Challenging Conventional Wisdom on Your House as an Investment

Every now and then I will have a client tell me how their home has been their best investment (well, not as much recently!).  We have data we can review to see how this has really been a myth in most cases.  Below is a chart compiled by the Yale Professor Robert Shiller on home prices:

In computing the figures here are some of the details:
Nominal return of home prices (1890-2012):  3.00%
Inflation (CPI- 1890-2012):  2.83%
Real Return of home prices:  0.17%

Because housing tends to be the largest purchase an individual will ever make, most tend to look at the dollars and not the returns.  For example, let’s use a recent conversation I had with a client.  This client purchased a home in 1980 for $150,000 and it is currently worth $500,000.  On paper, this looks like a great investment…a $350,000 gain!  When we dig into the numbers, here is what everyone misses:  there are substantial carrying costs with a home that are often overlooked (real estate taxes, maintenance, repairs, closing costs, insurance, etc).  Second, when you calculate the returns (even without those costs) it comes out to 3.83% per year.  As a comparison, over that same period, the S&P 500 averaged 11.2% per year.  Had the $150,000 been invested into the stock market it would be worth over $4.4 million. 

I am not saying that homes should not be purchased, but that you should be leery of conventional wisdom that says your personal residence(s) will be good investments over time.  The data just does not support that argument. 

Does Active Management Work Better In Inefficient Markets?

A commonly held belief in the investment world is that active management works better in inefficient markets where there is less information available (e.g. small cap, international, emerging markets, etc.).  The theory usually suggests that this market inefficiency creates opportunities for managers, through superior security selection, to achieve outperformance.

First, we know of no statistical or empirical data that supports this commonly held belief.  Here is a discussion with Kenneth French (economics professor at Dartmouth) where he discusses this very topic.

In addition, if this argument were true, you would expect to see Small Cap, International and Emerging Market managers outperform their benchmark indices due to the perceived inefficiencies in these markets.  Here is the actual data from the Mid-Year 2012 S&P Indices Versus Active Funds Scorecard (SPIVA):






Interestingly, the best performing asset class against its benchmark index was large cap US stocks.  Since most would consider this to be the most efficient asset class of the four, the argument that active management is desirable within inefficient markets is not supported by the data.


Challenging Conventional Wisdom on the Federal Debt

The conventional wisdom says that our current deficit is out of control and is leading to all sorts of economic problems.  When we look at the data, this is hardly true.  Interest payments on debt as a percentage of GDP is less than 1.5%, which is some of the lowest levels since the 1970s:

FRED Graph


 This is because of ultra low interest rates and the shrinking of the deficit we’ve seen over the past several years.  Now, this doesn’t mean things are all clear ahead.  Rising interest rates could reverse this pattern quickly which is why this is still something the country needs to deal with over the comings years, but the idea that our debt and deficit has created a crisis is just untrue.  As investors it is important for us to make decisions based on facts, not talking points we may hear on TV which is promoting someone’s agenda.  

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.