Home Single Family Second Mortgage Note Form: Fill & Download for Free

A Complete Guide to Investing in Real Estate Mortgage NotesMortgage notes are an alternative asset class within active real estate investing. They have many benefits and present unique opportunities. They also earn higher-than-average returns for real estate investments.Let’s dive into what it means to invest in mortgage notes by starting with the basics.What's a mortgage note?When a home buyer or investor wants to buy a house but isn’t able to pay cash at closing, they get a loan. They pay part of the purchase price as a down payment and borrow the remaining amount from a bank or lending institution. In exchange for the money, the lender has them sign a promissory note and a mortgage.A promissory note, often just called a note, is signed by the borrower and is a promise to repay a debt. This document outlines:who borrowed money from whom,how much was borrowed,the interest rate of the loan,the timeline for loan repayment, andwhat happens in the event of default.A note isn't typically recorded in public records, but it's a legally enforceable document.A mortgage is a separate document that collateralizes the lender. In short, it says that the lender can take possession of the home if the borrower stops paying. It outlinesthe roles and responsibilities of the lender and the borrower,what would qualify as a breach in the agreement, andwhat property the mortgage is tied to.These two documents do different jobs, but they go hand-in-hand. You would never create or buy a note without a mortgage and vice-versa.The different types of mortgage notesMortgage notes can be categorized by type, lien position, performance, and asset class. Let's take a look at each.TypeMortgage loans can be broken down into several sub-categories:Secured.Unsecured.Private loan.Institutional loan.If a loan is secured (or "collateralized"), there's a tangible asset tied to the loan -- in the case of a mortgage, this asset is property. This means if the borrower stops paying, the lender can take legal action to gain title to the real estate or asset. If the loan is unsecured, there's nothing collateralizing the loan.A mortgage note can also be classified by who created it, as in the case of institutional or private loans. An institutional loan means a bank or lending institution created the mortgage note. These loans have strict laws and guidelines for underwriting. They're held to a higher standard than private loans and must comply with the Dodd-Frank Act and Bureau of Consumer Financial Protection regulations.A private loan means the mortgage note was created by a private individual. This could be a family member, friend, colleague, private lender, or even the seller of the home. In some instances, if the seller owns the property free and clear (with no mortgage), they can create and hold a mortgage for the buyer. These are called seller carryback loans, seller-financed loans, or owner-financed loans.A private loan still has a note and mortgage, but the underwriting process isn’t as heavily regulated. The language that goes into the documents is up to the lender. Some use attorneys or title companies to create the documents while others don’t.Lien positionThe lien position categorizes the position of the lender’s claim on the asset. Ultimately, it determines which lenders get paid first if something goes wrong.Mortgages that are in the first position have the highest claim. Any loans created after the first are second-position, third-position, and downward from there. A second lien or junior lien is a subordinate mortgage note. The first position will always be paid before the second position gets paid.Here's an example. Before the 2008 crisis, banks regularly let people buy properties with little or no money down. If someone wanted to buy a house for $200,000, they could get a first mortgage for $180,000 -- this was recorded in public records first. They could also get a second mortgage for $20,000, which was recorded later.The buyer paid two separate mortgage payments each month. If they stopped paying and the bank foreclosed on the house, the first mortgage would get paid off before the second mortgage received any money. This practice isn’t as common since the Great Recession, but there are other forms of second mortgages. A home equity line of credit (HELOC) is one example.That's why second-position or junior-lien mortgage notes are a riskier investment. There's typically the first lien in a priority position, and if things go poorly, they'll get their money first.Asset classYou can also classify a note by the underlying asset class. There are mortgage notes on every type of real estate, including:single-family homes,small multi-unit homes,townhomes,apartment complexes,commercial strip malls, andindustrial buildings.Most of the time, however, they're categorized as residential or commercial mortgage notes.Loan performanceThe last way to categorize a mortgage note is by its performance or payment history.If a borrower has paid their mortgage on time and never missed a payment, the note is "performing." If the borrower has stopped paying their mortgage note, they're in default. The note can be categorized as 30 days late, 60 days late, 90 days late, or 180+ days late. Typically, if borrowers haven't paid in the past 90 days, their loans are categorized as “nonperforming."What does it mean to invest in mortgage notes?Investing in real estate mortgage notes is a lot easier than you may think. When someone buys a property, whether it's a personal residence or an investment property, the buyer is put on the title. They're on the deed and are responsible for maintaining the property, having adequate insurance, and paying taxes.The lender has a vested interest in the home but isn't responsible for property upkeep, taxes, or insurance. They simply collect a principal and interest (P&I) payment each month until the note is satisfied. If something goes wrong with the property, like the roof needing to be replaced or a plumbing issue, the owner has to take care of it -- not the bank.When you buy a note and mortgage, you're buying the debt that remains to be paid on the note, secured by the asset outlined in the mortgage. You're not buying the property -- you're buying the debt and secured interest in the property.Essentially, a note buyer steps into the shoes of the bank. You can now collect the remaining debt on the note and receive the monthly P&I payments. You can also take legal action to regain title in the event of default.While many loans are bought and sold at full price, some can be bought at a discount. If the loan is nonperforming, or the note holder needs to sell the note badly enough, they may be willing to part with it for less. In my experience, you can negotiate a discount of 5% to 40% off the current market value or unpaid balance, whichever is less.Nonperforming notes may not seem like a worthwhile investment since the borrower isn’t paying anymore. They have a high risk of default, and that's bad for cash flow.But investors often use these notes to acquire real estate at a discount. Once the tenant defaults, the investor can take possession of the property and create a long-term rental, fix and flip the house, or simply sell it.There are significant risks to using mortgage notes in this way, but if you're smart about your investment strategies, it can pay off.Investors can also modify the terms of the mortgage. For example, if you buy a nonperforming note, you might lower the balance of the note, reduce the interest rate, decrease the monthly payment, or otherwise assist the borrower in making good on their loan. This can result in very high yields if you buy the note at a discount.Over the past 10 years, the cost of nonperforming notes has risen -- but you can still get them at 20% to 40% off of the current market value or loan balance.Where can I find mortgage notes to buy?Banks create and sell mortgage notes as a part of their business model. They make their money from lending and receiving interest. The more they lend, the more they make.There are guidelines for how much money a bank has to keep in reserve in order to lend -- this amount is called a reserve ratio. If a bank has low liquidity, it may sell some of its loans in a "pool," which is a group or package of mortgage notes. Other banks, hedge funds, and private individuals can buy these pools.Hedge funds and banks are the largest buyers of mortgage notes direct from banks because you typically need millions of dollars to purchase them in bulk. For this reason, it can be difficult for individual investors to buy directly from banks, though it can be done.Individual sellers that created a private mortgage note may also want to sell simply for the benefit of having cash now. Maybe they're experiencing hardship and need cash today rather than waiting for the remaining term of the note to pay off.You can find private sellers of mortgage notes on online marketplaces like Notes Direct or Paperstac. You can also buy a list of private individuals who own or hold a note from a company like List source. You might send the noteholders a series of letters or postcards or get in touch with them another way to see if they're interested in selling.If they need cash, banks and individual sellers will sell at a markdown. When you buy at a discount, your rate of return is higher than the nominal interest rate on the note.Performing notes are typically more expensive. While you can buy them at a discount, it’s typically only a slight discount from the remaining balance of the note. Nonperforming notes are often sold at steep discounts from the balance owed or the value of the property, whichever is less. Pricing is also higher on first-lien mortgage notes compared to junior liens. The more secure the position, the higher the price.Let’s look at a few examples to see how this works.Buying a performing mortgage noteLet’s say you find a private mortgage note that the seller needs to get rid of. The note is secured by a mortgage on a single-family home. The property originally sold for $150,000 and the borrower put down $15,000. That means the original loan was for $135,000. The note is a 5% fixed-rate 30-year loan, making the borrower’s payment each month $724.71.The borrower has been paying the loan for seven years and is current. So, at the time you're evaluating the note, the unpaid balance is $118,725.68. There are still 276 months (23 years) left.You decide you'll only buy this note if you can receive a 10% return on your money, or a 10% yield to maturity, so you offer $78,162. That’s $40,563 less than the current unpaid balance, or a 34% discount to the face value of the note.This may seem like a big loss, but the seller gets $78,162 immediately and has already collected $60,875 in principal and interest to date. If the seller takes the cash now, he or she is essentially collecting $146.97 less per month from the borrower's P&I payment over the remaining 23 years.If the seller needs the cash, they may accept that offer. In that case, you receive a nice 10% internal rate of return (IRR) and a passive $724.71 of cash flow each month, provided that note keeps performing for the remaining 23 years.Buying a nonperforming mortgage noteLet’s look at a different example. A hedge fund finds a bank with a low reserve ratio and a high proportion of non-accrual loans (180+ days past due). The bank sells a pool of nonperforming loans to the hedge fund. The hedge fund keeps some of the notes that meet its criteria but decides to sell the notes that don’t fit its investment model.The hedge fund sends you a list of nonperforming loans for sale and you look through the list to determine which assets you want to buy.A nonperforming note where the borrower has not made a payment in over two years piques your interest. The current unpaid balance is $128,934 with 214 payments remaining. The note is secured by a nice single-family home in Georgia that you believe is worth $140,000 as-is. The original note had a 5.5% interest rate for 360 months (a 30-year loan) with a monthly payment of $794.90. Because it’s nonperforming, you're able to pick this up for a steep discount -- just 58% of the unpaid balance, or $74,781.Now that you own the note, you can reach out to the homeowner and see why they stopped paying. Then you can find out if they want to keep the property and work out a plan to get them paying again if they're interested.Because of the discounted purchase price, you have flexibility in the terms of the loan. You could lower the interest rate, re-amortize the loan, decrease the balance, or offer other conditions to make the home more affordable. If you simply get the borrowers to start paying their monthly mortgage of $794.90 again without adjusting any of the terms of the original loan, you'd get a 10.92% yield to maturity.There are several other scenarios where you could increase the overall yield to maturity by adjusting the terms of the loan. You might increase the interest rate, re-amortize the loan, or shorten the length of the loan to meet your desired rate of return.In many cases, these adjustments are temporary. A borrower might agree to pay you a lump sum upfront to show good faith, then pay a lower amount each month until they can get back on their feet. There are many situations you might encounter when buying nonperforming notes, and you'll have to assess each one individually.If the borrower isn’t interested in keeping the home or can't pay, there are other options. You can work out a deal where the homeowner signs the deed over to you and you eliminate the mortgage and their obligation to pay the debt. This is often called a deed in lieu of foreclosure. It’s not always the best solution, but it's an option for many lenders and homeowners.If they aren’t interested in either option, you can start the legal process of foreclosure. Foreclosure varies from state to state in cost, length, and procedure. It’s important to know the relevant state foreclosure laws before you buy a note. After you foreclose, the home goes to a public auction. If an investor buys the property at the auction, you get paid. If it doesn’t sell, you're put on the title and own the physical real estate.Once you gain title to the property, you can:sell it as-is, like an REO sale;fix it up and sell it;keep it as a rental (you may have to do repairs); orsell it by creating a new mortgage note.It’s important to note that this strategy of active real estate investment has inherent risk. The borrower could trash the home before they leave. Or they could contest the foreclosure and cause delays and legal expenses. They could even file bankruptcy, which can halt your collection efforts completely.Nonperforming notes can be a lucrative way to create passive income by working with the borrower to create a performing note. They're also a great way to gain title to the physical real estate at a discount. But they can also be very risky.The best strategy with mortgage notes is the one we’re going to talk about next.Creating a mortgage note from your own real estateWhen I first started investing, a wealthier and more experienced colleague told me to buy real estate, rent it, and create a note when I'm ready to retire. It’s great advice.With this method, you can take advantage of the tax benefits of owning physical real estate, make money through the cash flow of a rental, and enjoy the appreciation of the property. Then, when you’re ready to sell, you create a seller-financed note in which you hold the mortgage, receiving the passive income in the form of a P&I payment. Pretty genius, right?An added benefit of this model is that you break up the tax hit from capital gains over the life of the loan rather than paying it in one tax year. From a tax perspective, it’s one of the best things you can do once your depreciation calendar runs out on a property.Let’s say you own a single-family home that you kept as a rental for 30 years. You had a mortgage on the property, but using the additional cash flow from the rental, you paid off the 30-year fixed-rate mortgage in just 15 years. You now own the property free and clear. It’s performing well, but your depreciation calendar has run out. You no longer have the tax advantages of holding this physical property and would rather buy a new rental to take advantage of the tax deductions. But if you sell, you'll be hit with capital gains tax. So instead, you create a mortgage note.You list the property for sale at $200,000 and offer owner financing. A nice couple wants to buy the property at your full asking price and has $30,000 to put down. Their credit is good, but they're unable to get traditional financing because they're self-employed. You offer them a 20-year fixed-rate mortgage at 6.5% interest. They’re happy to find a dream home they can finance and you’ve just created an additional passive income stream with tax benefits.You now get to collect $1,267.47 every month and have zero responsibility in maintaining the home, paying taxes, or insurance -- the new homeowner does that.Because you collect interest, you won’t only get your $170,000 back, but you’ll also make an additional $134,194.71 in interest over the entire 20 years!To keep you compliant with the Dodd-Frank Act, it's best to use a licensed mortgage loan originator (LMLO) to underwrite and create your mortgage note. LMLOs charge nominal fees for their services. They'll prepare the loan paperwork and confirm that the potential buyer qualifies and can afford the home.There's always a risk that the borrower stops paying, which turns this from a passive investment strategy to a very active one. You'll have a lot of work to do if you want to get them paying again or resolve the situation another way. This is especially true if you lend to someone who can't qualify for bank financing because of financial problems. Consider this risk before determining if creating a mortgage note is the right investment option.What are the expenses of owning a mortgage note?Expenses are rather low with mortgage notes, especially compared to rental property.Most people hire a third-party servicing company to handle the loan. The servicing company keeps records of the payment history, can collect payments on your behalf, provides the borrower with their balance and statements, and separates the interest and principal received in each payment.While you can service a loan yourself, this industry is heavily regulated. To keep your risk mitigated, we suggest paying the low monthly cost, which can range from $20 to $40. The servicer can deduct the fee from the buyer's mortgage payment, making it even easier.Nonperforming loans have more costs associated with them. There are legal fees involved with regaining the title, as well as securing and maintaining the property.Additionally, the borrowers may not have paid their taxes or insurance in several months or years -- those payments become the responsibility of the bank or noteholder.Experienced note buyers factor these costs into their offer price and know exactly how much they expect to spend.How do I know a good note from a bad one?There's a saying in this industry: If you wouldn’t want to own the property that the mortgage note secures, don’t buy it. While you’re actually buying the paperwork relating to the loan, the property is the collateral and what secures you. Make sure the collateral is a quality asset. Due diligence on a mortgage note often includes finding out:the value of the property in its as-is condition;if there are any liens or encumbrances on the property that might affect or jeopardize your position;if there are any unpaid taxes, potential tax liens or tax deed sales;the annual tax rate;if all required paperwork (the original note, mortgage, and other documents) is in possession of the current lender;the payment history on the note; andthe borrower’s credit score.What’s the risk of investing in mortgage notes?A common concern when an investor buys a performing note or creates a mortgage is the risk of default. If the goal of the investment is to receive cash flow as passively as possible, the last thing you want is for the borrower to stop paying.For this reason, it’s important to thoroughly review the borrower, including their income, credit history, down payment contribution, and if applicable, pay history. According to the Federal Reserve Bank of St. Louis, the residential mortgage default rate nationwide was below 3% in Q2 2019 but was over 11% in 2010. Economic and financial conditions can change a borrower’s ability to pay at any moment. Weigh the risk of default before buying a note.One of the greatest concerns when buying nonperforming mortgage notes is not being able to talk to the borrower or see the interior condition of the property before buying the note. To help alleviate some risk, assume the property is in terrible condition. If you gain title to the property, you'll have a welcome surprise if it's in better condition than you anticipated.Another way to minimize risk is to get the largest possible discount when purchasing the property. The lower your investment, the more your risk is mitigated.Where can I learn more about investing in mortgage notes?If you’re interested in learning more about this method of real estate investing, read as much as possible. Invest in Debt by Jimmy Napier is one of my personal favourites on this topic.There are many educators who specifically teach the ins and outs of investing in mortgage notes, as there are many laws, rules, regulations, and steps you must know before making this a successful business. Some of these educators charge a few thousand dollars for classes, while others charge tens of thousands.If you're interested in formal education, do your research on the educator. Read reviews, talk to current students, and weigh the cost of the course. Rarely does the experience and knowledge of one person justify a cost of tens of thousands of dollars, but that's up to you to determine.Mortgage notes can be an incredible vehicle for building wealth and are one of the more passive streams of income you can get as an active real estate investor. If you do your research and carefully weigh the risks involved, it can be a great way to invest in real estate without becoming a landlord.

If you flip a coin, what are the odds you will get tails? You’d probably immediately answer that it is 1/2, or 50%.But this question is more loaded than you think.It involves the motivation behind the law of large numbers, a theorem that illustrates the results of an experiment repeated a large amount of times. Specifically, the average of the results of something like a coin flip, for instance, will tend to be close to the expected value, or 1/2, over a large amount of trials.It guarantees that the average value, as more trials are performed, will only get closer to the expected value.We know further that the central limit theorem specifies if we conducted several identically similar random samples of coin flipping, for large sample size values and for a given number of samples, we would eventually get the sample average.We would converge to 1/2.But why am I telling you this on a question about investing?It reveals the nature in which statistics are often bent and skewed to lure people.Let me flip that same coin only 10 times.It might be very possible I get 10 heads.It might be very possible I get 5 heads and 5 tails.It might be very possible I get something other than 1/2 heads or 1/2 tails.What we actually know nothing about are the full answers to the limiting behavior of our statistics in question. We have a guarantee for some kind of convergence, but the general problem for limiting behavior is not fully solved.Precisely, what exactly are we saying when we say you have a 1/2 chance for tails or heads?Because, when the coin is flipping, we say there is a chance for either. When the coin has flipped, we now have a 100% chance of either one or the other.In its best case, statistics is a weird field with some minor clarity issues on definitions. Probably because of our own limitations as human beings.At its worst, I’m not sure I could finish the list here.Remember this weirdness. We’re going to come back to it.For now, let’s move on.Part 1I’m not going to sell you anything. I’ll go over things that people can launch off of themselves—some of the answers might be things I’m working on myself.A lot of answers on this thread that are popular are selling you something.There is a funny twist to investing. Many conflate what it means, so it is often blanketed for things that aren’t investments.This conflation is often intentional. You see the shiny lights on the “I have made X amount of money doing this”, so you are gravitated towards it. You see some sympathetic story about family and how it taught a lesson, so it becomes instantly personal and meaningful. You see fancy words about compounding or magical transformations, so you keep clicking through the advertisement and go to the person’s website.But it’s a silly, yet powerful, acknowledgement. In fact, it’s better in the form of a brilliant question:“Why would anyone who makes a lot of money using ‘secret’ or ‘hidden’ information help so many others out of charity?”If you scroll through some of the answers here, you’ll start to become aware of the sales tactics. You’ll realize the notion of “pay me first, then get the secrets”.You’ll notice the “put your money in this cryptocurrency” strategy.We could run through a thought experiment where this happens. Let’s just say that I have this amazing cryptocurrency, Verge, and I am telling everyone I possibly can about its ingenius capabilities.It has transformative powers, never-before seen technology, security unlike any currency that came before it.I start to run ads for it and talk about it all over Quora. I tell you to invest in it. I use my hundreds of thousands of followers to help themselves. I tell them that they’ll change their lives.My advertisements catch more people who are looking for desperate ways to make money.What is once trading for pennies now is undergoing an invisible process naked to the observant eye.For me, and my 5 buddies own almost 95% of the currency bits. Every time 1 Verge coin is being bid on, I tell my pals not to let them go until it hits some value 50% higher than the previous.They sell, then I tell them to hold. The average weight of the higher bids now pushes the price of Verge up.I tell them to wait for all the bid demands to go up a similar proportional amount. I instruct them not to sell until it hits that threshold. When the bids get near it again, they sell a little more.We keep doing this at a faster and faster frequency. The person with the most leftover coin that didn’t actually sell any is me.And what do I do when all my buddies run out of coin?I sell mine in waves.Let’s look at this crypto, Verge. While I don’t have direct evidence that this was a fraudulent coin, we should take a look and decide for ourselves.March 23, 2017: Priced at .00000003 dollars. That’s seven 0s, in case you were wondering.Market cap of $393,641. That is what all the Verge coins added up are worth.December 23, 2017: Priced at .269137 dollars.That’s a market cap of $3,893,076,609. That’s 4 billion dollars.In case you are very curious, as I am, that is a 990,505% increase.Your original investment in this coin would have been worth about 10,100 times what it was originally worth.Meaning, if you had $10,000 in March, you would have had $101,781,000 by December of the same year.Sounds like a wise investment if you ask me.But it isn’t you making that money. The entire thing is predicated off the mathematical notion of a zero-sum game. For me to gain, you must lose. Or, for me to gain, you must gain a lot less than me, and somebody else must lose. Somebody is always losing. In this case, hundreds of thousands probably lost. Exactly how much?Probably about all of it. And at varying amounts.It’s worth $.004 today. It isn’t quite as worthless as it used to be. It isn’t quite the 27 cents it was at one point. I don’t hear many people shouting that cryptocurrencies are going to be the earth-shattering revolution they were going to be.I like Bitcoin. I think Bitcoin probably has a future in our society. It’s been around for over a decade and it hasn’t gone away. I own some myself.But things like this are not only silly, they’re fraudulent. People should go to prison, and I haven’t heard anything about finding what actually happened. I have heard stories about 51% mining attacks, a lot of which was unclear.I might even conclude it could have been a smokescreen.Either way, nearly a million percent increase on what you owned in less than a year is an insane amount to walk away with. Clean and clear.That’s nearly 4 billion dollars somebody transferred from the masses into the hands of a very few.If you’d like a visual of this investment, look no further:Part 2Housebuying.Or; house-leveraging for renting.I actually wrote a whole piece on how housebuying or leveraging can be an awful financial decision.I won’t go into every little detail, but I’ll ask you an extension of the cryptocurrency ordeal:If every single person is buying the same vehicle to invest in, and they’re doing it at massive debt, what does that start to look like after a while?What begins to happen if there is a slight correction to the prices of homes? Will you still be able to take a loss on your investment for a short while and collect lower rent while prices recover over the next decade? What if your tenants are late on their rent, or worse, they leave and you can’t find anybody to fill your rental property for half a year?What happens if there is something that is massive to fix that you don’t currently have the cash for?What if the interest deduction isn’t nearly as big as you thought it was going to be at the end of the tax year, and you don’t know how to pay the tax man the remaining balance?Homes are like any other investment vehicle in this world. They’re volatile. Especially when they’re being integrated with modern day technology to be traded like any other equity on the market. With the growth of the instant-buying culture, comes major problems.In fact, the biggest problem is probably your real estate agent.There is always a reason to buy a house, and there is always a reason to sell it. There are always reasons for either, and those reasons contradict each other depending on the season you are in. Real estate agents exist for the purpose of transacting, they’re not economists or accurate predictors of financial times. If they could do that, they wouldn’t be in the business of buying a house or selling one for you—they’d just do it themselves and get rich.Investing in homes isn’t an impossibility. It’s just far exaggerated in the world of real estate, and anywhere somebody is making a percentage commission off you, you should practice caution.But houses are something more than other investments.They need management.Warren Buffet in 2012 said:"If I had a way to buy a couple hundred thousand single family homes and have a way of managing them, I would load up on them. I would take mortgages at very low rates… It is a very attractive asset class… If I was an investor who was a handy type, which I am not, I would buy a couple of them at distressed prices and find renters and again take a 30-year mortgage, it is a leveraged way to own a cheap asset. I think that is probably as attractive as an investment you can make."But Warren Buffet never solved that management problem. Mostly because the leveraged way to get an asset, like a single family house, is not meant for billionaires. It’s meant for the average family to own a piece of land and call it home. The people who manage the home are usually called family.And it is a home first, and everything else a distant second.The S&P national index for U.S. home prices shows that we have just recently returned to the pre-recession prices. This recovery took over a decade.Even with homes continuing to go up, studies show that the bottom 90% of the socio-economic ladder is worth less now than 25 years ago. Stated another way, the rich are actually getting richer. That is, even if you adding equity into your home, even if your net worth is technically increasing, the top 10% are increasing at a rate faster than you, at all points in time present and future.The ability to climb the ladder at the same pace as your parents doesn’t matter so much anymore.In fact, millionaires and billionaires are related to the next point. Well, maybe not billionaires exactly, but the power of the amount of money—and not so much anything else.Part 3The magic of compounding.It’s not really magic.In 1683, Jacob Bernoulli wanted to figure out what happened when $1 pays 100 percent interest per year. He looked at what happened if that interest was credited once, and he arrived at exactly $2.Naturally, he wanted to partition that interest into as many splices as possible, at 100 percent interest, over one year.When he chopped up the compounding into once a month, at the end of the year he got $2.613035.When he compounded 52 times, or weekly, he got $2.692597.When he did it once a day, he got $2.714567.Eventually, he got [math]e[/math]: 2.71828182845904523536028747135266249775724709369995.But the point isn’t to show you the power of compounding at all.The important things to note here are how close compounding monthly and compounding an infinite number of times are.Another essential thing is this rate of 100% per year.But the most important thing to note is the amount you started with.Bernoulli asked this question:An account starts with $1.00 and pays 100 percent interest per year. If the interest is credited once, at the end of the year, the value of the account at year-end will be $2.00. What happens if the interest is computed and credited more frequently during the year?But he was being one part scientist and one part academic.Imagine if he didn’t start at $1, but he started at $1,000.Or, imagine starting at $10,000.Or, imagine starting at $100,000.What if you had $1,000,000?The most important thing about compounding is that the power of infinite compounding isn’t important.It’s the principle amount and the interest rate.Take James Simons Medallion Fund, for instance. He has generated 66% returns over the last 32 years or so.Let’s say, for simplicity’s sake, you are going to have an estimated return on your money of 50%.You’re going to invest for 5 years.We’ll look at daily, monthly, and annual compound frequencies for a variety of principle amounts.If your initial starting amount is $10,000, at a 50% rate of return, at the end of year 5, you will have:If compounded daily: $121,617If compounded monthly: $115,836If compounded annually: $75,938If your initial starting amount is $100,000, at a 50% rate of return, at the end of year 5, you will have:If compounded daily: $1,216,168If compounded monthly: $1,158,352If compounded annually: $759,375If your initial starting amount is $1,000,000, at a 50% rate of return, at the end of year 5, you will have:If compounded daily: $12,161,671If compounded monthly: $11,583,512If compounded annually: $7,593,750Are you noticing a pattern?If I had 10 times more in my initial investment, my end result also ended up being 10 times larger.$1.2 million is a lot more than $121,000. And $12.1 million is a lot more than both of those. Actually, it is equivalent to the sum of every single method of compounding, save the $11,583,512 amount.Proportions matter, whereas looking for the frequency of the compounding doesn’t matter. As you can see, the difference between compounding monthly and daily had very little difference. It was only when you looked at $100,000 and $1,000,000 that you had a difference between annually and monthly compounding that became noticeable.It’s only when you don’t compound or you compound once a year that you start to see some problems.Bernoulli didn’t get to the part of creating massive profits through leverage. But James Simons, the world’s greatest hedge fund manager, punctuated the lemma from his original findings.Since 1988, he has made trading gains north of $100 billion. Today, the total assets for his hedge fund are summed at $110 billion.The more you have, the quicker you can change to the next gear.Part 4Gambler’s fallacy.Remember when I said we’ll use the coin-flipping example above later?The gambler’s fallacy is exactly that example.Specifically, the incorrect use of that statistical nuance.You’ll read about how people have earned a bunch of money and then lost it all only to earn it back again.These people are not geniuses. They’re gamblers. They’re not investors. They’re not gurus.There is no such thing as a guru.Run away when you hear the word.Wikipedia defines the gamblers fallacy “as the Monte Carlo fallacy or the fallacy of the maturity of chances, is the mistaken belief that if something happens more frequently than normal during a given period, it will happen less frequently in the future (or vice versa). In situations where the outcome being observed is truly random and consists of independent trials of a random process, this belief is false. The fallacy can arise in many situations, but is most strongly associated with gambling, where it is common among players.”We should pay attention to the words “the mistaken belief that if something happens more frequently than normal during a given period, it will happen less frequently in the future.”In the opening, I went over that probability, or advanced coin-flipping, has an addendum.Specifically, if we are flipping a coin, we are saying much more than the odds of heads or tails being 1/2.Something is omitted from the probability. We don’t write the part that, as we flip the coin many, many times, the law of averages tells us that we get a large amount of tails and a large amount of heads. Even though the literal difference between the number of heads and the number of tails never reaches 0, we use this result to illustrate the law of large numbers. We then use that result to yield the central limit theorem, where we conclude that given enough identically independent random variables—that is, a sequence of samples of coin flips of large amount, we will converge upon an anticipated value that will give us the distribution for our expected value, which in this case would be 1/2.It’s a mouthful, so we say it is 1/2.This is a simulation of a coin that is red on one side and blue on the other. When the coin is flipped, the dot represents the side the coin flipped on. It illustrates the law of averages and the law of large numbers, and how the proportion eventually reaches about 50/50.But the interesting thing to note about each trial run simulated is the amount of partitions you can make on the flips.In reality, nobody is going to flip a coin thousands and thousands of times. You will never truly realize the 50/50 nature of coin flipping over long periods of time.What we often realize, however, are the anomalies in the study of probability.If you focused on the moments where only blue dots are piling up or only red dots are piling up, that’s the interesting part. The gambler’s fallacy tells us that if we get 10 consecutive blue flips in a row, we have no reason to believe that we are more likely to get a red flip. The flipping of the coin each time is independent of the last. We will always say that there is a 1/2 chance of a red flip.I like to call what I’m motivating the reverse gambler’s fallacy. The issue with the gambler’s fallacy is that they focus on what hasn’t happened. Sometimes in Las Vegas you’ll walk across a roulette table and you’ll see the screen of all red numbers or all black numbers (I know that there are also two green numbers, but for the sake of the discussion we will talk black or red). Even though you see 15 black numbers consecutively, you are yearning to put your money down on red.But you’d be silly.You want to know in what fashion you can predict the statistical nature of all those red or black numbers to begin with. You want to know more about the behavior of that probability for that sliver of time.You actually only want to be playing for those consecutive black or consecutive red numbers.To create an analog to the stock market, you want to figure out where the concavity or convexity is about to happen for your equities.You want to figure out when the stock price will change at an increasing pace before that actually happens and you want to figure out when the price will increase at a decreasing pace before it actually happens. These would be the ideal points of entrance or exit.These are really the layman’s questions that people want answers to (among many, many others). Figuring out when a stock is far too beaten up or when a stock is far too high is oftentimes nonsense. This is because your 52 week high could be next year’s 52 week low. And this year’s 52 week low might be next year’s 52 week high.Things could either be getting far better or far worse.People make money doing this.In fact, searching for some simple answers to the behavior of specific portions of the stock market has been a great source of profit for James Simons. His fund is almost fully comprised of money from all of his employees, and every year they make tens of billions of dollars figuring out answers to small, but insightful, questions. He’s been making money consistently while beating the S&P index. For over 31 years. If you look at almost every single hedge fund to date, most under perform the S&P index.In fact, after even one year, 64.5% of funds under perform.After 10, that number becomes 85.1%.After 15 years, it’s 91.6%.If you look at the marijuana industry right now, you’d look at periods where short-sellers are either getting absolutely killed or they’ve gained about a billion dollars in capital so far in the year.Believing in either would probably give you an even chance of losing your money.That’s insane. Talk about thinking that your result or your luck is somehow going to turn around. It’s as if you are watching the gambler’s fallacy, live.The only reason people like Simons don’t get any media coverage is because the media does not know about him and he does not care to advertise. He doesn’t need to advertise. The day-trading gurus all around the internet need to advertise for a simple reason:When you can’t be successful, you try to sell your services as success.In other words, if you can’t gamble your way to the top, you sell your failed tools to others for a premium.The best information out there is in the form of questions that haven’t been asked yet.Turns out that the best questions often lead to the best investments.Part 5Diversification is the key.If diversification is the key to anything, I’ll be shocked.This is severely misunderstood, mainly because it is told by people who can’t explain why diversification is good.If you look at the funds in the last portion of this answer, you’ll see why.Diversification is also an ephemeral thing.People often look at stock indices and think that something is financially healthy or unhealthy.We look at the Dow Jones or the S&P, and we see it go up, and we think, “The total stock market is looking good!”But there is a caveat to this.From 1963 to the end of 2017, the S&P 500 index has had 1,259 components replaced. On average, each year, there are 23 companies swapped, changed, or modified.Similarly, changes happen to the Dow Jones Industrial Average, too.And it leads to the question:What exactly are we tracking?or perhaps:Is what we are tracking relevant from year to year?I would argue that it is not.They’re bad measures of the total market because the total market just does not matter.The people who actually make money in the market trade in the things that they know and they stick to it. You can look up a lot of the holdings of some very famous traders—minus their options positions, which they are not obligated to show those. You’d see that there is a pattern to the way that these people trade, and it doesn’t necessarily reflect what any indices show.Furthermore, they’re usually the complete opposite of diversified.They’re concentrated portfolios. They’re heavily concentrated portfolios.Similar to the real estate example, diversification is usually a tool a money manager gives to lure in customers. Their primary motivation is making a percentage on what they are ‘investing’ for you, and making money for you is eitheran accidenta general consequence of every single stock going upnon-existentAgain, as in the portion with housing, anytime commissions are involved, proceed with great caution.If you look at Simons, you’ll see that their primary motivation is to make a lot of money. It turns out that the money in their fund is provided by all the employees. They work together, and their work stems from high level complex mathematics.And it isn’t diversified.If I can make one addendum that’ll bring together all these parts, I would say that the point of investing is to put money in your pocket. But the way to do that is by figuring out the changes that aren’t anticipated.The theme of each part was to illustrate that figuring out which questions to ask is what makes investing essential. I didn’t want to actually tell you what to do, but I wanted to give you a way to eitherstart thinking about the right questionsstart thinking about why I might be wrongBecause whether we are talking about Euler’s number, the power of compounding, leveraging a loan for a house, gambler’s fallacy, or probability, it is essential to always dig for nuance.There is always a question deep inside a concept that either isn’t being challenged or isn’t being asked.Some people know that, and instead of figuring out the questions to ask themselves, they exploit the concepts for meager profit. In a landscape where everybody wants to find out how to invest, exploitation naturally runs rampant.Otherwise, doing what every single person is doing won’t tell you what you need to know about investing. In fact, even I probably can’t tell you. I’ll be figuring it out alongside all of you who read this.Consider this a starting point.I didn’t use too many specific references, but I’ll link as many sources as I believe are relevant:RenTech’s Billion-Dollar Tax Cloud Darkens After IRS RulingGambler's fallacyUnited States S&P Case-Shiller Home Price IndexCentral limit theoremLaw of large numbersRenaissance TechnologiesActive fund managers trail the S&P 500 for the ninth year in a row in triumph for indexingHedge funds lose money in 2018 but outperform S&P 500 by a whiskerThe Real Reason Active Managers Underperform The S&P 500 IndexThe Myth Of Compounding InterestCompound Interest-The Real Wealth KillerCannabis stock short-sellers made almost $1 billion in 2019Pot Stock Short Sellers Are Getting Killed. That Means the Marijuana Rally Could Continue.

I own almost 600 apartments in the form of 9 communities. I started by buying single family homes and duplexes and now, 20 years later, own primarily apartment communities with about $25M in market value.Do it yourself real estate can be very profitable and also very frustrating. Unexpected things happen and, most bothersome of all, you occasionally get a tenant from hell. If you choose real estate then get a property with more than one tenant, perhaps a four-plex. That way if one person moves out or is evicted you still have 75% of potential revenues from the property. Also, the free cash flow is generally higher on a multi-unit.The amount you put down is dependent on what the bank will allow (they will demand a sufficiently high "debt coverage ratio") as well as what your projected cash flow will be using realistic assumptions. Some properties have sufficient cash flow so as to permit you to get 80% from the bank plus 20% on a second note from the seller and still run positive. Other properties are in such high priced communities relative to rents that you may need to put down 50% to achieve a positive cash flow. Regardless, never buy a property unless you realistically project a positive cash flow. To run negative month after month can ruin you over time.Finally, returns on real estate have four main components.First, cash flow. Aim for 5% to 12% annual cash return on your invested capital.Second, appreciation. If you put 25% down and the property appreciates 2% a year, then your return on invested capital is 8%.Third, paying down the mortgage. With every mortgage payment you make you gain additional equity. Over a 20 year mortgage you will, on average, pay down about 5% a year (Less at the beginning, more at the end). And it is all paid for with the rents.Fourth, tax benefits. Uncle Sam allows you to deduct depreciation as an expense which can often offset your positive cash flow for the first 5 to 10 years. (This will disappear if you are properly raising your rents over time). You realize cash and it is essentially tax free. That being said, you eventually pay the tax man when you sell and realize your capital gains and also recover some of your previously deducted depreciation.Overall, between the four components, it is realistic to obtain a 20% or more return on your money. I certainly have done it for 20 years and can verify that it is possible. To be fair, I should also say that this does not include a valuation on my invested time which has been considerable.If you are interested, read a lot and then only invest a potion of your money in real estate. It can be very scary at first. It also requires hard work and it can be very frustrating. I only recommend it to other people who want to work hard and who have the reasoning acumen, mental toughness and stability to persist over a long period of time. Finally, and I must say it again, read, read, read. Good luck.