You can find this post in this weeks Carnival of Personal Finance ….
As I mentioned yesterday, I drafted yesterday’s and today’s series of two posts before the latest round of stock market crashes … it seems that with all the money LEAVING the market at exactly the wrong time – i.e. the market bottom (or, close to!) – everybody is suddenly ‘anti-stocks’ … of course, as soon as we get towards the top of the next bull market all the pro stock / anti-real-estate people will come out of the woodwork again … and, the cycle repeats 😉
There is a great argument for investing in stocks and businesses: Warren Buffett has done it successfully for 40+ years turning himself into either the #1, #2, or #3 richest man in the world (depending upon what’s happening with Bill Gates and Carlos Slim on any given day).
Warren has shepherded his company, Berkshire Hathaway to compounded returns averaging 21% for the past 20+ years doing the one thing that us ‘mere mortals’ have difficulty doing: picking ONE horse and riding it all the way home.
What we seem to prefer to do is invest in Mutual Funds, the stock market equivalent to following all the advice of a ‘top tipster’ in the Saturday Racing Guide for either the horses or the dogs (how many of these newspaper ‘tipsters’ are rich, anyway? If not, how good are their tips, really?) …
… or, we plonk our money into Index Funds, which is the stock market equivalent to betting on every horse in the damn race!
By betting on every horse or – in this case – stock, we are aiming exactly for the average result … for the time frame that we manage to stick it out.
But, wouldn’t we get better results if we simply bought all the stocks in the Index Fund that are above average and ignored all the others? 😉
Simple and powerful strategy, no?
We know that the logic is there: by simply NOT buying the dogs, and concentrating on the (even slight) favorites, we push the odds markedly in our favor.
But, when it comes to stocks – or horses and dogs for that matter – the form guide, tips, and other sources of ‘best buy’ information have proven to be highly unreliable.
The past is simply NO guide to the future, so we are left with either relying on others to pick some winners for us (they will lose us money, relatively speaking, because of the fees they charge, but at least we’ll feel good about having an ‘expert’ doing our guessing for us) or ‘playing the whole card’ i.e. buying the Index Funds …
… the net result is that we tend towards the average (returns) or worse … never better.
So, quite rightly, we talk about the stock market in terms of aiming towards (but, never quite getting there) long-term average returns.
Yet, the total opposite applies to real-estate:
The pro-stock / anti-real-estate movement [AJC: I am neither; I am simply pro-profit 😉 ] points to the average return from real-estate and compares it to the average return from stocks and says “aha … stocks are better!”
Putting aside the leverage, tax, income and other benefits of real-estate, the problem is that nobody buys the whole card when it comes to real-estate …
… there is no Index Fund for real-estate!
[AJC: well, there might be an artificial ‘index tracking’ ETF that does this … but do you know ANYBODY who’s ever bought it? 🙂 ]
You either buy a Mutual Fund (technically, called a REIT) that buys a selection of real-estate for you, based upon what some inside ‘expert’ predicts will do well (after fees, fees, fees) …
… or, you buy one or more properties yourself.
You see, unlike stocks, you NEVER buy the market, so comparing average returns is just plain dumb.
There is also one other key difference:
You DO know how to pick real-estate … you have at least some experience: you bought your own house, didn’t you?
You chose a ‘nice area’, close to schools, transport, in a nice neighborhood, didn’t you? And, if you still live with Mommy and Daddy, well, they bought a nice house, etc., etc. … right?
Right there, you bought in the top half of the market in terms of growth … you just beat the (real-estate) market average!
When it comes to stocks, not one of us is Warren Buffett, so we ‘gamble’ on the performance of some market index that we don’t really understand …
… but, when it comes to real-estate, we are all like Warren Buffett – we all have the capability to pick the horse … oops, house … that will perform better than average.
And, even if we only get ‘the average’ return on our real-estate investment … we are going to do two things that we are never going to do with stocks:
1. We are going to leverage our investment – we will almost always take a mortgage on real-estate, but we will hardly ever borrow to buy an Index Fund
2. We are going to invest for the long-term – we will most likely stay in the real-estate investment for at least 7+ years, but we will most likely try and time the market (i.e. get scared and sell at the first sniff of a ‘down market’) if we buy stocks or Mutual Funds, thus absolutely killing our potential returns.
Still don’t believe me?
Then why is that conservative old banker prepared to back your real-estate acquisition with a couple of hundred grand?!
[AJC: at least until a couple of months ago … and, again in a couple of months time]
See if he’ll do the same when you want to go and visit your bookie … or stock broker 🙂