Housing Hooplah

For the last couple of years I have been experiencing "deja vu all over again". Am I the only one that has seen the eerie similarities between the stock market of the late 90's and the most recent housing market? Does anyone remember the term "irrational exuberance?" and how dangerous it can be to get caught up in market trends?

I didn't think I needed to remind people, but in the late 90's people were so confident they could make quick, easy money in the stock market that they were buying stocks with little to no earnings, little research, and in on or two sectors alone. And, we all know what happened. People paid the price and paid it dearly. In fact, we experienced one of the largest losses in personal wealth in history soon after that.

Isn't this the same as what we have been seeing in the real estate market? How many people do you know that have changed their career to that industry, abandoned prudent investing philosophies to strike it rich in the real estate market, or simply think that making money in real estate is the best and only way? Real estate has an allure, but in fact real estate has not performed as well as stocks over the long-term and there are many risks of which people are either unaware or choose to minimize. Luckily, I am not alone in seeing this trend.

Robert Shiller, a finance and economics professor at Yale, sees the same trends in housing prices (which is no real surprise given the nation-wide softening) and warns that getting rich on real estate is usually overrated. If you recall, Mr. Shiller wrote the book called, you guessed it, "Irrational Exuberance", which forecasted the end of the 90's stock bubble.

In a recent Money Magazine interview, Mr. Shiller points to a few interesting facts: from 1890 to 1990 the return on real estate was just about zero after inflation, since 1986 its been about 6% or 3% after inflation, and that over investing in real estate is a recipe for disaster. At this point he has about 60% of his portfolio in stocks, he is very light on real estate, and continues to have a lot of holdings outside of the United States.

Money Magazine also ran a similar story on real estate versus stocks. They compared performance, costs, diversification, and effort needed to expand as an investor. In their analysis, stocks won. The only place that real estate wins is in the area of leverage. Most people know that it is the power of other peoples money or leverage that makes real estate investing powerful. However, the data suggests that this added leverage is oftentimes consumed by taxes, closing and purchasing costs, maintenance and other associated expenses. In all, people we continue to run after one trend or another. The smartest, however will avoid the hooplah or the "irrational exuberance" in any market. It's your choice.

What is the real risk?

I hear it all the time: investing is risky and it is not a sure thing. I just read a good article by The Motley Fool that discusses how investment volatility is almost always associated with risk. Beta, as one measure of risk. measures how much more a particular investment (namely a stock) deviates from the actual returns or movement of the overall market. While I do not agree with the articles slight suggestion that we throw Beta and other volatility measurements out the window, I would agree that investment volatility and downside risk is NOT the biggest risk we face. The article does a good job of addressing the fact that the biggest risk we face in achieving any financial goal and more specifically or retirement goals is the risk of outliving our assets or drastically undermining our lifestyles due to a loss in purchasing power. As you know the costs of goods and services go up over time - around 4.1% on average per year to be exact. What does that meant to you? Your money must be growing to outpace that average or your purchasing power is losing value. They warn that many people avoid the investment risk associated with volatility and they make the grave mistake of socking away money in investments that are way too conservative like money markets, CDs, and short-term bonds. Don't be fooled and buy into the fear that investment risk is to be avoided at all costs - it is really the risk that you will lose your purchasing power or, worse, outlive your assets, that is the biggest risk of all. Stocks continue to be the best hedge we have against inflation. Almost everyone should have some portion of their assets in stocks to help mitigate inflationary erosion.