March 29, 2020

Sketch Guy: Some Investing Stories Sound Good Until You Analyze Them

Making smart money decisions is an incredibly difficult way to behave. So after my post last week about buying a house based on your situation, my jaw dropped when I saw an article in The Wall Street Journal about young home buyers.

“A new generation is skipping the ‘starter home’ and betting heavily on high-end real estate.”

Seriously? We’re back to “betting” on real estate?

Now, the stories are incredibly persuasive, but hidden within them is something else. When asked why they are buying an expensive home, or even buying multiple expensive homes to rent, young buyers say they are doing it as an investment strategy.

“Buying real estate has grown more attractive, these young buyers say, compared with the stock market, which appears riskier to a generation that entered the work force during a market correction,” the article in The Journal says.

This reminds me a lot of what I have referred to before as “that guy.” It’s the guy at a neighborhood barbecue or in the office who always has a story to share about how easy it is for him to make money. The problem is he only talks about the times he made money, not the times he didn’t.

The stories of these young real estate buyers, like Matt Winter, follow a similar theme.

“ ’I have always felt that having your money in property is the safest and best thing to do if you want to grow your personal wealth,’ says Mr. Winter, who founded his design company at 23. None of Mr. Winter’s assets are in the stock market — he says the market ‘spooks him’ and that he prefers to invest in real estate,” the Journal article reads.

Stop and think about this for a minute. Mr. Winter is now all of 28, and the story he is telling is that property is the safest place to increase your wealth. But I suspect that if you ask anyone dealing with real estate in the last 10 years (or who is over 40), they would disagree with the idea of it being safe. So why is our attention caught even though our experience tells us something different?

When we hear stories like this one, about young, beautiful people spending a lot of money, it’s easy to go with the assumption that they must be making smart decisions, too. After all, who doesn’t want to buy a house on the beach? And in our desire to be like what we see in those glossy beauty shots, we ask the question, “Shouldn’t I be doing that, too?”

We remind our children all the time, “If your friend jumped off a cliff, would you?” And yet when we ask that question, we are engaging in similar herd behavior. We need to recognize that we aren’t those people, and whether they are making a good decision isn’t the point. All that matters is whether it is actually a good decision for us, and these stories can make it difficult to reach this conclusion.

So lest you think I’m picking on these people only because they are young, beautiful and wealthy, let’s take a look at what are some flat-out questionable arguments.

Buying real estate is a safe way to build wealth. Because most people don’t hand over a sweaty wad of cash, real estate usually involves leverage in the way of a mortgage. While leverage can be good, it’s a double-edged sword. There are certainly home buyers in Phoenix and Las Vegas who would argue with the idea that property is the safest investment.

You will get hurt in the stock market. I get why real estate looks so attractive, especially to younger buyers. As the article noted, it is hard to trust the stock market if what you have seen to date hasn’t been wonderful. But it takes a willingness to ignore history to go with the story that real estate represents a sure thing in comparison to the stock market.

It makes sense to buy a second property as an investment. If you’re thinking about becoming a landlord, think again. Barry Ritholtz captured the problem with the rental market perfectly: There are a lot of rental properties just sitting on the market. And with a lot of people playing the rental and investment game at the moment, can you afford to have your investment property sitting empty? Don’t assume that a home you have bought to rent will actually generate rent every month to justify the purchase.

Buying real estate may turn out to be a great decision for the people profiled in The Wall Street Journal. But the notion of real estate as being somehow a better or safer investment than the stock market doesn’t add up based on what we know.

We know that the weighty evidence of history tells us that having a low-cost, well-diversified portfolio has been the better investment in the long run. We know that we probably don’t want to become landlords, either. And most important of all, we know what matters most when it comes to investing success: behavior.

So the next time you see stories like this one, keep in mind that you know better. You know what questions you need to ask before buying a house. You know what kind of investments you need to reach the goals that matter to you. And you know that what might work well for someone else isn’t guaranteed to work for you.

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