JB Grills Me on Investment Opportunities in Japan 

“I read your blog,” JB said. “I know that you do business in Japan. And you seem to be a big fan.”

“That’s fair,” I said.

“So,” he said, “Do you think it’s a good idea to invest in Japanese companies?”

I laughed. “Well, I’m not an economist or a student of the Japanese economy.”

“But you do business there,” he said. “You must have an opinion.”

“I wouldn’t call it an opinion. It’s more of an adjustable hunch with bumper guards.”

He laughed. “What does that mean?”

“If there is one thing I’ve learned from publishing economic and investment information over the years,” I said, “it’s to be very careful about acting on opinions.”

He wasn’t satisfied with that.

“Come on,” he said, smiling. “You write about Japan all the time. You can’t tell me that you don’t have an opinion about their economy.”

“Okay,” I said. “You got me. Let’s talk.”

This is what I told him…

Charles Ponzi arrived in the US in 1903, broke, ambitious, and without the wherewithal to hold a steady job and build a future for himself, as did so many thousands of others.
 
After quitting one job and getting fired from the next, he spent several years tinkering in the street hustles and con games that were popular at the time, but never managed to get very far with them.
 
He did, however, get a bit of an education from his grifting: He learned that the cons that worked the best – the ones that regularly produced the biggest stakes – were those that preyed upon the target’s desire to “get rich quick.” One scheme in particular involved gambling games where the target wins the first few times and is then encouraged to increase his wagers to make even more money, until he loses all or most of it. (Ponzi was said to be very good at this.)
 
In 1920, Ponzi devised the scheme that bears his name. It was essentially the same hustle he’d been practicing for several years, but he upgraded his look and his language and changed the frame of the ploy from gambling to investing.
 
He presented himself as an authorized seller of “international postal-reply coupons” that would give investors a 50% return within 45 days. 
 
That should have raised eyebrows – and it did, at first. But after several months of regularly giving his early investors the 50% returns he’d promised, word got out. Ponzi became trusted and admired, and the scheme started selling itself.
 
The reality – and the part of the scheme that was almost impressively audacious: There was no such thing as an “international postal-reply coupon.” But it sounded like some sort of financial instrument that could have existed. And, like Ponzi’s old cons, early investors were allowed to “win,” paid with money scammed from new marks.
 
Eventually, the heralded story of Ponzi’s ability to deliver what he promised was replaced by the dawning knowledge that something was awry. 
 
The genius – if you want to call it that – of the scheme was not the churning of other people’s money. That was how all such cons worked. The genius was that when he upgraded the name of his game from gambling to investing, he kept the promised ROI at 50% – which had some plausibility to it – rather promising 100% or more in the hope of bilking more people. This, incidentally, was the same strategy that Bernie Madoff used in showing investors falsified past returns in the 15% range, rather than promising 30% to 50% returns, which would have made experienced investors highly doubtful.

In the late 1970s, I made my first investment in rental real estate.

It was a tidy little one-bedroom condominium apartment in a recently refurbished building on Massachusetts Avenue in Washington, DC. The woman selling it was the owner of a townhouse we were renting. She persuaded K and me to look at it by explaining how prices had been escalating in the area, assuring us that they would keep on rising, and by offering us a loan that required no money down.

“No money down! How cool is that!” I thought.

We went to see the apartment. It was small but not cramped. The building was old but had been remodeled recently, with a handsome entry and a gilded elevator. It had central AC, and, as she put it, “good bones.” Plus, the woman noted, it was in the center of an up-and-coming neighborhood.

“It will be easy to rent out,” she said. “You really can’t lose.”

“And there’s no down payment, right?” I said.

She smiled.

K was suspicious, but it seemed like a no-brainer to me – and it was. Alas, the no-brainer was me!

The woman was correct in telling us that property values in that part of DC had been going up. (She was also correct in predicting that they would continue to rise.) And she did, indeed, come through with a no-money-down deal, although it required us to sign some papers that didn’t quite make sense to me.

“Don’t worry about it,” she assured me. “This is what we call creative financing.”

“And the bank’s okay with it?” I asked.

“They drew up the documents,” she said.

A month later, we had a mortgage and the keys to our first investment property. All without coming up with a dollar in cash.

What the woman hadn’t told us was that the value of the apartment we bought – the estimated value that was indicated on the mortgage – was considerably higher than what it was actually worth. And at the end of the three-year term of the mortgage, I discovered, quite disturbingly, that had to file for a new mortgage. The new mortgage had a higher interest rate than what I had been paying. Plus, I had to come up with several thousand additional dollars for bank fees and other “transaction costs.”

But the pièce de résistance was that, at the end of the three-year term for the new mortgage, the balance was higher – by thousands – than it had been on the first mortgage!

I learned the hard way what negative amortization means. It means that the mortgage payments I was making were not sufficient to cover the interest payments on the loan, and not a penny was going towards the principal.

The Bad News Gets Worse 

I wish I could say that was the totality of the bad news, but there was more to come.

We had rented the apartment to a nice young woman that presented herself as a college student. As it turned out, she was earning her tuition – if she was actually going to college – by entertaining random men in her apartment at night.

This led to regular complaints from the neighbors (which were transmitted to us by the building’s foul-mouthed superintendent) and fines from the homeowners association.

To add insult to injury, after the second month, our tenant stopped paying rent!

I asked a lawyer friend of mine about how to kick her out. He told me that DC had recently enacted a string of tenant “protection” regulations that would make the eviction process long and difficult. “You’ll be lucky if you can get her gone in a year,” he told me.

I considered changing the locks when she was away, but my friend said that if I did, I’d be arrested and put in jail.

“Well, that’s a nice thought,” I told him. “I’ll be sitting in jail, still paying the mortgage, still losing money every month on the negatively amortizing loan, still paying fines to the HOA, and she’ll still be comfortably entertaining.”

I had fallen into real estate hell with no prospect of getting out.

When I finally saved enough money to pay off the overpriced mortgage and sell the damn whorehouse of an apartment, I took a hit of nearly $40,000, which was about $40,000 more than my net worth at the time.

The Silver Lining to the Story 

I made a Master’s Degree of mistakes in making that one investment – most of which I would never make again.

Ten Edifying Facts About Investing 

1. Fact: Since 1916, the Dow Jones has made new all-time highs less than 5% of all days, but over that time, it is up almost 300,000%, including dividends.
Takeaway: 95% of the time you are underwater. The less you look, the better off you will be.

2. Fact: The Dow has compounded at less than 4 basis points a day since 1970. Since then, it is up more than 30,000%, including dividends.
Takeaway: Compounding really is magic. CHF 1,000 became CHF 300,000.

3. Fact: The Dow has only been positive 52% of all days. The average daily return is 0.73% when it is up and -0.76% when it is down.
Takeaway: See #2.

4. Fact: The Dow has spent more time 40% or more below the highs than within 2% of the highs (20.6% of days vs. 18.4% of days).
Takeaway: No pain no gain.

5. Fact: The Dow lost 17% in 1929, 34% in 1930, 53% in 1931, and 23% in 1932.
Takeaway: Be grateful.

6. Fact: At the low in 2009, US stocks were back to where they were in 1996.
Takeaway: Most people think long-term means 5 to 10 years. Sometimes it can be longer.

7. Fact: At the low in 2009, Japanese stocks were back to where they were in 1980.
Takeaway: Different stock markets have different cycles.

8. Fact: Gold and the Dow were both 800 in 1980. Today, gold is $5,000/ounce, the Dow is at 49,000.
Takeaway: Cash flows > commodities.

9. Fact: Since the dot-com peak, gold is up 1,400%. Stocks are up 500%, including dividends.
Takeaway: You can support any argument by changing the start and end dates.

10. Fact: Warren Buffett is one of the greatest investors of all time. In the 20 months leading up to the dot-com peak, Berkshire Hathaway lost 45% of its value. The NASDAQ 100 gained 290% over the same time.
Takeaway: No pain, no premium.

I’ve known Joe Seta since we were both in our early 30s, working to build our fledgling direct marketing businesses. We were both very busy. We still are. In all those years (40+), we probably spent fewer than two dozen days together. But perhaps because our careers had similar arcs, we stayed in touch over email.

Joe is a regular reader of this blog. He’s also a serious student of health and investing, about which we share many views and opinions. Today’s main essay is one that he sent to me a few weeks ago. I wanted to publish it here because it addresses a common problem that investors face – a problem that can be very costly if you don’t know the facts.