Pssst - Wanna Be a Real Estate Millionaire? (Part 19)

Chapter 19: You Are In Control

Earlier, we’ve discussed passive vs. active involvement in day-to-day management of income-producing real estate. Let’s delve into the active/passive concept more deeply; especially as it applies to your overall investment plans.

We’ve discussed active/passive as it applied to dealing with tenants, collecting rents and making needed repairs. Now we want to consider the overall effect your participation might have on your investment results.

Suppose you decide to invest in the stock market to help supplement your future retirement income. Perhaps you work for a company that sponsors a 401(k) plan. You are offered a choice of investments that most likely include bonds as well as stocks. Some portfolios are broadly based and diversified. Others are more concentrated in specific industries. Some are very conservative while others are much more high-risk aggressive. Normally, each plan tries to give you a wide investment choice so that you can select the area(s) in which you feel most comfortable. So far, that sounds like a good selection process, right? How can you beat that? Initially, you made the decision to invest and selected specific investment categories. Now you’ve got professional management making the day-to-day decisions, your investments are diversified, and you can sleep soundly.

Perhaps you also or separately decide to mastermind your own stock investment program; buying and selling individual stocks and bonds that you personally select. You open an on-line brokerage account or you establish an account at one of the Wall Street wire houses and deal with a stockbroker. You may rely on investment recommendations made by your broker or you may do your own research and stock selection. Either way, you’re in control, right?

Not really. When you invest in stock (or bonds), essentially you’re giving your money to a corporation that then decides what’s the best use for that money. They might use it to acquire additional equipment in order to expand their production. They could also use it to simply buy-back some of their stock from the open market. You don’t have a single thing to say about what is done with the money you’ve just invested. You have to trust the management to do the right thing; to make the correct business decision. That applies to every type of investment I’ve listed above except for the real estate that you own and operate by yourself. Why is this important?

Let me give you a real-life example. Several years ago, I decided commodities would be a good investment. I’ve had the utmost respect and admiration for Jim Rogers for many years, and Jim had established a proprietary commodities index. Separately, he also founded Roger’s International Raw Materials Fund and hired professional management to run the company. The fund bought commodities in direct relationship to the Rogers’ Index and placed their buy and sell orders through a commodities firm.

Shortly after moving millions of dollars to REFCO, a Chicago-based commodities trading firm, REFCO got into financial difficulties and started comingling customer funds with company funds (sound familiar?) and then filed bankruptcy. Even though our Fund had specifically instructed that REFCO keep our funds segregated, REFCO comingled our funds with their company funds. We’re talking millions of dollars. It took several years and countless attorney fees (at our expense) just to get our money back.

Meanwhile, our Fund then established a trading account with MF Global and deposited millions of dollars in what was again supposed to be a segregated account. The next thing I know, Jon Corzine, former Governor of New Jersey, former U.S. Senator from New Jersey, and former head of Goldman Sachs is testifying in front of a Congressional Committee saying “Gee guys, I really don’t know what happened to the $1.6 BILLION of our customers money.” Duh!

The point here is that I, as an investor, had absolutely no control as to where our money was deposited nor with whom we would do business. Our company did not properly do what is called Due Diligence, meaning they didn’t properly investigate MF Global before depositing our money with them. The handwriting was on the wall; specifically the website of MF Global. There were 35 items on the firm’s record, most of them related to actions brought by the CFTC (similar to the SEC except specifically for commodities) due to shoddy supervision and record-keeping. The CFTC actually fined MF Global on several occasions for their misdeeds in numbers identified such as $2 million, $75 million and $142 million. If you did a minimal investigation of simply looking at a company’s web site and you read those numbers, wouldn’t you think twice before depositing any of your money with those folks?

Yet, I had absolutely no control over where this fund deposited our investment dollars. A REFCO can happen to anyone. But to immediately be followed by a MF Global? That, my investor-reader, is the problem you face when you let someone else make investment decisions on your behalf. You may not yet be the most knowledgeable or astute investor, but I’d speculate that you’d be far more cautious with your money before you invested it than these folks were with our investment funds. That doesn’t mean we don’t make mistakes. To err is human. But there is a limit before the term “sheer stupidity” is applied to this behavior. You may be a newbie to investing, and real estate in particular, but you have the highest proprietary interest in what happens to your money. Simple caution will drastically minimize your chances of ever suffering the stupidity of what I’ve just described.

NOTE: Stay tuned for Part 20