In our last column we discussed that real knowledge is the key that makes wealthy investors wealthier and over the long run helps to keep transferring to them the assets of the average novice investor. I found this lesson very important as I entered the investment maze.
One of the biggest phenomena I have witnessed as a financial manager was the high propensity of people who earn high incomes for making bad investments. When I first started in practice a number of years ago, I decided to start researching my clients’ investment portfolios. The process involved separating the good investments from the bad.
The amazing thing was how few investments there were in the good stack. Almost no investment that I saw my clients had made, year after year, had worked out. It almost seemed that trying to find a good investment was like trying to net a rare, elusive butterfly. You take a swoop at it, and when you check the net, it is empty.
It didn’t seem to matter whether my clients bought an oil-and-gas deal, real estate program, stocks, bonds, mutual funds, cattle-breeding program, or macadamia orchards – they always came up losing. The more I researched, the more puzzled I became.
Finally, it dawned on me what was the problem. All my clients were very successful people. They worked very hard and were very good at what they did. That is why they earned enough money to need my services.
Once these people earned enough to live comfortably, they knew enough to make investments for their future. However, their investments usually went sour. They assumed that because they were very successful in their individual fields, they could simply transfer their knowledge to their investment analysis and enjoy similar success.
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Unfortunately, it does not work that way. Each investment area requires significant knowledge to truly succeed. I like to think of each investment area as being a specific scientific field unto itself.
If you select any single investment area and approach it as a science, I believe there are no risks to take and only gain. For example, if you decided to invest in real estate, you would be competing with the likes of Trammel Crow Company, one of the largest real estate development firms in the world, and Ross Perot, one of the world’s richest men.
Prior to making your investment, you are going to attempt to evaluate site selections, architectural design, tenant mix, rent projection, financing options and demographics. Either you are going to do all of this yourself or read the prospectus of someone who has a project for sale and is presenting it to you for decision. It should be obvious that your chances of selecting a high-quality project that can make a profit are not the same as the Trammel Crow Company or Ross Perot’s. Why can you not do it as well?
The answer is you do not have the years of experience the Crow Company has, and you cannot afford to hire the experts Mr. Perot can. Their advisers know many hidden questions to ask – questions they have learned from their experiences that prevent them from making foolish mistakes.
Each investment area is like a minefield. It looks perfectly safe to enter, and you do not know you have a problem until you step on a mine. Only after you have done so do you know what not to do next time. There are only two ways to successfully traverse a minefield. The first is to follow behind someone who has blazed the way and shows you the path you are on is safe. The second is to get down on your hands and knees and carefully take it an inch at a time.
In the investment world, this translates to learning from the prior experience of others or spending years of patient research and study to become an expert in that field yourself, prior to ever investing your first dollar. I believe each investment area is a science, which in its purest state of knowledge offers no risk, with total reward. If you had enough years and enough lifetimes, you might be able to figure out all the right questions to ask. The more right questions you know to ask the more risks you can eliminate.