03/18/2010 05:12 am ET | Updated Nov 17, 2011

Would You Invest in a Zebra?

In medicine, they say: "When you hear hoof beats, think horse, not zebra." According to the doctors in my Live Out Loud community, that translates to: "Don't go to the obscure and unlikely when you're dealing with the ordinary."

I believe there are two ways to invest: horses and zebras. Horses are obvious. Zebras are obscure. To my amazement, many investors choose to invest in zebras. Not me. I am in favor of horses.

Horses are simple, direct assets. Horses can be found in every asset class and sector, such as private equity, real estate and commodities. They include clear cut businesses, land and buildings, gold mines and oil wells -- the actual mines and wells, not the publicly traded stocks representing them. I'm also in favor of alternative investments like buying an actual bank or purchasing undervalued currencies, but again, only if these are horses, not zebras.

How do you identify these types of investments?

Horses are:

  • transparent and simple
  • not intertwined with other products
  • not lost in the haze of murky markets
  • things that have few layers between investor and asset
  • what they are and ain't what they ain't.
Zebras, on the other hoof, are exotic, extraordinary and often confusing. They may appear to be one thing, e.g. a fund that promises high-reward, low-risk value investing. But then turn out to be another, e.g. a fund that is not well-supported by a firm's best management, research or trades. Those unlikely zebras are like zero calorie fudge -- too good to be true.

I think anyone who invests in zebras is nuts. Yet, it's done all the time by the smartest and most experienced investors.

Take, for example, the zebra of collateralized debt obligations. To those who invested in CDOs they seemed to be excellent packages of diversification designed to manage risk. But, alas, no. In reality, they were mysterious mixes of mortgages more malicious than moderate. And the well-secured assets in the mix were no match for the insidious junk that spread to infect the whole deal.

The most interesting part of this, though, was that few people understood what exactly was in the CDOs. And this includes some of those people who sold them. (Yikes!) Yet, these were the hot ticket investment product of the last few years. And not only did these zebras of confusion and obscurity mess up investors, but they helped mess up the economy.

And this is just one example. Consider if you would ever buy into the following advertisement: "Accumulate great wealth by putting a lot of money into our newest derivative product assembled by the top Quant jocks on Wall Street using such sophisticated mathematical models that even they don't understand them." Absurd, right? But in the past decade many investors bought into exactly that.

People seem so eager to trust the experts that they are willing to put their hard-earned money into investment vehicles that make no sense to them. And you know what? I think people do this precisely because they make no sense. In some skewed alignment of logic and laziness, I believe people suffer through the tangled transitive traffic jam of:

complexity = sophistication = success, and thus, complexity = success.

But hey, guess what? If something is over your head, it's not necessarily a smart thing.

When investing, it's good to think like Jinbei Yamada, founder of Arrow Bicycles. The sign above his Tokyo shop reads: "simple is best." In the high tech world of gadgets and add-ons, he's been able to survive for over 35 years by keeping his simple machine simple. And I agree with him -- simple is the best way to invest.

1. Sensible. Make sure the investment actually makes sense. If there's a logical gap, (a water park in the desert? Wow!), don't let it go.
2. See-through. Don't hope for transparency, require it. And this means access to operations, as well as financials.
3. Stand alone. Assets that rely on too many other moving parts in order to be successful can create complications.
4. Stable A good climate and foundation are key. Investors must understand all of the environmental and internal issues that can affect returns.
5. Simple. ('Nuff said)

A responsible and diligent investor does not complicate. Building wealth can be simple when you invest in horses. You can learn more here.

I'd like to hear your thoughts. Call in to the Loral Langemeier Show at 877-777-7713, Monday through Friday, 7 a.m. Pacific, 8 a.m. Mountain, 9:00 a.m. Central, 10:00 a.m. Eastern. Or listen to the podcasts.