Content provided by Case Eichenberger, CLS Client Portfolio Manager
I’m looking to buy a house. It’s a big move for me, as a 31-year-old single guy, but I know my financial advisor is right. Interest rates are at historically low levels, and now is a good time to jump into the housing market. I’ve spent several weekends touring open houses with my agent already, and I’m starting to learn more about the process. One piece of advice I’ve picked up: Stay at the property for at least three years before trying to sell again. That helps build enough equity to recoup commissions.
This got me thinking about investors and their own financial plans. Are they sticking to them? The best investment allocation with proper diversification means nothing if you can’t follow your own plan. Why do most investors fail to perform as well as the investments they select? I think the answer comes down to one word: emotion. The 24-hour news cycle draws attention to every economic release or stock price tidbit, and this can make it difficult for investors to make clear decisions. Combine the noise with the ease of checking balances and following asset allocations with intraday pricing, and, well, you can see how most investors fail to capture full returns. (This gap in investment and investor returns is known as the behavior gap.) I’m all for technology and believe it truly enhances our lives, but behavioral finance tells us losses hurt twice as much as gains, and the more you look at your account, the better the chance of seeing a loss.
This brings me back to real estate. Most people say buying a home is a great investment, a no-brainer, and a historically awesome diversifier for other equity assets. Why? Real estate can boom and bust like any other sector in the stock market. Maybe it’s because there’s usually a very, very long time horizon planned when buying real estate. The stock market shouldn’t be any different.
Imagine this: You buy a house or condo, and the next day you start assessing the value of your investment as events impact its price. Maybe it’s an unkempt neighbor who is letting his house deteriorate or a brand new development that could generate tourism. The value would rise and fall every day, making it quite an emotional ride for a huge investment. What would you do if another housing bubble burst? Would you sell because the value dropped so much? I hope not. It’s not a good philosophy to buy high and sell low.
Real estate values are just as volatile as the global stock market. The only difference is we don’t read daily valuations of our real estate assets.
Now for the breakthrough, aha moment of this blog: The more time you have, the better your chances are to realize gains! I know it’s not groundbreaking stuff, but sticking to a long-term plan is also easier said than done. With a short-term time horizon you limit yourself to a coin-flip chance of positive gains. Push the time horizon out to 5, 10, or 20 years, and the probability of earning positive returns approaches 100% very quickly. Now that sounds like a good reason to have a portion of your money in the market.
Investing is a long-term process, but the problem is that most investors live in the short-term world. Having a financial advisor who can coach you and keep your emotions in check is crucial to keeping you on track to your goals.