I have read a lot of books from Robert Kiyosaki.  I think that he single-handedly changed the way we think about money and investing.  I’ll never forget when I read Rich Dad Poor Dad when I was a junior in college.  My thinking and thought processes about money would never be the same. 

Mere “quotes” can’t summarize his impact on financial thinking, but they represent a start for anyone who hasn’t read any of his books.

Here are the my 10 favorite quotes from Robert Kiyosaki:

1) “The only difference between a rich person and poor person is how they use their time.”

2) “It is not how much you make that counts but how much money you keep.”

3) “The reason so many financial advisers are called brokers is because they are often broker than you.”

4) “The rich buy assets.  The poor only have expenses.  The middle class buys liabilities they think are assets.”

5) “A job is really a short-term solution to a long-term problem.”

6) “Be sure to have friends who demand more of you rather than tell you why you cannot do what you want to do.”

7) “The poor, the unsuccessful, the unhappy, the unhealthy are the ones who use the word tomorrow the most.”

8) ”Money is kind of a base subject.  Like water, food, air, and housing, it affects everything, yet for some reason the world of academics thinks it’s a subject below their social standing.”

9) “Inside of every problem lies an opportunity.”

10) “Today is the word for winners, and tomorrow is the word for losers.”

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As the market continues to tank, I couldn’t help but re-post this article I wrote about Robert Kiyosaki’s useful metaphor for investing.  It resonates pretty strongly today as people continue losing money they invested in stocks.

Would you drive a car without a steering wheel?  What about if it didn’t have brakes?  How about if it didn’t have a gas pedal?  Would you drive a car under any of these circumstances?

Robert Kiyosaki has posed this question to viewers in his television show on PBS.  (You can also read about this analogy in the book Kiyosaki wrote with Donald Trump, Why We Want You to Be Rich.)  In particular, he asked his viewers if they would ever drive a car without any of the following items: (1) a steering wheel, (2) brakes, (3) a gas pedal, (4) a gear shift, (5) a driver’s license, and (6) auto insurance. 

The obvious answer is “no.”  But why is that the answer?

Because it’s RISKY!!  You’d be insane to get in a car that didn’t have a steering wheel.  Ditto if it doesn’t have breaks.  Driving a car with brakes, a steering wheel, a gas pedal, auto insurance, etc., gives you control.  And that control helps you relax while you drive and almost ensures that you will arrive at your destination in one piece.    

While no one in his or her right mind would drive a car that lacks these items, people still engage in other activities in their lives that lack similar precautions and, thus, pose great risks.  One of these activities is investing.

Investing Without Control

Many people invest in stocks and mutual funds because they believe these are “safe” investments.  But the opposite is true.  Investing in stocks and mutual funds is like driving a car without any of the aforementioned items (i.e., steering wheel, gas pedal, brakes). 

The investors who put their money in stocks and mutual funds have no control over their investments.  They turn their money over to someone else (a financial planner, an advisor, etc.) and leave it to the discretion of those people and the markets to make their money grow.  Like Kiyosaki says, what’s worse is that these financial advisers, planners, and brokers don’t have any control either.  They’re just stepping into your shoes, and a lot of them don’t have the expertise you think they have.

(Have you ever wondered why these advisers and brokers recommend to ”diversify”?  It’s because they have no control over your money.  I’m going to write a post about this, but, for now, heed the advice of Warren Buffett: “Diversification is protection against ignorance.”) 

In addition, a lot of investors haven’t researched or learned about the stocks or funds into which they’re putting their money.  They also haven’t received any training at all on stock-investing.  Moreover, they have no insurance in case the market tanks.  If the market heads into a recession or, worse, a depression, they lose their money with no recourse whatsoever. 

So the investor who invests in stocks and mutual funds gives up control (steering wheel, brakes, gas pedal, gear shift), has no training (driver’s license), and no insurance (auto insurance).  This investor is making the exact same mistake made by the driver of a car with no steering wheel, brakes, etc.

Why do investors invest like this?    

Investing Isn’t Risky

People invest in stocks and mutual funds because they think investing, in general, is risky, and they think that stocks and mutual funds are the safest investing vehicles.

The irony is that investing is NOT risky if you take the proper precautions.  Taking those precautions gives you the control you need to make a safe and sound investment.

For example, if you train yourself to learn how to invest in a particular area (like real estate), you lessen your risk.  This is the same as learning how to drive a car: once you learn and obtain a driver’s license, it’s no longer risky for you to drive a car because you know how to do it.

Likewise, if you make sure you have all the tools necessary to invest in a rental property (i.e., an inspector, analysis of rental rates in the area, property tax information, title search, tenant occupancy rates, etc.), you lessen your risk when you buy that property.  This is the same as making sure a car has a steering wheel, brakes, a gas pedal, and a gear shift.  If a car has all those tools, it’s safer for you to drive it.

Investing With Control

Kiyosaki loves to distinguish between investing without control and investing with control.  People who blindly invest in stocks and mutual funds invest without control.  But people who educate themselves financially and learn and understand what they invest in are investing with control. 

Obtaining the proper education and tools before investing in real estate helps you control that investment.  The same can even be said for stocks.  If you research a company, understand its industry, evaluate its financial position, and assess its long-term stability and growth, you will make a safer investment.  (This is what Warren Buffett does.)

Driving a car without all those necessary parts is a great metaphor for investing without control.  People invest like that on a daily basis and are deceived into thinking that they are making “safe” investments.

To obtain control, a financial education is essential.  And learning everything possible about a particular investment will ensure that you have the proper control over your money.  Like Kiyosaki says, it’s control of this kind that separates the rich from the poor.

So the next time you’re thinking of investing in stocks, mutual funds, or anything else, ask yourself whether you’d get in a car that didn’t have a steering wheel, brakes, a gas pedal, or a gear shift.  And ask yourself whether you’d sit next to and trust a driver who didn’t have a license or insurance.

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Given the recent drops in the stock market, I thought I would explain an alternative (and more secure) method of investing your money.  Here is the formula for how to invest in real estate and how to derive cash flow from it.

This form of investing involves buying a property (an apartment, a house, etc.) and renting it out.  The rent payments cover the mortgage, insurance, and tax payments.  What is left over after you subtract the mortgage, insurance, and tax payments is passive income.  That is the kind of cash flow that liberates people from jobs. 

This is not “flipping” properties or buying foreclosed properties.  Investing in real estate for cash flow involves buying and holding a property.  There are various details, including incredible benefits such as tax-free rental income and 1031 exchanges, associated with this type of investing that I have covered before. 

In broad strokes, this is how this investment works. 

The Initial Investment

If you buy a one-bedroom apartment for $80,000, and you put 10% down ($8,000), you can make $125.67/month in passive income and almost a 19% annual return on your down payment.

The Expenses

After putting 10% down, you obtain a mortgage for the balance of the purchase price ($72,000).  The monthly payments for a 30-year mortgage at 5.75% (rates are currently at 5.5%) are $420.17.  Let’s assume that annual taxes on the apartment are $1,600 (based on 2% of the property’s value), and homeowners’ insurance is about $250 annually (the national average is $481).  Thus, your monthly escrow payments for taxes and insurance are $133.33 and $20.83, respectively. 

Putting all these numbers together, total monthly expenses are:

$420.17 + $133.33 + $20.83 = $574.33. 

Renting It Out For Cash Flow

The rental rates for one-bedroom apartments depends on local property values.  Since we’re using averages, let’s assume that you can rent this apartment for $700/month.  If you subtract your expenses, this is what your monthly passive income will look like:

Rent ($700) – Expenses ($574.33) = $125.67.

Your monthly passive income, or cash flow, is $125.67.  (Remember that you make this money whether or not you get out of bed in the morning.) 

Return On Your Investment: Cash-On-Cash Return

The fun doesn’t stop there. 

Recall that you invested $8,000 in this apartment when you bought it.  You can calculate your annual return on that investment.  This is called cash-on-cash return.  To arrive at this figure, you divide the annual cash flow from the property by the initial amount invested.  Here, your monthly cash flow is $125.67.  To calculate the total annual cash flow, multiply your monthly cash flow by the number of months (12):

$125.67  x  12 = $1,508.04.

Your total annual cash flow is $1,508.04.  To calculate cash-on-cash return, divide this number by the initial amount invested ($8,000).  Thus,

$1,508.04/$8,000 =  0.188.

Your cash-on-cash return is 0.188, or 18.8%. 

An annual return of 18.8% on an investment of $8,000 is VERY GOOD.  That beats practically every index fund and about 80-90% of mutual funds.  Furthermore, you may be able to keep that return tax-free, and you also benefit from the annual appreciation of the property.                  

That, in a nutshell, encompasses how to invest in real estate for cash flow.  It is a very lucrative (and secure) method of investing, and it is a perfect example of leveraging money for passive cash flow.

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For those of you interested in knowing just how our current economic hiccup has affected stock investors, look no further than the very CEOs who played a role in this mess. 

These chief executives receive a large part of their compensation in the form of company stock. This chart from the New York Times, dated September 21, 2008, illustrates how much value these CEOs have lost in their stock ownership (not including stock options) in the last couple of years.  I listed the names and stock values below.

As you review these names and the diminished value of their stock ownerships, take into account the risk of having a large share of your wealth in the stock market.  I have always written that that’s a bad strategy and that some of your money should always be invested in tangible assets like real estate.  The numbers below should drive home the point that, because stocks are effectively paper assets, they can lose value literally overnight:

LLOYD C. BLANKFEIN, C.E.O., Goldman Sachs

JANUARY 2007: $405.6 million

SEPTEMBER 19, 2008: $291 million

VIKRAM S. PANDIT, C.E.O., Citigroup (Started in December 2007)

JANUARY 2008: $31.7 million

SEPTEMBER 19, 2008: $22.6 million

JAMES E. CAYNE, Former C.E.O., Bear Stearns

JANUARY 2007: $1.06 billion

SEPTEMBER 19, 2008: $61.2 million

CHARLES O. PRINCE III, Former C.E.O., Citigroup

JANUARY 2007: $89 million

SEPTEMBER 19, 2008: $33.2 million

RICHARD S. FULD JR., C.E.O., Lehman Brothers

JANUARY 2007: $827.1 million

SEPTEMBER 19, 2008: $2.3 million

MARTIN J. SULLIVAN, Former C.E.O., American International Group

JANUARY 2007: $3.2 million

SEPTEMBER 19, 2008: $173,000 

MAURICE R. GREENBERG, Former C.E.O., American International Group

JANUARY 2007: $1.25 billion

SEPTEMBER 19, 2008: $49.6 million (Doesn’t include shares transferred from direct ownership into trust)

RICHARD F. SYRON, Former C.E.O., Freddie Mac

JANUARY 2007: $10.6 million

SEPTEMBER 19, 2008: $130,000

KENNETH D. LEWIS, C.E.O., Bank of America

JANUARY 2007: $153.7 million

SEPTEMBER 19, 2008: $111.6 million

JOHN A. THAIN, C.E.O., Merrill Lynch (Started in December 2007)

JANUARY 2008: $28.5 million

SEPTEMBER 19, 2008: $16 million

JOHN J. MACK, C.E.O., Morgan Stanley

JANUARY 2007: $224.6 million

SEPTEMBER 19, 2008: $80.4 million

SANFORD I. WEILL, Former C.E.O., Citigroup

JANUARY 2007: $914.9 million

SEPTEMBER 19, 2008: $342 million

DANIEL H. MUDD, Former C.E.O., Fannie Mae

JANUARY 2007: $26.5 million

SEPTEMBER 19, 2008: $476,000

JAMES DIMON, C.E.O., JPMorgan Chase

JANUARY 2007: $197.1 million

SEPTEMBER 19, 2008: $203.7 million

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This is one of my posts (which I have now revised) from earlier this year in which I argued why it was prudent to buy gold.  I thought its core message might resonate well today given the impending federal bailout, and the possibility that the U.S. is heading into a deep recession. 

The issue here is that, when you consider the loss of wealth that awaits many people in this country, particularly those invested in the stock market, remember that hedging against these types of drops and downturns involves investing in tangible assets, particularly gold.

Here are some compelling reasons to buy gold as a safe haven for your money:  

1) Bet Against The U.S. Dollar.

The dollar has hit record lows this year.  However, a government bailout of bad debt creates more inflation and, thus, puts even more pressure on the dollar. 

There is less and less of a demand for the dollar.  Moreover, the Federal Reserve continues to increase the supply of dollars.  These trends show no signs of slowing down.  In basic economic terms, when you have a low demand for something and a high supply of it, the price of that something inevitably goes down.  

Thus, the dollar is losing value, and it will continue to lose its value.  Instead of holding onto the dollars in your bank account or IRA, it is better to take some of those dollars and buy gold.  By trading those dollars in for gold, you preserve the value of your money.

2) Inflation.

Obviously, increasing the supply of dollars accelerates inflation (which is a rise in the general level of prices over time).  More dollars in circulation means that those dollars have less purchasing power.  A decline in purchasing power means that more of those dollars are required to buy consumer products.  Hence, the rise in the level of prices. 

If you take some of your money and buy gold, you take that money out of this vicious cycle, and you help it maintain its buying power by, instead, pegging it to the price of gold.

3) Bet Against Oil.

The price of oil rose this year for several reasons, and I would argue that we’re not out of the woods yet. 

First, as the value of the dollar decreases, oil producers demand more dollars per barrel of oil.  They demand more dollars because the dollar’s purchasing power continues to fall.  (When oil producers accept dollars for oil and then turn around and use those dollars to buy other things, those dollars are buying less and less of what they need.  Thus, they are forced to raise their prices and demand more dollars.)

Second, the supply of crude oil that is easy to produce is decreasing.  (Although the U.S. Congress plans to let the moratorium on offshore drilling expire, there are rumors that, next year, it might push to reinstate the moratorium.)  Extracting heavier crude oil and harder-to-find oil will cost more, and that cost will be passed along to the consumer.  Inflation will also rise as a result.

Buying some gold, again, takes your money out of this equation.  You’ll have less eroding dollars that buy you less gasoline.  Instead, you’ll create a safe haven for some of your money and protect it against the rising price of oil and inflation.

4) Historical Relationship Between Gold And Oil.

According to the historical relationship between gold and oil, if the price of oil keeps going up, the price of gold should skyrocket.  Historically, gold has traded at about 18 times the price of oil.  Today, and for the last 5 to 6 years, gold has been trading at about 9 times the price of oil. 

This means that gold is cheap.  If history is any indication, the price of gold will correct itself.  Thus, oil at around $100/barrel will inevitably lead to gold soaring to $1,500/ounce or $2,000/ounce.  And this rise could take place within the next couple of years.  Moreover, if the price of oil rises again to $140-per-barrel heights, gold could soar into the range of $2,500/ounce. 

5) Yes, Gold Is Cheap.

In addition to the gold/oil trading ratio, there is another reason why gold is cheap.  Before gold eclipsed the $800/ounce mark, the previous all-time high for gold was $875/ounce in 1980.  In today’s inflation-adjusted dollars, that high would translate into approximately $2,300/ounce. 

Thus, gold has yet to reach anywhere near its previous all-time high.  So even if you think all this “buy gold” hysteria is just hype, and that the price of gold is merely the product of cyclical trends, it is still a great buy because it has not reached the peak of that cycle.  Gold at $900/ounce is a bargain. 

6) If Oil Falls, Gold Is Still a Good Buy.

Even though the price of oil has recently dropped (and may drop some more), the dollar will still be weak.  A decrease in the price of oil will likely be due to factors unrelated to the dollar.  The dollar will continue to lose value.  Historically, the dollar and the price of gold move in opposite directions.  When the dollar goes down, gold goes up, and vice versa.

If this bailout goes through, the dollar will lose some more value.  This will, in turn, push the price of gold up.     

7) Gold Is Real Money.

Remember that gold has real, tangible value.  It is real money.  (So is silver.)  The dollar is a paper currency with no intrinsic value.  It only has value because the Federal Reserve says it does.  Holding some tangible assets is always better than holding your entire net wealth in dollars alone.  The value of tangible assets stays the same, while the value of dollars has eroded and will continue to erode over time. 

8) Supply of Gold Is Decreasing.

The supply of precious metals like gold and silver is dwindling.  Combine that decrease in supply with an accelerating increase in demand (as I described above), and the price of gold will continue to go up.

9) Bet Against The Politicians. 

If Ben Bernanke, the Federal Reserve chairman, wanted to save the dollar (i.e., save its buying power), he would raise interest rates.  Raising rates increases demand for the dollar, which, in turn, slows down inflation.  The problem with this strategy (aside from the fact that it would NEVER happen in this economic climate) is that, generally, people would stop spending their money and move it into savings.  This trend would slow down the economy and almost certainly move it into a recession, notwithstanding the downturn that is already around the corner.

But Bernanke didn’t do this, most likely because he was trying to prevent a recession.  The Federal Reserve kept lowering the federal funds rate and printing more money.  These actions increase inflation.  They might delay an economic recession, but they inevitably push the dollar towards collapse.  And the Federal Reserve has shown no signs of changing its course.

Bernanke took the wrong approach.  The choice was between saving the dollar or preventing a recession.  He chose (and continues to choose) the latter–trying to keep the U.S. economy from falling into a recession.  In the long term, however, the dollar is more important.  Recessions occur in cycles and result from normal market forces.  To save the dollar, he needs to raise rates. 

The lesson?  When in doubt, bet against the government, even if it’s acting through a private surrogate like the Federal Reserve.       

10) Many Analysts Agree That Gold Will Skyrocket

I don’t usually put much stock into what “analysts” advise regarding investing.  Nevertheless, approximately 40 analysts, hedge fund managers, CFO’s, investment officers, strategists, newsletter editors, and experts have agreed this year that gold is cheap, a great buy, and that its price will continue to rise. 

How Do You Invest In Gold?

Don’t worry, you don’t have to go out and buy gold bullion and find a safe place to store it.  Instead, you can invest in gold in two easy ways:

-Street-TRACKS Gold Trust (an exchange-traded fund that tracks the price of gold).

-Buy stock in gold mine operators.  Some of these include Barrick Gold, Coeur d’Alene, Glamis Gold, Newmont Mining, and Goldcorp.

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Given the past week’s events with the financial crisis and the resulting downward pressure on the dollar, I thought it would be helpful to list 8 reasons why you should buy silver. 

In today’s economy and for the next 10-15 years, silver is a great investment.  The declining value of the U.S. dollar illustrates the worthlessness of paper currency.  Obviously, in order to achieve wealth, the goal is to acquire as many dollars as you can.  But we also have to protect ourselves against those dollars losing their value. 

Thus, we should put some of our wealth in commodities that hold their value.  Moreover, we should look for commodities that we can exchange in the global market without sacrificing their value. 

The U.S. dollar fails on both these fronts (especially if the government moves forward with this bailout).  But items such as silver, gold, and oil do not.  Silver, for instance, has many benefits.  Here are various reasons why you should buy silver: 

1) It is very cheap.  Right now, silver is worth $13 per ounce.  (In 1980, when adjusted for inflation, silver was worth about $122 per ounce.)  By contrast, gold is worth almost $900 per ounce.  Sacrifice next Friday’s night out, and you can buy several ounces of silver on Monday morning.  Do that twice a month, and in a year, you will have approximately $1500 invested in about 90 ounces of silver.  That’s a good start. 

2) Silver requires a minimal time investment.  Unlike other investments such as stocks, businesses, index funds, or real estate, you do not have to dedicate much time to silver.  When deciding which stocks to buy, you have to research the companies in which you want to invest, and you have to analyze the potential for those companies to increase in value. 

When deciding whether to buy real estate, you have to educate yourself on real estate investments, evaluate the local market, determine whether a  particular property has income potential, inspect the property, perform a title search, manage the property, etc. 

With silver, however, you just have to finish reading this article, buy it, and hold it.  You don’t need to research it any further.  You don’t need to manage it.  You simply hold onto it, and pat yourself on the back.    

3) Silver is in demand.  Unlike other precious metals like gold, (which people put away or hoard), silver is consumable.  Various industries use and require silver.  It is used in electronics, cutlery, jewelry, tableware, electrical applications, rear window defrosters, etc.  That will not likely change in the near future.  Basic economics dictate that, when something is in demand, it has value.  Its value is even more precious when you consider my fourth reason below.

4) The amount of silver in the world is limited.  Experts agree that silver stockpiles are decreasing.  Thus, under basic principles of supply and demand, the less silver there is, the higher its demand (especially considering #3 above), and the higher its price.

5) The U.S. will probably not take action to strengthen the U.S. dollar.  Moreover, the entitlement mentality that is holding the U.S. hostage (as evidenced by this $700 billion bailout) will likely prevent the government from taking the necessary steps to restore the value of the dollar.  Thus, as investors, we have to take actions into our own hands.  We must invest our wealth in inflation-protecting commodities like silver.

6) Silver is easy to buy.  You don’t have to buy silver and put it in a safe deposit box, nor do you have to buy silver coins.  Instead, you can buy silver as an exchange-traded fund.  The iShares Silver Trust (SLV) was created on April 21, 2006.  You can buy this fund and trade in silver as if it were a mutual or index fund.  Moreover, if you have a pension, you can hold silver in that pension by buying into the iShares Silver Trust.

7) The public is still oblivious to silver and its value.  That is understable because, in part, people don’t really know how to buy silver and gold and hold them.  That means that, by reading this post, you are ahead of the game. 

If and when the public realizes that the U.S. dollar is as good as toilet paper, the movement towards precious metals and valuable commodities will begin.  By then, you should be firmly entrenched in this asset class and looking forward to the subsequent rise in prices when the masses start buying silver.

8) Warren Buffett loves silver.  If you are still skeptical about silver and have not changed your mind even after reviewing the seven reasons I listed above, there is one last fact you should know.  The Greatest Investor of Our Time–Warren Buffett–apparently holds an enormous amount of silver.  Enough said.

If you want to read more about investing in silver and how to buy silver, check out these books:

• Get the Skinny on Silver Investing
• Ruff’s Little Book of Big Fortunes in Gold & Silver: A Middle Class License to Print Money
• Junior Mining Investor: 14 Natural Resource Experts Show You How to Invest Profitably in Emerging Gold, Silver, Platinum, Base Metals, and Uranium Mining and Exploration Stocks
• Turning Silver into Gold: How to Profit in the New Boomer Marketplace

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As President George W. Bush and the U.S. Congress unveil the largest bailout in U.S. history (and the largest since the Great Depression), I couldn’t help but write about the vivid message this unprecedented action sends to all of us.

The Bailout

As this post goes up, I have no clue what kinds of details are included in the government’s plan.  What we do know is that it aims “to buy $700 billion in toxic assets clogging the financial system.”  In other words, it will “purchase bad mortgage-related assets from U.S. financial institutions for the next two years.”

So this bailout involves big government stepping in and trying to the problem. 

How We Got Here

But how did we get to this problem? 

We got to this mess because of . . . big government.  In the 1990s, new regulations “forced lenders into high-risk areas where they had no choice but to lower lending standards to make the loans that sound business practices had previously guarded against making.”  Lenders had to give out these mortgages ”or face stiff government penalties.”

Then, in the ensuing years, Freddie Mac manipulated its accounting to mislead investors, and Fannie Mae did not adequately hedge against rising interest rates. 

This was yet another government-created problem.

Big Government Problem + Big Government Solution = Problems For You

So we have big government trying to fix a massive problem that big government itself created.  The lesson here is that YOU–the individual American worker and investor–cannot depend on government for anything. 

Just imagine what kinds of consequences will result in the future from this bailout. 

First, these big financial institutions aren’t learning their lessons.  They over-leveraged themselves, and, for their bad decisions in that area . . . they’re getting bailed out?? 

You know what typically happens to a business that takes on too much debt?  In the real world (not this new government-controlled stock market), when a business over-leverages itself and can’t cover its debts, it goes bankrupt.  Its owners and managers walk away without work and with a valuable lesson learned.  That isn’t happening here.  Instead, these financial institutions made critical mistakes, and YOU, the taxpayer, (and not them), are paying for those mistakes.

Second, by bailing out these institutions, the government is injecting itself into a free market.  History has shown (in socialist countries) that, whenever a government tries to manipulate a free market or a free, capitalist economy, the result is inevitably a contraction of the economy, businesses, and capital.

Even though the stock market rallied late last week upon the announcement of the government’s bailout, don’t be deceived.  Sooner or later, the repercussions of this financial meltdown will be felt in the market.  And that means, a downturn in the financial system and, in turn, a downturn in the stock market.

Your Money

What do these problems (financial institutions not learning their lesson and a soon-to-be stock market downturn) mean for you?

Simple.  It all comes back to one of the main reasons why I started this blog: Working your entire life and saving money in a 401(K) isn’t enough.  I can’t help but feel concerned for those individuals on the cusp of retirement who have their entire retirement savings in the stock market.  If this bailout does not work, or if this bailout simply postpones the inevitable short-term crash that is looming, these on-the-cusp retirees will lose some of their savings. 

Investing in stocks is risky for many reasons, none other than what has happened this past week.  Putting your money and your retirement in the stock market is no different than putting your money in the hands of the executives and CEOs of these financial institutions.  They made bad decisions that resulted in a disastrous loss of value for their companies and for their shareholders.  Those decisions, in turn, affect your money. 

Entrepreneurship Is YOUR Only Bailout

Putting your money in a 401(K) and cashing it in at age 65 isn’t the way to go.  I’m not saying you shouldn’t do that.  Instead, I’m saying that it can’t be your ONLY course of action. 

Investing in real estate and starting a business are more surefire methods to securing your financial well-being.  Entrepreneurship is a crucial supplement and/or alternative to a 401(K).  If anything, do all of these things.  Invest in yourself, because the government is obviously not investing in you. 

After last week’s historic events and the impending bailout, this message could not be more clear.

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Every now and then, I like to write about investing.  I don’t generally like stocks because, without the proper research, you’re taking a flier on a paper asset that you know nothing about.  I prefer investing in real, tangible items, like real estate and businesses. 

One item I recently read about is investing in pipeline partnerships.

What is a ”pipeline”?

A pipeline is a basically a metal tube under the ground that shuttles natural gas around the U.S.  In this insightful Forbes article, it states that, every day, 280,000 miles of pipelines shuttle 63 billion cubic feet of natural gas around the country.

OK, so what does my money have to do with buried steel?

A lot.  About 25% of those 280,000 miles of pipelines are held as tax-advantaged vehicles called master limited partnerships, or “MLPs.”  These MLPs are public and exchange-listed and, thus, trade like stocks.  The dirty little secret is that, since they are partnerships, they pass on earnings and depreciation to investors.  That equates to passive income.

What makes MLPs advantageous over other investments?

MLPs are very advantageous because (1) they produce constant passive income; and (2) that income will most certainly increase in the near future. 

The income streams from these pipelines remain constant whether energy prices go up or down.  Pipelines make money per pound of gas shipped, not per dollar of product.  So, no matter what the energy market looks like, these pipelines will put money in your pocket.

In addition, the U.S. is going to sink another $100 billion into its natural gas infrastructure over the next decade.  This translates into 4,000+ miles of new pipeline in 2008, and more beyond that.  More pipelines = more pounds of gas shipped = more money for you.

So how do I invest in these MLPs?

Investing directly in an MLP can be quite complicated.  Although they’re taxed less than other investments, filing and paying those taxes can be very complex.  However, there exists a much simpler method for investing in MLPs: own shares in one of two exhange-traded funds: Kinder Morgan or Enbridge. 

These funds trade and are taxed like traditional exchange-traded funds.  Check out the table below (from that Forbes article), which shows the consistent yields from MLPs, including the Enbridge fund:

 

A 7.5% yield certainly isn’t sexy, but it’s almost a guaranteed return that will likely go up.          

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A few months ago, I wrote a post about why your house is not an asset.  I recently found the YouTube video below about the very same topic. 

In the video, Robert Kiyosaki (of Rich Dad, Poor Dad fame and someone with more knowledge than me) explains exactly why (with a helpful accounting diagram) the house you own is not an asset and, instead, is a liability.

Kiyosaki makes some very helpful points, such as:

• People today call their liabilities “assets”;
• The concept that an item that takes money out of your pocket is a liability, and an item that puts money in your pocket is an asset; and
• The power of cash flow.

It’s a short and very insightful video.  Enjoy!

 

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You have to love the guts of the Oracle of Omaha. 

Last month, Warren Buffett, the CEO of Berkshire Hathaway, bet that a collection of carefully selected hedge funds will not beat the returns of the S&P 500 over the next 10 years.

Buffett made the bet against Protégé Partners LLC, a New York City money management firm that runs funds of hedge funds.  Protégé bet that the averaged returns of five funds of hedge funds will deliver higher returns than the fund Buffett selected: a low-cost Vanguard S&P 500 index fund. 

Each side bet about $320,000.  The total of $640,000 was used to buy a zero-coupon Treasury bond that will be worth $1 million by the time the bet concludes and will be donated to charity.

The real test here is a more general philosophical difference and one that I’ve written about–whether index funds are better than actively-managed mutual funds.  Buffett has long argued that the fees of hedge funds and other funds are very large, (and he’s right). 

The Bet

At the May 2006 Berkshire annual shareholders meeting, Buffett offered to bet any taker $1 million that, over 10 years and after fees, the performance of an S&P index fund would beat 10 hedge funds that any opponent might choose.  Being the gamesman that he is, he repeated the offer when no one bit, arguing that, since no one had taken the bait, he had to be right.

In July 2007, however, Ted Seides, a principal of Protégé, wrote to Buffett and accepted the bet.  The two sides negotiated and settled on the present terms of the bet.

And it looks like Seides and Protégé are no slouches: From July 2002 until the end of 2007, Protégé’s main fund gained 95% (after all fees), which handily beat the Vanguard S&P 500 index fund’s 64% over the same period.

Buffett and Seides agreed that they’d disclose where the wager stood at Berkshire’s annual meeting every spring.

Hedge Fund Fees vs. Index Fund Fees

The fees involved with these funds are Buffett’s MAJOR advantage.

A fund of funds–like the ones Seides and Protégé run–normally charges a 1% annual management fee.  The hedge funds it puts that money into charge an annual management fee of their own, which, for funds of funds, is typically 1.5% (paid quarterly).

So we’re currently at fees of 2.5% of an investor’s money.  And remember . . . this is regardless of the returns earned during the year. 

Now, on top of the management fee, the hedge funds typically collect 20% of any gains they make.  That leaves 80% for investors.  The fund of funds then takes 5% (or more) of that 80% as its share of the gains.  Thus, an investor earns only 76% or so of his or her annual return, with the rest going to the “helpers” that Buffett comically refers to in his annual letters.  And don’t forget, the investor is paying his that management fee of 2.5%, too. 

By contrast, Vanguard’s S&P 500 index fund had an expense ratio in 2007 of 0.15% for ordinary shares and 0.07% for “Admiral” shares (available to large investors).  Buffet bought the Admiral shares for this bet.

This huge discrepancy in fees simply means that Protégé has to do A LOT better than the S&P in order to win the bet.

Gentlemen, start your engines.

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