My theme this week has been to demonstrate, by fact and anecdote, that most people are emotional. But they can’t help it. Human nature’s a tough gig.
Rational people would buy things when they’re cheap and affordable. They’d sell them when they became valuable. They’d understand it’s not assets which make you wealthy and finance your life. It’s money.
Most people avoid things that decline in price. They covet stuff which becomes inflated. They value what others value, especially when it’s overvalued. They hoard assets, often illiquid, and think it’s wealth.
Real estate’s been the example du jour. It’s so perfect. Millions of us now live in houses we cannot afford, having used debt to create the illusion of equity. It’s always a chuckle when media flips refer to people who live in homes worth a million or more as ‘millionaires.’ Half the houses in Vancouver now have valuations of at least seven figures, yet the average income is less than $85,000.
Of course, when house prices rise people want real estate. When it falls, demand slacks. The same holds true of gold or stocks. Most people simply can’t help themselves. They buy high and sell low. They gamble, and call it investing. It’s why 2008 destroyed so much wealth – millions bailed out of their funds at the bottom, instead of buying more. Today stock markets have risen 150% in four years, which has made some people nuts all over again.
So far in 2013, for example, the Dow Jones Industrial Index has added 20%, while the S&P 500 is ahead 19.8%. These are ridiculous numbers, reflecting not just corporate profitability and economic revival, but speculation and misadventure. And what do people do? They pile in.
More money went into equity funds in the States this week than at any time since 2008. The avalanche of cash equalled $19.7 billion coursing into stocks, while almost three billion came out of bonds. Comments this past week from the US central bank that it will not be zealous about jumping rates or trimming stimulus spending just added more fuel to the fires of avarice. As with million-dollar bungalows in Vancouver or Toronto, risk grows when equity markets reach daily for new highs.
Thus, sane people would be harvesting gains or spreading risk by diversifying into other assets – like fixed income or cash. But sanity’s in thin supply. Instead, investors flee when asset values fall, and this pathetic blog’s comment section fills with people who come here to say we’re all gonna die.
This is called recency. Another reason humans suck at investing. We believe what happened most recently will happen forever. Rising markets will swell without end (Calgary real estate in 2013). Falling markets will decline to zero (bank stocks in 2009). Recency leads doomers to say every negative current event (the bankruptcy of Detroit) defines the future. Recency makes people whose ETFs jumped 15% totally unable to sell a portion and realize their capital gain.
So be careful. This blog has argued with breathtaking boredom that residential real estate in most of the country is inflated and dangerous. Prices will correct. Those who use extreme leverage to get a house (less than 10% down), and those with the bulk of their net worth in property (hello, wrinklies) are considerably at risk. Residential real estate could be lights-out for a long time.
By the same token, equity markets – at least those in the US (and much of Europe and Asia) – are probably flying too close to the sun. My faith in the American resurgence is undiminished, but when almost $20,000,000,000 flows into stocks in a single week in one country, it’s probably time to sneak out back for a smoke.
The best approach is balance. You need a place to live. You need your savings safe. You need them to grow. And you need income for life. A house is not a financial strategy, any more than is an RRSP full of funds or a bevy of bonds.
Thus, my rule of 90. Deduct your age to determine the right portion of your net worth in a house. The remainder should be liquid, and diversified.
And don’t wait long.
About the photo: The best relief John Unger could find for severely arthritic, 19-year-old Schoep was to take him into Lake Superior, where the water’s buoyancy would allow the dog to sleep in his arms, free of pain. Schoep died this week.