Sunday, January 19, 2014

The Banker's Secret To Business Works! Lesson #4

I would rather earn 1% off a 100 people's efforts than 100% of my own efforts.  --John D Rockefeller

Banks have a simple model.  They borrow at a low rate and lend at a higher rate.

The funds they "borrow" are in that of their customer's savings accounts, usually paying around 1% or less.    However, they actually have the ability to lend out 10x the amount of funds they've taken in as deposits.   

They get to supercharge their profitability 10x thanks to the magic of Fractional Reserve banking practice.  

Other industries can't do this  - leveraging their product and profiting on a fraction of the commodity.   Imagine paying for 100% of a car and only receiving the front half for instance.    

The model works.  

This is evidenced by The Wall Street Journal's recent reports of Bank of America, CitiBank, Chase and Wells Fargo are making a strong comeback from the financial crisis of the late 2000s.    Since 2006 over 380 banks and mortgage lending institutions failed (The Mortgage Lender Implode-o-Meter), but it looks like banks are just as healthy as they ever have been.   

It's proof again that the banking model works.   

In addition, there are many things to be learned from the world's largest banks.  One thing they do very well is hedge their investments.   Banks are invested in many diverse industries which allow them to balance any risk of loss.   How can this be applied to the Real Estate Investing business?    One thing that can be done is balancing your portfolio by shorting investments in the equities market which strongly correlate to the housing market.    This will offer you an upside if the market turns down.  

Covering the downside should be #1 priority when evaluating an investment.  Trading rose-colored in for a dose of humble pie allows one to slow down and look at the downside of the investment before we look at the upside.   Mitigating these potential risks will make your balance sheet stronger which can build momentum, confidence and more success.   

Following a list of identified best practices based on the bank's business model is something we can all learn and profit from.    I'll share more tips in the coming weeks. 

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