, I figured my best chance of entrepreneurial success would be to start little publishing businesses. I started some with JN and I started others with friends and family members.

Since I was working 60 hours a week on my main job, I knew I couldn't run those start-up ventures. So I made it a point to partner with people I could trust to manage them honestly and intelligently. I kicked in all or most of the capital and provided advice on a weekly or monthly basis (more frequently in the beginning and less frequently as the business matured) and my partners would run the day-to-day operations.

It was a formula that worked very well. There were some mistakes (getting into industry sectors we knew too little about) and some disappointments (partners who overvalued their importance simply because they were managing the business) but generally speaking the formula worked very well.

Over a twenty year period I started dozens of businesses this way and most of them worked. Some were sold to outsiders. Some I sold to my partners. And some I kept. Today, besides my primary business which is substantial and takes up most of my working time, I have about a dozen streams of income from past ventures that I've kept. Some of these bring five or ten thousand extra dollars a month. Some are much bigger.

I liked real estate next best because I felt like I could understand it pretty well. Buying and selling fixer-uppers was a very simple business. And rental real estate, though more complicated, can be learned pretty quickly too. The only part of real estate that is at all tricky is predicting the market. But by sticking to local neighborhoods that I knew and making very conservative projections when I was figuring out whether a particular deal made sense, I felt like I couldn't go far wrong.

And I didn't. I started investing in real estate in earnest around 1985. In the 20 years that followed I developed a very substantial international real estate portfolio. If all my other investments disappeared over night, my real estate holdings would be more than I need.

Amateur market historians will note that my timing as a real estate investor could not have been better. I went into the market just after a real estate recession in South Florida had ended and enjoyed one of the best long-term rides in modern financial history.

My initial stock market investments were in individual stocks recommended by full-service brokers who put me into all sorts of companies I knew nothing about and told me all sorts of good stories when the stocks failed to achieve their lofty projections. I also bought a lot of life insurance during this period of time. The guy that sold those policies to me was very likeable and completely impossible to understand. When my life insurance investments failed to do what they were supposed to do, his explanations were completely incomprehensible.

For a while I blamed myself for doing so poorly with equities. But then gradually I realized the full truth of JN's early advice to me: If the secret to getting rich was selling things, then who was getting rich on all these stocks I was buying? Me? Or my brokers?

In the early 1990s I cut bait with my insurance broker and all but one of my stock brokers (one guy had kept me in conservative blue chips and hadn't churned the account and, as a consequence, had left me with a return that was about equal to the market) and started investing in no-load index funds and high quality municipal bonds.

And that's all I've done since then and have been happy with the average returns I've been getting. But two years ago I got out of the real estate market (except for one investment I made in another part of the country with Justin ford) and I am worried about the stock market.

The two are closely related.

What's Going on With Real Estate, anyway?

Generally speaking, real estate is a local business. The truth of this axiom was demonstrated during the months of June and July. Nationwide, sales of existing homes fell to a seasonally adjusted rate of 5.75 million in July, which was almost 10% lower than last year and lower than it has been in five years. And yet home sales in the West and Northeast rose during the same period and stayed flat in the South.

Home prices in the Northeast were particularly strong. According to the National Association of Realtors, they rose almost 6% compared with a year ago. "That was the first region to undergo weakness," an NAR spokesman said, "and they are climbing out of it now."

That's one point of view. Mine is that home sales will continue to fall for at least another 9 months -- which is about the size of the supply of single-family homes right now - and possibly longer. I also think that as nationwide sales keep falling, prices in the Northeast, West and South will fall with them.

These most recent figures don't reflect all the fallout that took place in the mortgage markets during August. And from what my banking friends tell me, the trouble that's been reported in the press so far is just the tip of the iceberg.

I am writing this in the airport. The lady next to me is on the cell phone telling her friend that her firm, apparently a large lending company, has just fired 2500 employees.

My personal holdings in Florida have gone down. I'm not sure how much, but they are definitely down. And my employees that own homes are being squeezed by rising property taxes, mortgage rates and flood insurance premiums. I know at least a half dozen people who have recently defaulted or are planning to default on their mortgages.

DR, the guy who fixes our computers at ETR, is a typical example. He came to me with a proposition. He had invested $18,000 in a brand new, $270,000 1800-square-foot house that he intended to flip for a profit. Now that prices have softened he figured he would rent it. But the cost of his mortgage, property insurance, maintenance and taxes will amount to about $3000 a month. The most he could get for rent would be about $1500. That would leave him with an $18,000 a year deficit. He wanted to know if I thought that the property would appreciate that much in the next few years. I told him no. and then he wanted to know if there was some way I could put some cash in the deal and bail him out. As a favor to him, I spent an hour trying to figure something out. I was happy to get only 5% on my money - which is what I get at my bank right now - but even at 5% the deal couldn't fly. DR bought this property at $150 per square foot, which is a pretty good price for this area. Yet he can't sell it at that price. And if he can't, there are hundreds more in his situation.

All that said, Justin Ford is making good money investing in real estate in specific areas of the country. He just sent my sister a check that almost doubled her money in less than a year. And AS got $48,000 back in 11 months on a $30,000 investment. Those are very good ROIs. I've just put about a hundred grand with him and am considering a larger investment. In making real estate investments Justin sticks to the fundamentals: he buys undervalued properties in growth regions. And he makes sure that he can at least cover his operating costs with rent if the market turns against him.

And What About the Stock Market?

I'm getting the feeling that we are going into a recession. I could easily be wrong. I am not an economist and have no experience making economic predictions. But you don't need to be a professional forecaster to recognize that things look pretty bad right now. The stock market is being choked by a major credit crunch. The financial industry is in turmoil with thousands of brokers and bankers losing their jobs. The mortgage industry is crumbling from the inside out. And consumers are feeling poorer. And why shouldn't they feel that way? They are poorer.

When the stock market tumbled in 2000, I didn't feel especially concerned because the housing market was still appreciating and because all the entrepreneurs I knew were still doing good business. Today, business is still pretty good for the small businesses I know, but business owners are worried, like I am, and are canceling plans to expand or bring out new product lines.

This retrenchment, if its typical, will slow the growth sensitive side of the economy which is the sector that needs to be strong and expanding if there is any hope of working our way out of the mess that the larger businesses and banks have got us into.

Those are some of the reasons why I am pessimistic about the economy. And because I felt that way I'm going to prepare for the worst while I hope for the best.

Preparing for the worst means survival planning. For each of the three types of investments I have, I will create a survival plan.

1. Entrepreneurial Investments: For the business I own or run, I'm going to create a short business plan that will describe how the business can operate profitably if sales drop considerably - say 20% to 50%. I'm not going to scare my employees by showing them the plan. Since I am operating on a hunch, there is good reason to hope that I'll be wrong and so there's no point in upsetting people. But I will scrutinize the plan with the CEO and CFO to make sure that it is realistic and can be put into effect relatively quickly. Because if sales collapse, they will likely collapse suddenly. Slipping quickly into a leaner, meaner infrastructure is essential for survival.
2. Real Estate: Most of the rental property I own was bought more than five years ago and so is producing a positive cash flow, even given today's higher prices and lower rental roles. I have just two properties that I stupidly agreed to buy early last year that don't cash flow. I don't want to sell them now. So I've paid down the mortgages and have allowed two key employees to live in them at rents that are below market. My partners and I have drastically changed the real estate developments I'm invovled in, cutting costs to the bone so that we can survive what I expect to be a two- to seven-year recovery period. And I've socked away some cash to start buying property when the great deals start comig in. That should be soon - maybe as early as January.
3. Stocks and Bonds: I continue to buy tax-free bonds as I always have and will continue for another six months or a year - however long it takes me to reach a target I set when I started investing in bonds. That target was a number big enough so that the yield I'm getting, if I took it, would be more than enough to pay for my current lifestyle. (My safe-harbor strategy is to have three primary streams of income - one from active busiensses, another from rental real estate and a third from stocks and bonds, each of which is more than sufficient. That way I'm triply assured against disaster.) As for stocks, I think I'm going to get out of them for a while and go back in after the real estate crisis is resolved - either by inflation or recession or both.
4. Other Investments: I bought a bunch of gold - bullion coins - about three years ago. They give me some protection against the dollar's decline. And I own some overseas businsses. So there's that. I own fine art too but I don't think this will do well in the near future because the market has been supported by multimillionaires and billionaires who made their money from leveraged buyouts and real estate. With these industries collapsing, art will probably take a dive too. It's probably too late to sell art now. In any case, I have it because I like it. Will I trade currencies or commodities? No. But not because it isn't an opportunity. It probably is. I just don't have time to learn about those things. One good thing: I can get 5% on my cash now. That's not enough to get rich fast, but it might - along with everything else I'm doing - help me maintain the value I currently have.

That's how I see it from here. But like I said at the beginning of this, I have no expertise in investing. So don't write me to tell me that. I already know it.

You have to figure out your own strategy: given today's economy and market outlook, how are you going to maintain the value of your current investments and - if possible - create additional wealth in the future?

posted by M. Masterson @ 11:24 AM,

2 Comments:

At 11:44 PM, Anonymous Anonymous said...

Michael,
Thanks for sharing - that was an invaluable post...to have a chance to 'look inside your head' and hear how you have and are approaching money, investing and savings.

MRZ

 
At 1:31 PM, Blogger T.C. said...

I think the #1 question you need to consider with regard to your investments is this: How will they fare in the evolution of a financial environment whose mantra is "INFLATE OR DIE?"

All things remaining much the same as they are right now, it is not difficult to imagine how our present financial arrangement is inexhorably drawing us ever closer to something resembling the hyper-inflation that beset the Wiemer Republic in 1923.

(We all know what followed, too.)

Indeed, this utterly reasonable speculation simply demonstrates why I do not suppose preparing for the worst is ever a foolhardy, transient exercise. Truth is preparing for the worst should be any wise investor's constant concern.

As such, then, you also might consider what the threat of war, theft and confiscation might have on certain of your holdings, because these are real (and growing) probabilities, too.

None of this, of course, is meant to frighten you (or any other reader). However, the "box" containing our present reality is much bigger than is often openly discussed. This, I am afraid, is as plain as day, and deserves your consideration ... at least if you are afraid your stored wealth could be swept away.

Be this as it may it only serves to further highlight the wisdom you have shared here, Michael—namely, IDEAS (the substance of which give birth to "Entrepreneurial Investments")—cannot be easily destroyed and, thus, are one of the safest investments around.

Still, the speculator ventures to gain quick glory...

I think we might be approaching a melt-up period in tech... Not quite as powerful and all-encompassing as the post-LTCM NASDAQ melt-up, but profitable just the same.

(Any further skakedowns from now through October notwithstanding.)

Those elements of our financial arrangement who glory in their ingenuity and ability to dodge bullets will be the power behind this move, just as they have been for the past five years.

Is this to say I disagree with your view on U.S. economic prospects?

No, not necessarily.

Rather, it is to say that FINANCE IS THE DRIVING FORCE BEHIND THE U.S. ECONOMY ... and as long as it is free-flowing—even in its dying breath—bravado will surely follow. This will hold true no matter if the middle class is being crushed ... much as has been true over the past five years.

 

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