You see, if you want to work on your ‘physical well-being‘ you have to define what that means …
… for you.
It will be different for everybody: for my wife it means eating strangely and exercising a lot. For me, it means, being totally sedentary, eating reasonably little/basic (except when I go out) and relying on good family ‘longevity genes’ (on my Mother’s side … hopefully, not my Father’s side of the family!) to keep me alive.
Yet, the government has managed to come up with (and, recently updated) a Food Pyramid that neatly sets out a plan for eating and staying healthy. Each ‘slice’ of the pyramid represents the relative proportion of each different food group that everybody should eat, every day.
But, the government soon found that this is enough to stop people from getting obesity-related sicknesses (cancer; cholesterol-related heart disease, etc.), but really wasn’t enough to make people, well, healthy.
What’s new about this, latest version of the pyramid is the stick figure climbing the stairs on the left hand side, like some Inca priest about to climb the pyramid at Machu Picchu for his monthly sacrifice of the young virgin (naturally, by ripping her still-beating heart right out of her chest … but, I digress).
This signifies that you can eat the right foods all you like, but won’t achieve true health unless you also exerciseyour body, in moderation.
One size does indeed fit all … at the most basic level.
Similarly with your ‘financial well-being‘ – while still a long way off being the Unified Theory of Personal Finance – we can at least lay out a basic Money Pyramid that will serve one and all reasonably well … enough to at least get you started; the bonus being that it might win me some friends back from the mainstream Personal Finance blogosphere.
Take another look at the Pyramid at the top of the post, and we can imagine the various segments as being common financial wisdom like:
1. Save 15%+ of your gross income
2. Pay down (and avoid all future) ‘consumer debt’
3. Increase your rate of savings by also allocating to your savings plan at least 50% of all future pay increases and ‘found money’ (inheritances; IRS refund checks; loose change from your pockets; money saved from quitting [insert vice of choice]; etc.
4. Buy instead of renting [AJC: which Financial Pyramid are you reading?!]
5. Invest for the long-term
6. You can fill in the other slices from your choice of any/all: live frugally; diversify; create an emergency fund; and so on …
And, this is certainly the Money Pyramid being promoted by most Personal Finance writers (other than the “Make Millions with No Money Down” and other ‘financial crackpot systems’, that I liken to the totally unbalanced “No [insert unhealthy sacrifice of choice: carbs; proteins; calories; glucose; food; etc.] Diet” diets).
The problem is, it might stop you from being poor (the financial equivalent, to not being obese) but will it be enough to make you Financially Healthy … a.k.a. Wealthy (however you choose to measure that)?
Probably not, which is why I have created the New Money Pyramid simply by adding the man climbing the stairs on the side:
This signifies that you can save money all you like, but won’t achieve true wealth unless you also exerciseyour money, in moderation.
How do you exercise your money?
Simple: you move it around! You aim high … setting a goal that has meaning to you, then:
– You invest at greater velocity (higher return),
– You leverage (the financial equivalent to exercising with weights),
… but only to the extent that your ‘heart’ (actually, your guts) can handle – start slow, get help, build up the velocity and the leverage as you get over a period of time – and, check with your ‘doctor’ before trying this at home 😉
Perhaps I just like this video because the ‘talking head’ is a fellow Aussie – although, I don’t know who he is or what his credentials are (I do know that if you watch all three of the videos listed on his blog you’ll end up with an ad for a new ‘personal finance’ educational board-game) …
… but, I do like his neat little whiteboard summary of the problem of ‘investing’ to chase capital appreciation. This was the sort of ‘wrong thinking’ that fueled the property market booms, both here and in Australia.
Conventional wisdom says that you can safely withdraw 5% of your Net Worth each year following ‘retirement’ (hence, the Rule of 20), but conventional wisdom is aimed at people who conventionally retire … which, I trust, is none of us 😉
However, there are essentially two conventional ways of deciding your retirement ‘income’:
There’s the percentage of portfolio method (where you always withdraw the same % of your portfolio each year) and the dollar adjusted method (where you always withdraw the same fixed $ amount, only adjusted each year for inflation).
Colleen Jaconetti, from Vanguard Investment Counseling & Research says:
The percentage-of-portfolio method can give your money a greater chance of lasting throughout your lifetime, while dollar-adjusted gives you a more predictable, inflation-adjusted withdrawal amount each year. If you’re more concerned about someday running out of money, the percentage method may be appropriate, but you’ll need to have some flexibility in your spending.
The percentage of portfolio method tends to last longer, making it more suitable for those of us who intend to retire young … and isn’t that all of us?! Colleen agrees:
If you’re retiring early, such as in your 50s, you may want to start out withdrawing closer to 4% to help reduce the risk of a long-term shortfall.
But, the problem isn’t with the method – in fact, in the first year of your retirement, they produce the same result (it’s only in subsequent years that they vary according to your then-current Net Worth OR according to inflation, depending upon which method that you choose) – it’s with the factor that you choose.
You see, 5% (or even 4%) may be too much!
These ‘common wisdom’ percentages assume average rates of return, but the market doesn’t operate in a line that simply tracks the averages … it moves around the average return randomly …
… and, if it randomly moves the wrong way too early and for too long (pity those who are recently retired) you could easily run out of money in years, not decades!
So, you could instead plug your numbers into a Monte Carlo Simulation (this is a really good one) which tend to produce much more conservative withdrawal rates – more like 2.5% (hence my Rule of 40).
Or, you can go the other way and set up a Bond Laddering strategy that Paul Grangaard claims can support a ‘safe withdrawal rate’ as high as 6.6%.
Do you see our dilemma? A doubling or tripling of life-style (or a similar scale reduction, depending on whether your glass is half full or half empty) depending upon whom you believe.
This is the dilemma that you face when your retirement assets are held in bonds, Index Funds, cash or CD’s … which is why I am trying (actually, failing miserably right now) to live a $250,000 lifestyle on an income and asset-base that actually supports way more than that (I think: I’ll have to wait for the post-meltdown; post-house-purchase; post house-renovation; post-move countries fallout to clear sometime during 2009 to be REALLY sure I’m still living within my means … I think – more likely hope – I am).
So, when I find the Perfect Retirement Formula, I’ll be sure to let you know … Lord knows, if it exists, I need to find it 😉
In the meantime, I have a third method – one that makes the concept of Safe Withdrawal rates virtually irrelevant:
You invest your money in income-producing assets …
… such as, dividend-producing stocks or income-producing real-estate.
You buy the asset with little or no borrowings (which is entirely different to the Making Money 201 strategies that I recommend, but we are now in Making Money 301 – ‘post-retirement’ wealth protection mode – so things change dramatically) and gain the following two huge advantages:
1. You can live off the entire after-tax rent/dividend – with a buffer for holding costs (in the case of real-estate, this could be things like vacancies, taxes, and repairs and maintenance), if required – which is pretty much automatically inflation-adjusted, and
2. Your capital (hence estate) or Net Worth also increases pretty much at least with inflation, as long as you choose your investment/s reasonably well!
No worries about outlasting your income … and, you get to leave your heirs (and/or your favorite charity/s) the bulk of your ‘fortune’ 🙂
PS What does the image of a man running on the beach have to do with a ‘safe retirement’? I have no idea … I just googled images with the keywords ‘safe’ and ‘retirement’ and pictures of beaches and horses (lots of horses!) came up … go figure …
I am working on my first US commercial real-estate deal right now and by coincidence received the following question from MoneyMonk:
I plan to buy commercial Real Estate (strip mall) in the near future within the next 4 yrs. I want your advice on some things.
I want a property between 350-400k, I plan to put down $80K <- which will take me 4 yrs to save/invest
I want a commercial re agent to search for me, Im think Im looking at 8-10% commission to give the broker;
I want to form an LLC for my company, apply for a federal id, get a good CPA, a lawyer to form the LLC, umbrella insurance for about 1 million (u never know, The U.S. like to sue).
For as cap rate I want something above 7%. Am I’m missing something???
I also want to visit a banker and ask about financing. Is commercial re different from personal RE? for as terms?
I know any decent bank want you to show a good income, credit and some cash in the bank. What are good questions to ask a banker?
First I would like to congratulate MoneyMonk on being so forward thinking; it doesn’t hurt to talk to a Banker upfront, but my suggestion as to the very first place to start is with the following four steps:
1. Identify the type / location / price ranges of properties that you want to buy – MoneyMonk is targeting “strip malls … between 350-400k”.
2. Start researching the types of properties in the areas that you are interested – with 4 years to go before MoneyMonk has saved sufficient deposit, nothing else matters right now other than the research: LoopNet and RealtyTrac are great places to do this research.
That’s it for now; when the deposit has been saved:
3. Find a real-estate broker – you’re looking for the trifecta: (a) a broker that you like/trust, (b) one who works with commercial RE in the area/s that you are interested in, and (c) somebody who invests in commercial RE herself.
Keep in mind that the best deals are NOT usually on Loopnet /Realtytrac – they are what the brokers haven’t been able to offload, so are probably NOT the best deals around – the best deals are still probably with the brokers. It’s still an “old boy’s club”, so don’t expect your broker to bring you these deals first time around … your first acquisition is unlikely to be your best!
4. Find a property that you like / can afford / that meets your criteria and put a refundable deposit down (subject to: finance, partner’s approval even if you don’t have a partner, and due diligence).
The investment clock is one of the best indicators on the movement and condition of the finance, property and equities markets. It was first published in London’s Evening Standard in 1937 and showed the movement of markets within a decade cycle. Many people, however did not readily accept the probability of events turning out in a cyclical fashion so it took a while for some to warm to this new area of thought.
As late as last year, I was reading articles that said that we were at One O’Clock on the Investment Clock: rising interest rates and fear that stocks were on the verge of falling (and, fall they did) …
… then, something surprising happened: the clock did a ‘fast-forward’ to where I think we are today:
At the bottom of the cycle when fear and bankruptcy are abounding and interest rates are down, remember that this is the time to be positive. It is the time when there are bargains galore, ready for the taking.
The driving factor behind the business cycle is the capitalist system itself. Recessions are a way of ridding itself of excesses. Things like speculative lending by banks, high risk real estate trading and inflation. Society simply starts going a bit faster than the economy and places a lot of strain on resources. This means we are left with inflation and high interest rates. The bank then imposes a credit squeeze for a period, long enough for those excesses from the system to force inflation down.
Always remember that during a slump the price of most things will fall, but the value of cash does not. In fact, the value of cash goes up because it is measured by its increased ability to buy things more cheaply. This is the best time to hold cash and come out of those holdings when the economy is in the doldrums.
Nobody knows how long we will languish in the ‘doldrums’, and if you count the recent stock market rally as a ‘good news’ indicator it may be almost over, but it’s clear – at least to me’ … we are already in the cycle where assets are cheap … both stocks and real-estate with the added bonus that interest rates are also cheap …
… Bargain Hunter’s Heaven.
Here’s what to do:
1. Start looking for good quality companies with a strong history of earnings growth that are undervalued (did you know that GE has produced 10 years of 10%+ year-over-year earnings growth?) that are selling for low P/E (that’s the price compared to earnings … if you can pick up GE at P/E’s of 13 and hold for a long time, you have a sure-fire winner!) and HOLD. Don’t feel obligated to borrow to buy these, but increasingly, this will be a good strategy as stocks will be the first to rebound.
2. Start looking for good quality income-producing real-estate that you can afford to HOLD … these will be the last to recover (could be a 7 to 10 year cycle to fully recover) but, prices will begin to steadily increase. So, buy soon to lock in these yummy low interest rates before they, too, start to rise. The combination of low prices and low interest rates is equally a sure-fire winner.
3. Start a service business that helps large corporates – as they recover, they will need to outsource more and more services. It can be tough (corporates can be tough to deal with) but they can also pay off big and provide a ready exit strategy (as the outsourcing ‘fashion’ begins to swing back to ‘insourcing’ and your largest customers fight to buy you out).
Just don’t forget to always keep an eye on the clock …
Hey, my name is Josh and I am 24 years old and I am a huge personal finance junkie. I really enjoy reading your site so far. I was particularly intrigued about your post about renting vs buying real estate. To make a long story short, my dad owns commercial/rental property (3 housing units, bottom floor is for business) that is mortgage free. It is in a great up and coming neighborhood in Brooklyn. If he were to sell it today it would fetch in the 2 million dollar range. He makes pretax annual income of about $100,000+ in residual income from the business and the 3 housing units. I have been for the past couple of years been trying to convince him to take a loan from the equity from his property and reinvest in other commercial properties or other properties, but he refuses claiming that it is too risky. I don’t how else I can try and sell him on this. Maybe you can help? I am just trying to help my dad become more cash rich, instead of cash poor, asset rich?
Join AJC as answers this question – and, more – as he shows how he went from ($30k) in debt to over $7 million in the bank in just 7 years … no scams, no schemes … just good-old-fashioned free advice … LIVE THURSDAY @ 8pm CST (6pm PST / 9pm EST)!
This is your chance to ask AJC @ 7million7years.com your personal finance, real estate investing, or business startup questions. Or, if you feel the need, go ahead an criticize him … AJC just loves a good, clean fight 🙂
Click on the link below to see AJC live and to chat with him and ask him questions (no webcam required!)
If you would like to ask AJC a question …
… during the show, AJC loves to chat, so why don’t you create a login to the chat room now (if you haven’t already created your login) it’s free, and takes just a few seconds!
If you would prefer to e-mail your question to AJC for an upcoming show (it’s too late to e-mail for tonight’s show, sorry), please see http://7million7year.com/live and scroll down until you see the contact form – type in your question and name/e-mail address and that’s it!
Due to the volume of e-mails he receives, AJC cannot reply to all e-mails or cover them on his show, but he will TRY to get to yours!
One of Dave Ramsey’s most popular ideas is that of a debt snowball. The idea is that you pay off your smallest debts first, then roll that debt’s monthly payment into the next smallest. When the next smallest is paid off, you roll the two former payments into the next smallest debt.The snowball grows and grow with each debt that’s repaid.
Here’s a real life example; here are your three debts and minimum payments:
$10,000 @ 20% APY, $500 minimum monthly payment
$4,000 @ 10%, $200 minimum monthly payment
$1,500 @ 12.5%, $75 minimum monthly payment + EXTRA PAYMENT
The debt snowball method states that you should put all extra debt payments towards the $1,500 balance. When you finally pay off that debt, your new payment schedule should look like this:
I have only added the words “EXTRA PAYMENT” to both examples, because I want to clarify – then expand upon – BFFP’s example.
First, though, what Dave Ramsey is saying – and, what BFFP is trying to illustrate – is the concept that you take one of your debts (the highest interest rate in the traditional ‘Debt Avalanche’ or the smallest balance owing in Dave Ramsey’s more psychologically-friendly ‘Debt Snowball’ method) and pay that down completely … merely making the required minimum payments on any other loans (but no more!) to stop them from going into default.
The credit card companies will love you for this!
Then when that loan is paid off in full you apply the payment that you USED to make on the first loan that you tackled to the next remaining debt, and so on …
… it ‘snowballs’ because you are applying more and more to each remaining debt, while never having to commit more (or less) to debt servicing than when you first started budgeting.
So, in both examples we are paying $775 (i.e. $500 + $200 + $75) towards debt repayment until all debts are paid off … THEN – conventional financial wisdom will tell you – you get to start INVESTING that $775 a month and you are FINALLY debt free and on your way to … what?
Well, let’s go back and make the small correction: if you only make the minimum payments, you will never pay off any of the debts (or, way too slowly), so you need to find some extra money and make some extra payments to the first loan that you decide to tackle; let’s use an example of $225 a month as an extra payment …
… and, from now on you commit to that monthly $1,000 i.e. $500 + $200 + $75 + $225 EXTRA PAYMENT + C.P.I. + 50% of any ‘found money’ (second jobs, part-time business income, loose change, IRS refund checks, etc., etc.) for your entire working life!
So, we are on the road to success! Or, are we?
The problem is that we have to decide where we’re heading: if our aim is to become a Ramseyesque Debt-Free=Happy clone, then well and good. Your financial plan is set.
[sign off now]
But, if we intend to get rich(er) quick(er)â„¢ we have two huge limitations, neither of which the Debt Snowball or Debt Avalanche address:
If we lose just 10 years to our investing plan by delaying investing while we pay down ALL of our debt and/or pay down our mortgage we can halve our potential return.
Do you think that might be significant?
So, we don’t want our debt-repayment strategy to unnecessarily delay our investment strategy.
Money
Where are we going to get the money to invest?
Sure we can accumulate $1,000 a month (after paying off debt) – and, grow that amount through C.P.I. and ‘found money’ strategies -but, will that really set us off on the path to financial riches?
The same graph shows that for every $1,000 A YEAR we invest, we can expect $100,000 after 20 years … so, our $1,000 A MONTH strategy should yield $1.2 Million over the same time period … unfortunately, that won’t be enough for a DEPOSIT on the Number that you really need …
… and, inflation will take at least a 50% chunk of that (not to mention taxes)!
So, the solution for most people – who don’t want to lower their expectations to match this depressing, but debt-free (!) scenario – is to move INTO debt … to invest!
This is so-called ‘good debt’ and I’m not sure what Dave Ramsey and Suze Orman’s take on this is, but most financial pundits call it ‘good debt’ for a reason. Assuming that you agree, read on [AJC: if not, I’m guessing that you hit <delete> about 4 or 5 paragraphs ago]
So, here’s what we need …. a different mind-set:
Since we already know that we will more than likely need to incur SOME ‘good debt’ as part of our investment strategy (i.e. some safe level of leverage for investment purposes e.g. a loan on a rental property) …
… why pay off OLD debt now in order to accumulate NEW debt later?
It doesn’t make sense, does it?
We merely waste time and money … instead, we should resolve the following:
1. To treat all Consumer Debt as ‘bad’ and incur no further such debt, unless it’s not really Consumer Debt at all (e.g. we need to buy a car to run our catering business, and public transport or a bike really won’t cut it)
2. To apply the minimum required payments + extra payment(s) + c.p.i. + ‘found money’ not merely to the lesser goal of paying down debt, but to the greater goal of helping us get to our Number (i.e. the financial representation of our Life’s Purpose [AJC: if you don’t buy into that philosophy, then simply insert the words “helping us become financially free”])
3. To, from this day forth, look at all debt as an INVESTMENT in your financial future: and, simply ‘invest’ where you get the greatest returns: is that in paying off an old debt? Or, is it in acquiring a new debt?
Example 1
In the example above, we have three debts of 20%, 12.5% and 10% (are they tax deductible? If so, look at the after tax cost which will be 25% to 35% lower than the nominal interest rates circa 14%, 8.5%, and 7% respectively) …
Compare these interest rates to the cost of money for the types of investments that you want to make …
… in this example, all three are higher than current mortgage rates so you will probably want to keep paying them off (although a good argument can be made for paying off the 20% loan first, then buying an investment property BEFORE paying off the others).
Example 2
Let’s make two changes to our example:
Let’s assume that one of the loans is a 2.5% Student Loan, and swap the amounts owing (so that the Student loan is now the ‘biggie’) and, let’s assume that we have at least 5 more years before it HAS to be paid back (so we have time to make an investment work for us); here’s our starting position:
In this case, we tackle first the 20% loan; I can’t imagine an ‘investment’ that will provide such a quick & safe 20% post-tax return! Then, we tackle the 10% loan.
Again, an argument could be made for leaving it in situ; however, it is only $4k – and, we’ll pay it off in just 4 months – so let’s go ahead do just that:
Once we have paid off our two HIGH INTEREST loans, instead of paying down the low interest student loan, we continue to make its minimum monthly payment, and instead apply all of the previous / extra loan payments (from our OLD loans) to building up a ‘reserve’ in a bank account (it pays us a – low – rate of interest!) …
… at this rate, we will have a deposit on a small rental (or our own first studio apartment) in less than a year, then our financial picture will look something like this:
Keep in mind that if you used Reserve # 1 to build up a deposit on a small apartment to live in, then you will have no rent to pay, so you can apply part to home ownership expenses (rates/utilities/taxes) and part towards your next Reserve!
And, if you bought a rental, then you may be in an excess rent situation and have more to apply to building your next Reserve, as well … if not, then you will need to decrease the amount going towards your next reserve to cover any rental shortfalls (e.g. mortgage payment deficits, vacancies, repairs & maintenance fund, etc.).
Now, you know why this is not a Debt Snowball, a Debt Avalanche, or even a Debt Meltdown:
It’s the Cash Cascade …
… the new way to look at paying down debt!
In the two years that it would have taken you to pay off your Student Loan and buy your first property, you now own two properties and are well on your way to financial freedom!
Intrigue over at 7m7y.com! Who’s the Millionaire … In Training leaving? And why? Click here to find out …
___________________________
“Oh, little 401k, how I hate thee … let me count the ways” (2008, Anon.)
I don’t know who first uttered these words 😉 but, they strike a chord with me; here are some (admittedly, slightly cynical) reasons NOT to like the humble 401k:
1. Little or no choice of investments
2. Have to wait to traditional retirement age to receive the benefits
3. Stuck with low-returning investment choices
4. Little or no opportunity to ‘gear’ (I guess the employer match and tax benefits counts as a kind of gearing)
5. Fees
6. Your employer may be ‘stealing’ from you
Stealing?!
Yeah, in a way … but, first let’s take another quick look at fees [AJC: Inspired by a comment left on a post by Dustbusterz … thanks ‘Dusty’!]; in 1998 (!) the Department of Labor received and published an independent Study of 401(k) Plan Fees and Expenses.
It found the following average fees being charged by the larger 401k funds:
Total Annual Plan Fees
Lowest      0.57%
Mean        1.32%
Median     1.28%
Highest    2.14%
(Source: Butler, Pension Dynamics Corporation, in Wang, Money, April 1997)
Now, this goes back to 1997, but I just covered some very recent work by Scott Burns, noted financial columnist, and published in his new book, Spend ’til the End, which points to the fees continuing to trend up, citing average (mean? median?) fees of 1.88% now.
Remember that, according to Scott, even a “1% increase in a fund’s annual expenses can reduce an investor’s ending account balance in that fund by 18% after twenty years”!
I calculate that a 1.88% fee reduces your returns after 20 years by a whopping 38% …
But, do you know how your employer actually chooses your funds / 401k provider? On the basis of better returns to you? Given the possible 38% ‘hit’, you would assume at least on the basis of lowest fees for you?
Right?!
Nope … not a chance. In fact, the study quoted an earlier report that found that “78% of plan sponsors [employers] did not know their plan costs” (Benjamin) …
… Great! You are putting your financial future into the hands of your employer, 3/4’s of whom don’t even know what the plans that they are choosing will cost you!
So how do they choose the plan that’s right for you [AJC: ironic snicker]?
The study found, one of two ways:
1. In my opinion, an unethical way: The Study of 401(k) Fees and Expenses quoted a prior report that found employers most often choose “the institutions that furnish the firm other financial services – banking, insurance, defined benefit plan management – to provide their 401(k) plan services and may not make an independent search for the lowest cost provider.”
Your employer feathers the bed of their own business relationships with your retirement money. Nice!
2. In my opinion, a criminal way: That would have been enough for me, if I hadn’t accidentally come across what is regarded as the Retirement Industry’s ‘Big Secret’ … it’s a doozy: it’s where the 401k provider shares some of the fees that you pay them with your boss!
Think about it; your employer provides you with a match to encourage you to remain employed then gets back some of that in fees, rebates, ‘free’ services, or just good old ‘relationship building’ at your expense, literally!
How do the funds and your bosses get away with this? Simple, nobody’s looking: “Revenue sharing is a poorly disclosed and relatively unregulated practice, which falls into the gap between Department of Labor and SEC oversight.”
OK, so does this mean that you shouldn’t participate in your employer’s 401K?
Not at all … it just means that you should do the following:
1. Decide if the 401k is going to do the job for you … will it get you to your Number? At a maximum ‘investment’ of $15,500 per year and a compound annual growth rate of 8% – 12% less fees, this is highly unlikely … you run the numbers then make your choice!
2. If not, is it still wise to continue your 401k (consider it a backup plan) as well as more aggressively investing elsewhere?
3. If you can’t do both, you have no choice but to decide which investing strategy is going to have to give way to the other?
4. If you do decide to continue with the 401k, choose any ultra-low-cost Index Fund option that may be on offer over any other selection; if not available, choose a ‘no load’ fund (be careful … some ‘no loads’ are actually just ‘lower load’). And, do your own homework on fees, because you just know your employer ain’t doing it!
5. Lobby your employer to pass back any revenue-sharing back to the employees
6. Insist that your employer choose funds that work best for you over the funds that work best for them.
What you do with this information is entirely up to you; I don’t need a damn 401k … never have and never will 😉
The text of a cable sent by Mark Twain from London to the press in the United States after his obituary had been mistakenly published.
Just like Mark Twain, I think that real-estate has been prematurely ‘written off’. Do you need proof?
Just check this often-cited graph (I think that it’s from Irrational Exuberance by Robert Shiller) floating around the internet:
It purports to cover a period from 1900 to 2005 in a linear fashion … a clear bubble-spike, right?
What could one reasonably conclude from this?
A long downward trend and/or an even longer flattening until house prices catch up with, say, 3% – 4% inflation?
Now, take the period covered by the red line beginning roughly in line with where the ’10’ starts in the phrase on the graph that says “Yields on 10-Year …” – got it?
That’s roughly 1987 until today …
Now, let’s look at an a national index of housing prices covering that same period from a source that I trust – Standard & Poors (the same rating agency that produces the S&P500 stock price index):
This picture tells a slightly different story, doesn’t it?
One reason is that this one, I don’t think, is inflation-adjusted whereas I believe the Schiller one is (or at least ‘adjusted’ for something … any of our readers know what that might be?). In either case, a definite ‘bubble’ can be clearly seen in both charts from, say, 1999 to 2007.
But, have a look what happens when you break this second chart into three sections:
1. We see the tail end of a rise from (we don’t know when, because S&P apparently only started collating this data in 1987) to the end on 1989 … the extent of this rise is pretty important, because we then see …
2. … a ‘flat’ line (or worse) from the end of 1989 to roughly the end of 1998, then …
3. … all hell breaks loose from the beginning of 1999 to somewhere towards the end of 2006 when a clear crash occurs.
So, was the flattening in 2. a correction for 1. OR was the growth in 3. an over-correction of 2.?
I can’t say for sure, but I can say this:
If you draw a compound growth curve between two points: a 20 year period when the market moved from an index of 75 (roughly at the end on 1987) to an index value of 200 (roughly at the end of 2007), we can see that that represents an average compound growth rate of just on 5%
Given that real-estate compounds at 3% to 6.5% annually, depending upon which source you believe (I’m firmly in the 6%+ camp), here’s what all of us as investors have to decide …
Buy now (or soon) while the going is cheap (particularly, if you think that interest rates will also start to go up soon), or wait because you believe that real-estate is still overpriced.
Be warned: if you wait too long (is that 6 months or 6 years?), the ‘real estate discount party’ might be over!
Let’s see … what are your health objectives?:
