Thursday, April 8, 2010

Is this the right time to buy?

How many times do I hear this question and throw up my hands in desperation. Market Timers! Speculators! Some make money, most lose it. To pick a market top or a bottom is nearly impossible and to do it consistently is even more difficult.

It doesn’t matter whether you invest in the stock market or in real estate. Market timing is a money losing game. Even if you time the market perfectly and you pick the bottom, next thing you know is that you picked the wrong stock or in your excitement of having picked a bottom dead on, you paid too much for the property because you were afraid of losing out. Statistics have shown over and over again that very few people call a market top or bottom correctly. If people like Warren Buffett, John Templeton or Peter Lynch don’t bother because they know they can’t then why do so many less skilled investors try to time their investments?

Really, how many gurus have consistently forecast market tops and bottoms? None, except for liars! Guess what successful investors don’t even bother. What they are concerned about is buying an investment at the right price! Here is why.

According to Jeremy Siegel’s data in his 2005 book: The Future for Investors, inflation for the last 200 years or so averaged in the U.S. 4.2%. The Bank of Canada states that the average inflation rate in Canada for over the last 40 years was 4.6%. So what does that tell you? Yes! Over the long term prices do not go down but up!

For those who missed this cute statistic:

Ever heard about GDP or Gross Domestic Product? Every month, every quarter, every year, we measure the GROWTH in GDP. Sometimes GDP declines (in recessions and depressions) mostly it goes up. If the economy grows over time, typically as measured in terms of GDP, then corporate profits increase accordingly. So why would the stock market then decline over the long term? Or why would housing values fall over the long term?

Housing and stocks are known to be protectors against inflation and of course their value increases with overall economic growth. Housing typically goes up in value when employment rises, when wages increase and... when the population increases. There are very few countries in the world, if not none, where there is no inflation, where there is no economic growth and where the economy does not grow over the long haul.

Investors, buyers of stocks or of real estate and numerous others may get caught up in euphoria and overpay for products or investments. But when matters get too out-of-whack or too disconnected with economic reality and/or demographics, we get corrections, recessions and sometimes even depressions. Over the long term, however, everything goes up.

Somewhere in the next 50 years or so, growth of world population may cease. Many countries have policies in place to rein in population growth and immigration because they fear that the economy cannot sustain a good quality of life for so many people. There is truth in that. Look at developing countries such as Egypt where economic growth fell behind population growth and the misery that can bring. Yet, in history overall, large increases in world population coincides with an increase of innovations.

Basically, the idea is that population growth may require lifestyle adjustments forcing, e.g. new sources of energy. For example, coal in the Renaissance and Industrial Revolution became a major environmental disaster – remember the smog and acid rains in an over-populated London during the adventures of Sherlock Holmes? It was soon replaced by electricity, oil and gas which with a growing population were more sustainable forms of energy. Fears of Climate Change, wrong or right, pollution concerns, oil tankers broken up during major marine disasters, the disappearance of cheap oil and gas are cause for the current revolution in energy technologies. Population increases force often big innovations. Not only that, the number of geniuses will increase along with the growth in population and that leads to ever more new discoveries.

Innovation and its relative ‘creative destruction’ create economic growth, and even if the world population growth momentarily comes to a halt, I am sure, innovation and discovery will continue to increase our productivity and thus our economic growth for eons to come. Who knows what will happen, what the consequence would be of the discovery of interstellar travel. In my mind, we, mankind, and our economy will forever grow!

This growth will not be homogeneous. There will be ups and downs around our average growth. But unless we create a true ‘End of the World’ disaster, mankind will prosper. So whether it is real estate or stocks or bonds or investments in general, the overall long term picture will be the one shown below. Stop whining and be happy! Let economists and other ‘chickenlittles’ worry, they seem to like it. We are more humble and only have the dream of becoming rich.

So now, that we are all believers in long term economic growth and the idea that we have economic ups and downs lining this overall growth pattern it should be easy to grasp why market timing does not work! Look at the graph; let it become part of your subconscious sense of reality. For this you don’t even need a law of attraction, it is so basic! Jeremy Siegel came up with an inflation corrected average stock market return based on data from the last 200 years of 6.5 to 7%! If you look backwards to the Great Depression and beyond, does the stock market graph not look exactly like the picture above?

So, say you bought a stock during the downturn labelled ‘Red A’ on the graph and you didn’t sell at the high ‘Blue A’. Your profits were cut in half if not more during downturn ‘Red B’. But guess what, if you wanted to buy more of that stock during down turn ‘Red B’ at the same price as at the low of down turn ‘Red A’, you may have to wait a long time if not forever because the average stock is typically not to go that low again!

So you bought on market high ‘Blue A’ and you kept your stocks or property during Red B. Guess what, by the time you are at the next market high ‘Blue B’ you are profitable again. And if you waited even longer and experienced downturns ‘Red C’ and ‘D’ you would despite market setbacks still be profitable. Now add a bit of dividends or when dealing with real estate add your mortgage pay-down and positive cash flow! You see the beauty of this scheme?

Only if you panic during down turns or if you are forced to sell because you were over-leveraged or plain out of cash, then you would have suffered losses. These are some quotes from Peter Lynch, world renowned stock market investor:

The only thing I know about predicting markets is that every time I get promoted, the market goes down. Obviously you don’t have to be able to predict the stock market to make money in stocks, or else I wouldn’t have made any money. I’ve sat right here at my Quotron through some of the most terrible drops, and I couldn’t have figured out the drop beforehand if my life depended on it. In the middle of 1987 I didn’t warn anybody, and least of all myself, about the imminent 1000-point decline”

“I wasn’t the only one who failed to issue a warning. In fact, if ignorance loves company, then I was very comfortably surrounded by a large and impressive mob of seers, prognosticators, and other experts who failed to see it too. “If you must forecast,” an intelligent forecaster once said, “then forecast often”.”

So how do you invest? Quite simple, you buy when the PRICE is right not when the price is perfect! Make estimates of income streams, cash flow, profits. Look at how much you have to pay for said profits and how that price compares with other investments. For example, company ‘A’ earns 1 dollar per share which can be bought for $10. In the same industry, you can buy $1 earnings from another company for $100 per share. What is the better deal? If interest rates are 5%, you earn 50 cents for every $10 invested. How does that compare to shares of company ‘A’? In real estate you can make $1 profit for every $7 dollars invested. So which is the better investmen real estate or company 'A't? What is a good price?

Of course, you want to incorporate other factors than just return on investment in your decision. In particular, determine how risky an investment is. Being able to determine risk is why it is so important to compare apples with apples and not with oranges. That is why it is so important to understand an investment thoroughly! If you don’t, then do just like Warren Buffett, walk away.


  1. Buying a home in today's market can be complex and confusing. Although it seems as though some rates are low, there are some differences criticism of the existing market that would be understandable if you're thinking of buying a home in the near future. This difference is the difference between the cost of the house and the actual cost of purchasing a home. Although these may seem the same, they are very different and it is important to understand that difference and the long-term cost of the loan could be the economic situation.

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  2. Appraisers use apply 3 methods of appraising properties using the ‘best use’ value as the final price .
    1: Replacement costs of building a property of equal utility or replacement cost of exact copy (for historical buildings).
    2: Recent sale prices of comparable properties in the community adjusted for features in which the comparables deviate from the subject property. 3: Income generated by the (investment) property.
    You can see that the value depends on what the property is most likely going to be used for. An inner-city property, based on market comparison may go for a much higher price than a similar one in the suburb. Based on rental income the value of both properties may be very similar. However, the final price of the inner-city property, as determined by the actual sale, is likely higher than the one in suburb because its 'best use' is trendy homeownership by a professional couple working downtown rather than rental income.