Avoid the Lemming Factor: 7 Ways to Find Great Investments

Average investors are often lemmings. The metaphor dates back to the 19th century illustrating the behavior of people who go along unquestioningly with popular opinion, unconscious of potentially dangerous or fatal consequences.

But instead of losing their lives, many lose their life savings.

There are many reasons why this happens, but one reason is because average investors blindly follow the pack. Doing what is popular rather than what is smart. Upon seeing their friends get rich, their fear of missing out kicks in and they follow the herd.

Warren Buffett said, “Be fearful when others are greedy. Be greedy when others are fearful.”

The Worst Time to Invest

Rich dad said, “When taxi drivers and shoeshine boys are investing, it is time to get out of the market. The worst time to invest is when the market is good.”

He didn’t teach us what a lot of financial gurus teach—“chase the next hot investment!”

Instead, he taught my best friend and I to sell our bad investments when the market was high and buy value investments when the market was low. He said, “The best time to get rid of the non performing assets in your portfolio is when the market is good, and amateurs are in the market buying.”

When interest rates dropped, and the real estate market climbed between 2000 and 2003, Kim and I began selling off our marginal real estate investments to investors desperate to get out of the stock market and into the real estate market.

Finding an Investment

One of the main reasons why so many investors fail to find a great investment is due to what I call the lemming factor.

The lemming factor occurs when investors buy because other investors are buying. In most financial publications, you will see ads that claim, “Voted the Year’s #1 Mutual Fund,” or, “A 36% Return for the Past 5 Years,” or, “5 Star Rating.” It is ads like these that draw the lemmings in. Generally, if it’s true that a mutual fund is number one or has delivered a 35 percent return for five years, then that usually means the end is near. In real estate, the lemmings are drawn in when they know of a friend or office worker who bought a property for $125,000 and sold it three months later for $165,000.

The rise of house-flipping televisions shows and the increase in available properties made was incredibly enticing—to lemmings. Sure, the remodeling or improvement is fun—they do it in under an hour, too! But these shows are in the entertainment business. They don’t show you the heartache, the pain the time and they don’t teach you to analyze an investment.

An analysis RealtyTrac ran for MONEY showed “that 12% of flips sold at break even or at a loss before expenses. In 28% of flips, the gross profit was less than 20% of the purchase price.

As rich dad often said, “Tales of success bring suckers to the market.”

7 Ways to Find a Great Investment

Rich dad said, “If you are going to be a successful investor, you need to be able to find great investments others miss.” He taught us to read and analyze financial statements, understand trends and how history can tell you important information, and not to invest in what is popular.

The following are seven ways to find great investments in good markets and in bad ones.

#1 Remember that people are lemmings

Average investors always get into the market late, usually at the top of the market. Because they are late, they come in droves, create a frenzy which drives the prices up. When the market crashes the average investor loses all his money, and the real investors go back in to find the best investments at the best price.

This is true for any asset class: business, paper assets, real estate and commodities.

#2 Personal Tragedy

This strategy might sound heartless and I don’t enjoy finding investments this way, but I have.

Many years ago, there was a property for sale by a man who had just lost his job. He was weeks away from foreclosure by the bank. I was hesitant. In fact, I declined as soon as I found out. But he insisted that buying the house for what was owed to the bank would help his family, avoid his credit from being damaged, and allow him to buy another house.

The point is, when personal tragedy hits, many people are desperate to sell. While this is a good time to invest, I suggest you let your conscience be your guide.

#3 A Recession

We only have to look back ten years ago. During the recession many businesses were selling the business and its equipment for pennies on the dollar. Homes fell in value, and doodads like cars, lake houses and boats also sold for pennies on the dollar.

Again, I do not like trading on personal tragedy, yet sometimes you can actually help someone out, even if you are giving them only pennies on the dollar. Let your conscience be your guide. It’s you that looks back at you in the mirror in the morning.

#4 A Technical, Political, or Cultural Change

In 1986, the government changed the tax law in America. The 1986 Tax Reform Act made it difficult for highly paid individuals (such as professionals like doctors, lawyers, accountants, architects, and others in the S quadrant) to have the same tax advantages that non-licensed business people had. That change contributed to the stock-market crash of 1987 and also the real estate crash that followed a few years later.

You might remember the Tuesday night before Trump was eventually named the 45th President of the United States, investors sent S&P 500 Futures plunging more than 4%.

#5 The 20-10-5 Cycle

Rich dad said, “The stock market dominates the investment market for a period of 20 years. As the twentieth year approaches, the possibility of a market crash increases. After the crash, the stock market tends to stay down for ten years. During the ten years the stock market is down, commodities such as gold, silver, oil, and property dominate the investment world. And every five years, there is some kind of major disaster.”

#6 Have a friend in the business

One of the best ways to find great investments is to have business partners who are in the market every day. Kim and I find great investments because we pay our brokers more than other investors do. For example, while many investors are trying to ask their broker to lower their commissions, we give some of our brokers their full commission as well as 10 percent of the profits from the investment. For some reason, because we are generous, we tend to get the first shot at the best investments. We have purchased several properties before they hit the market by having friends in the business and making them partners in the investment.

#7 Pay more money

Everything I own has a price. And that’s why when a real estate broker approached Kim and I with an offer to buy one of our properties, we listened. He asked how much we would sell it for, after thinking about it, we said $2.5 million. He countered with $1.9 million. We discontinued our talks with that broker.

You might ask why, here’s the math:

The property cost us $700,000. We converted it to an apartment complex with plans of leveling the building after five years and building high-end condominiums. Our plans show that we can build 12 three-bedroom, two-bath condominiums with garages, and sell them for at least $350,000 each, a gross value of $4.2 million. You can see why we turned down $1.9 million.

Regards,

Robert Kiyosaki

The Daily Reckoning