What you can learn from Greece's default and China's stock market dive

If you've been watching the news of late, you will have noticed two global issues that have captured finance headlines. The first is Greece "defaulting" on loans that are now due.

The second is the Chinese stock market losing over $2 trillion in value over the last two weeks. Yes folks, that's a trillion with a t.

I'm not an expert in the world of finance, but having now read and listened enough to get a basic grasp of what's going on, I do know one thing.

As the world experiences more and more topsy-turvy economic times, I'm not interested in owning any type of "paper" investment, be it currencies, bonds, or stocks.

Currencies - With the US Central banks having printed 2 trillion dollars (they basically made money appear out of nowhere) during the 2008 crisis and the US balance sheets now showing a debt-to-GDP ratio that exceeds 100%, I'm a little worried about the decreasing value of the dollar. I know the dollar is strong right now, but that's only relative to the rest of the world's currencies, which have all devalued in an attempt to keep export prices low. How long will that last? And if prices inflate and the dollar is worth less, how will the rest of the world respond? If the past is any predictor of the future, other countries will also respond by weakening their currencies. So that hard earned dollar, yen, won, yuan, etc. that you earned today, what will it be worth tomorrow?

Bonds - I'll let the wizard of Omaha, Warren Buffet, chime in on this. This is what he had to say in his 2011 letter to shareholders (p.18).

For tax-paying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income.

Stocks - Of course, Buffett is a big believer in stocks, but only if you can find the right companies with excellent management and a moat (a.k.a. a unique selling proposition) at the right price. And then, even if you manage to find that, you'll still be subject to the whims and fancy of the emotions of the stock-buying public who tend to buy at the peak of the market and sell when things fall. For instance, in China, 80-90% of the stock market participants are retail buyers. That means folks like you and me who are sitting at home trading through an online account. When they buy on credit during a bull market (as they have) and drive prices up to an unsustainable level (which they did), then there's bound to be a bursting of the bubble at some point (as there has been).

Although I'm not "anti-stocks" like some real estate investors, I know that if I did get caught in a situation where I need to sell now in order to cash out and the market is in one of it's cyclical valleys, then I might be facing some substantial losses like many of the Chinese are facing.

Which brings me to real estate.

If you foresee doom and gloom in our financial futures, you might think to yourself, "Maybe the smart play is in gold." And that's true. If currencies start to devalue, we could see a rush to buy gold as a safe place to park our money. But then again, what's the intrinsic value of a gold? What does it really do for you? Maybe with a blast furnace and a smelting iron you can fashion it into some pretty neat shapes, but it's value comes from our assumption that, as Buffet states in his 2011 letter to shareholders, "Other people will pay more for it in the future." Gold, however, is not productive in its own right.

Real estate, on the other hand, has an intrinsic value and its very productive. It provides some of our most basic necessities as humans - shelter to live in as in a house, a place to conduct business as in a shop, or a land to develop as in raw land.

Real estate, if managed correctly, also produces income, like a well-run business. That means that even in 2008 when real estate prices dropped, those who purchased at a price where they could comfortably cashflow, and who didn't become overleveraged and undercapitalized - in other words, true educated investors and not speculators - saw 2008 as an unprecedented opportunity. A chance to buy more income-producing properties at rock-bottom prices. They were not the ones hurt in 2008. It was the speculators and homeowners who were duped by the banks and CNBC into thinking that the market could only go in one direction.

I heard of one real estate investor who recognized the historic opportunity that the housing crisis offered and sold his $800,000 house in San Francisco, moved to Arizona and preceded to buy over 68 units of income-producing properties. He was able to find bargains such as a four-unit (quadplex) for less than $30,000, with each unit renting out for $1,000 a month.

Needless to say, this real estate investor made out very well. If you would like to hear his story, check out this BiggerPockets Podcast episode in which he appeared as a guest speaker.

And now, about 7 years after the crisis, we're starting to see signs of potentially another bubble occurring. Home prices have been rising at red hot rates. As an example, the house I bought with Ben Hauser last year has potentially appreciated $15,000 in less than six months, according to comps. The total cost of the house was $44,000 making that a potential return of 34% if we sold now, or an annualized return of 68%.

We all know what happens to bubbles - they eventually pop.

Of course, Ben and I are not too worried since we're not speculators. We're quite happy to get our $750 to $1000 in market rent that the house commands, so we're not looking to "time the market" and sell at the peak. Overall, the market we're in, with it's unique properties, should make it a good long-term appreciation play (although 68% annual returns are certainly not expected).

But I'm glad that I'm getting the education that I'm getting right now. I'm glad that I'm getting the experience that I'm getting right now.

I missed out on 2008 because I wasn't focused on real estate at that time.

But as any student of history knows, the past tends to repeat itself. Only, sometimes, when it does, it magnifies and amplifies events.

I want to be well-positioned with the knowledge to know how to best protect myself from future financial crisis as well as how I can take advantage of any opportunities that present itself as well.

The world will need people like us - educated investors who aren't afraid to dive in when everyone else is fleeing - because we understand market cycles. Because we know how to apply the formula of population growth, job growth, neighborhood desirability, and income levels to know what real estate is really worth and not what a bunch of panicked sellers think it's worth. Because we don't wait for appreciation. We know how to force it by buying at the right price and knowing what improvements to make.

If and when we face another financial crisis, the most important thing we'll have to protect ourselves is knowledge. With knowledge, we'll always be able to find investors. But without knowledge, we'll be stuck along with everyone else, waiting for "the government to figure it all out for us."

I don't know about you, but I'd rather rely on myself to look out for my best interests rather than some self-serving politician who's more interested in protecting blue chip stocks prices and banks.

As I say all this, I'm not preaching a doom-and-gloom mentality. I don't think it's necessary to go out and start hoarding gold or to start digging an underground shelter and storing food supplies.

But if you look at publicly available information such as the US debt-to-GDP  ratio (or Korea's, for that matter), or read stories about Switzerland offering a 10-year negative bond (yes, you pay for the privilege of the bank loaning your money to someone else), or see housing prices again start to balloon upwards, then you know what the potential consequences might be, and you know it's best to protect yourself as much as possible and to prepare to take advantage as well.

Anyways, I'll keep you posted on anything else that happens that I think might be of interest to the group.

In the meantime, keep arming yourself with knowledge and working toward converting those scraps of paper you get each month into productive, useful income-producing real estate.