First, I want to thank all those who commented on my recent entry, “Why the Lottery is a Better Investment than Mutual Funds.” This entry is a follow up to several of those commentators, many of whom were asking the question, “If mutual funds are not a good risk, what is.”
To those who were concerned about Yahoo plagerizing me, I appreciate your concern but suggest you re-read Robert Kiyosaki’s introduction to the article where he states that he was having a conversation with me about mutual funds and this article is what I said. Indeed, Robert and I did have that conversation. I memorialized it in my blog and gave him full rights to publish it on Yahoo or anywhere else he would like to publish it.
With that cleared up, let me clear up one more possible misconception. While the article was meant to be tongue in cheek (I would never suggest anybody buy lottery tickets), I do have a fundamental problem with “typical” mutual fund investing. Most people who invest in mutual funds subscribe to the ridiculous notion that is promoted by many financial planners and financial advisors that you should put you money into the stock market, hold it for a long time, and pray that the market and the mutual fund goes up. There are others who make the even bigger mistake of getting in and out of mutual funds without a consistent, well-thought out strategy of what type of mutual fund, when to buy the mutual fund and when to sell the mutual fund.
One of our commentators suggested that they have consistently received 15% on their mutual funds. That’s amazing and I sincerely congratulate that individual. I have never known anyone to do that well consistently in mutual funds and I suspect the reason for the return being that high and that consistent is that this individual spends a lot of time learning about mutual funds, the stock market, trends in the stock market and economic conditions generally.
But I would add that a 15% return is not great!!! This same commentator suggests that his mutual funds have outperformed most real estate. I would answer that he is probably correct on an absolute basis, meaning that most real estate does not appreciate at 15% per year consistently. In fact, average appreciation in real estate in the U.S. over the past 90 years is around 7%. THE FALLACY IN THIS ANALYSIS IS THAT IT IGNORES THE LEVERAGE OF REAL ESTATE.
Most real estate investment is highly leveraged. And the best type of investment real estate provides positive cash flow as well as tax benefits, principal reduction and appreciation. But let’s just focus on appreciation for now. Suppose that we acquired “average” real estate and made an average return of 7% on that real estate. If we leveraged that real estate by letting the bank put in 90% of the money, then our true return is 70%.
Let me give you a simple example. Suppose you buy a single family home for $200,000 and rent it for the amount of your expenses, including your debt service. There are many parts of the country where this is possible even now. I personally own several of these properties. Let’s also suppose that you put 10% down, or $20,000. At 7% appreciation, that house will be worth almost $400,000 in 10 years. That’s a $200,000 return on a $20,000 investment in 10 years. If you put the same amount into a mutual fund and it returned 15% a year for 10 years, your return would be about $61,000. The difference of $139,000 is simply because of leverage.
The fact is, leverage is also available in the stock market. In the stock market, leverage is obtained through options. Many people hear the word, option, and they immediately think “risk.” But a good option strategy does not have to be risky. In fact, a good option trader will tell you that a strong option strategy is much LESS RISKY than a “buy, hold and pray” strategy of holding stocks or mutual funds for a long time.
The other opportunity for substantial leverage is business. In business, you not only get to leverage the bank’s money and investors’ money, you get to leverage your time, technology, contacts and knowledge.
The key to all investing, of course, is knowledge. Learn all you can about investing and the principles of compounding, leverage, and velocity. Then, develop a wise strategy and implement that strategy with a good team and a strong wealth strategist.