The Essence of Investment

While browsing the Internet, I encountered a site devoted to investment. The message greeting me proclaimed “POWER YOUR RETIREMENT WITH A BITCOIN IRA,” followed by “Bitcoin is your best investment today – popular Wall Street strategist Thomas Lee.”

Those of you familiar with Bitcoin, are aware they’re a highly volatile form of “digital currency,” created in 2009 and stored in a “digital wallet” existing either in an imaginary bank account, known as a cloud, or on a user’s computer.

You may think of them as peer-to-peer currency, inasmuch as no central authority issues new money or tracks transactions. This task is managed collectively by the “network.” For your interest, Mr. Lee, founder of Wall Street firm Fundstrat Global Advisors, predicts Bitcoin will enjoy broader adoption as a “store of value” similar to gold.

Others, however, view it as a passing fancy which will be a relic of the past within the next few years and fade from memory as did the 17th century Dutch tulip bulb mania.

As I continued my excursion through the many sites devoted to investment, I learned from one that investing involves the purchase of assets with the intent of holding them for the long-term, while speculation involves attempting to capitalize on market inefficiencies for short-term profit.

Another described ownership as generally not a goal of speculators, while investors often look to build the number of assets in their portfolios over time.

Yet another discussed the principal of investment banking, a concept designed to assist an individual or business in increasing associated wealth. Apparently the institution focuses on investment vehicles such as trading and asset management, where financing options may also be provided to assist with these services.

And as I delved more deeply into the various descriptions of investment, each seemed to become increasingly convoluted. Had I tried to reconcile the numerous explanations, I’m sure I’d have given up in a state of confusion.

With this plethora of investment theory now behind us, I propose to offer my view as to what constitutes the soul of sound investment. I admit, up front, my background in the field includes neither a degree in economics nor a Master’s of Business Administration. It also does not entail experience as a stockbroker, a mutual fund administrator, a Certified Financial Planner or an investment advisor.

Rather, my sole experience involves actual participation as an investor, with my own money on the line in each venture. It’s my belief nothing sharpens investment skills more effectively than observing, as the participant, a drop in your bank balance resulting from the effects of a bad investment decision. With this said, what is the principal factor determining whether an investment is inherently sound? A half century of involvement convinces me the single most important ingredient – from the onset – is the continuous cash flow generated.

Rather than evoking a set of theoretical principals or quoting a series of acclaimed experts, I’ll provide details from a pair of my involvements and let you decide upon the importance of cash flow.

The first dates back to late 1994, where a prior real estate recession eased in many parts of the nation, with expectations Southern California would share in the recovery. However, a Chapter Nine bankruptcy filing by Orange County in December of that year made an impact. For the next 18 months newspaper articles described the area as an economic basket case, with dire predictions for recovery. As expected, both buyers and sellers lost confidence in the county’s local real estate and prices once again dropped.

However, perception is not always reality. Despite gross malfeasance by some local public officials and a temporary budget problem for the bureaucrats, the county remained as fine as ever. With these factors in mind, it seemed an ideal time to acquire residences, hold them for a few years as rentals and then dispose of them at a handsome profit.

In collaboration with a real estate agent long active in the local condominium market, I selected a half dozen projects from which to cull properties – all in Santa Ana, the county’s largest city. Each contained several hundred units, mostly 15 to 20 years old, in areas described as lower middle income. In May 1995 we began acquisition.

We concentrated our efforts on units held either by government agencies such as the VA and FHA, or by commercial banks and mortgage insurance companies, acquired by prior foreclosures. Clearly these hapless owners wanted quick and unfettered disposal. We designed our proposals to meet the requirement: purchase price all cash; property condition “as is,” no contingencies; and escrow to close in 15 days. In the sealed-bid auctions, our bids often won out over competing bids offering more cash to the seller.

Our program played out as expected. During the interval extending through the end of 1997, as the media portrayed the county as slipping into the Pacific, sellers remained motivated while serious buyers all but disappeared.

Over that period we acquired over 50 units at prices about 60 percent of then current market value. As the escrows closed, we quickly renovated each property and, thanks to a brisk rental market, made them income producing, with an annual 12 to 15 percent cash flow generated. Regardless of future appreciation, the cash these properties generated met all the criteria for sound investment.

As the calm inevitably follows the storm, 1998 ushered in an era of recognized prosperity. With the bankruptcy now a distant memory, the media discovered a revitalized economy and by spring Orange County again became recognizably prestigious. Property values rose as buyers and sellers reacted, at last, to market reality. And with the advent of a healthy sales climate, we wasted little time in selecting units for profitable disposal.

My other cash flow project, dating back a number of years, is the creation of trust deed loans (similar to mortgages). My associates and I now offer loans to prospective borrowers who are driven to frustration by the rules the 2010 Dodd-Frank legislation imposed on the banking industry. Our loans carry somewhat higher interest rates and loan fees than those the banks will offer, but we’re able to commit and fund far more quickly. Although the 6.5 percent interest rate we charge is historically low, it provides a satisfactory return, particularly with the multiplier effect of compound interest. And as our trust deed position is in first place, the risk is virtually nil.

I’ll conclude with a few observations. The majority of investments offered to the general public are uninspiring at best. Annuities normally carry high fees and restrictions which make them remarkably uncompetitive. Precious metals are exercises in pure uncertainty. Timeshares are designed for purchasers who are oblivious to numbers. The traditional mutual and exchange traded funds, promoted by financial planners, specialize in fee skimming while they assure their clients all will be well in the distant future because a rising tide lifts all boats.

It’s only the knowledgeable investors who control what ends up in their portfolios; most are simply sold whatever items produce the maximum commission or fees for their agents … and this is true regardless of whether fiduciary status is involved. It’s for these reasons most Americans end up dependant, in one fashion or another, upon government or charity for their livelihoods in retirement. And worst of all, I see no changes in the offing. It will only be those persons with some understanding of the investment world who will escape what is otherwise inevitable.

al@beachcomber.news

Al Jacobs, a professional investor for nearly a half-century, issues a monthly newsletter in which he shares his financial knowledge and experience. You may view it on http://www.roadwaytoprosperity.com.