The Upside of the Downturn

Most people, I think, would label much of the change we've experienced in the past year as negative. If you take into account the banking crisis, the growing numbers of unemployed people, the double-digit losses in so many 401(k)s and retirement plans, and the number of cities and states whose budgets are upside down, it all paints a pretty dismal picture.

However, being the optimist that I am, I'm always looking for the positive lessons in seemingly negative events and circumstances. I've asked myself: What is the upside in all this? Today, I see two very powerful and encouraging things that could come out of this worldwide economic mess.

A Financial Wake-Up Call
Sometimes things have to get bad before we take action to fix them. This time in history could very well be our financial and economic wake-up call. Many pieces of this puzzle are broken, and it will take more than a new president, new rules for Wall Street and some crooks going to jail to fix it all. This is undoubtedly a global problem, and it will take resources from around the world to turn this around. This should convince our political, business and financial leaders that real and tough changes have to be made now.

There's an even more important wake-up call for each individual who is willing to address it--the absolute need for true financial education. We can't allow ourselves to remain so ignorant that we accept a well-crafted, seemingly sincere but greed-based sales pitch as education or financial advice, and then blindly follow that advice.

In the article, "Contemplating the Boobs We Were," Peter Applebome of The New York Times says:

"...a toast to us all--the boobs and easy marks who from time immemorial have mastered the art of buying high and selling low, investing in bubbles as transparent as an open window, making crashes and swindles as much as part of the human experience as love, vanity and bad breath."

He says there are many lessons to be learned from "this latest round of financial catastrophe" and suggests, "Maybe it's time we even start thinking about ways to teach (people)."

After reading the article I wondered whether the general public is finally beginning to recognize the vital need for financial education--from grade school upward.

I trust these cataclysmic events to serve as one giant wake-up call so that we become aware, educated and in control of our money. And in the bigger picture, I hope the same holds true for our cities, states and nations. Ignorance is not bliss--it's foolish, expensive and painful.

A Return to the Fundamentals
One of the things that created this financial fiasco is that many of us ignored the basics of sound investment and went off on a tangent of day trading, derivatives and the latest hot deals--without the knowledge of what we were buying.

So I trust that the outcome of this dilemma will be a return to sound and proven investment fundamentals. Here are seven basic investment rules for quick review.

1. Increase your financial education. My friend and CPA/tax advisor/investor Tom Wheelwright simplified the essence of financial education:
   
   The greater your financial education, the lower your risk and the greater your returns. Simple.
    
2. Look at the overall fundamentals of an investment. Do they make sense? If you're buying a stock, is the company solid? Why should the revelation that the 55-year-old CEO smoked pot once in college affect the stock price? What does that have to do with the performance of the company? Are the financials, the management, the products and the market demand strong? If you're buying an investment property do the income, expenses and debt generate a positive cash flow? If you're investing in an upcoming business, have you checked out the management's track record, where the investment money is going and if there a demand for what it's selling?
    
3. Are you making decisions based upon facts or opinion? A fact is that you have three years of financials on Property ABC and know how well or how poorly that property is performing. The opinion is, "Rents are going up all over. You'll get a great cash flow on this property."
   
   The facts about Stock XYZ: The company has strong cash reserves, no debt and has just signed three five-year contracts with companies K, L and M. The opinion is, "This stock is going to the moon!"
    
4. Know the difference between cash flow and capital gains. The average capital gains investor only makes money when the markets are going up. When the stock market or real estate market goes down, she loses. Capital gains investors only make money when they sell the investments.
   
   Cash flow investors generally invest based on the fundamentals of an investment and tend to take a longer-view approach. They're not affected as much by the ups and downs in the market. They make money every month if they manage their investments wisely and continue to own the investments. The return on their investments is, to a great extent, determined when they buy the investment.
   
   Neither strategy is right nor wrong, and each reacts differently to the changes in the markets. It's important to know which strategy you're pursuing.
    
5. Invest your time first, money second. Before investing your money, invest your time to research and understand the investment you're considering. You probably research a set of pots and pans before you buy it. Why wouldn't you research an investment the same way?
   
   If the return on your investment sounds too good to be true, then it probably is. Do your homework. Don't blindly invest in a "hot tip." If the crowd is all running to A, head to B.
    
6. Management is key. Whether you are investing in a startup company, buying stock in a public company or purchasing an investment property, the success of your investment rests primarily on how well that investment is managed.
   
   One vital rule of money is that money follows management. If it's a company or stock in a company you are considering investing in, then who is the management team behind the company? Does that team have the skills, the track record and the leadership needed for success? If rental real estate is your investment of choice, then it's the experience and talent of your property management person or team that determines the quality of your cash flow.
    
7. Stay neutral. This one is easier said than done for me. Once I see an investment I like, it takes everything I have to keep my emotions in check. Neutrality typically goes out the window. It's OK to be excited about an investment, but if I let my emotions take over, then that blinds me to the potential problems that can affect the true value, or cash flow, of the investment.
   
   Keep it neutral. Calmly look at the pros and cons of the investment without bias. If you can do that, your success with the investment greatly improves.

It's Not Rocket Science
The world of investing is not nearly as complicated as many would have you believe. Good financial habits and fundamentals are as much common sense as they are education. It's time for us to get back to the basics of sound investing. Sometimes it takes a wake-up call to bring us to our senses.