A similar folly can be seen with the way some people view real estate, which has many investment subcategories. Studies have shown that while residential realty values are immediately sensitive to interest rates and to recessions and booms, commercial real estate is less sensitive because of long-term leases. Experts agree, though, because of statistical studies, that real estate should be in nearly everyone’s portfolio because value changes are not perfectly in sync with either growth stocks or several bond categories. It helps with diversification and will be recommended by the models I urge you to use. Fortunately for small but growing investors, real estate can be purchased in the form of mutual funds, albeit less liquid funds than stock or bond funds. Many people manage their own real estate physically. Managing one’s own real estate is extremely demanding and has risks, from potentially violent tenants to zoning changes.
The irritations, collection duties, maintenance, excuses about who broke what, potential lawsuits … endless. Own investment real estate through composite investments, such as mutual funds and exchange-traded REITs, and maybe as a way to cut college expenses for a child. If you must hold realty in kind, let a qualified property manager handle it.
Real Estate Investment Trusts (REITs), for “qualifying investors” (those with portfolios well over $100,000 and no reliance for income on the amount invested), are touted as more direct investing than mutual fund versions and, as such, provide a better likelihood of a strong return. History does bear this out. However, I caution against REITs altogether for several reasons.
First, one purchases discrete units of a REIT for prescribed amounts. Hence, there is no way for the market to directly determine a price. Traditionally, this lack of transparent or market pricing caused brokerages to show the investment at the purchase price for its entire period of ownership. The result was that clients falsely assumed it at least had the value they originally paid. In recent years, independent appraisals have been required annually in order to show the value more accurately; there was a shock for owners! Eventually, “exchange-traded” REITs were devised and marketed, and some of the private units were converted for public trading and more accurate valuation. But the biggest heartburn I have with these is in how they are described to buyers, the “distribution rate” versus “rate of return.”
A close cousin of the REIT is the limited partnership, with similar tax advantages; superior for the oil and gas equipment leasing versions. But all such products have one tax problem in common. They do have nice tax benefits, but these all are subject to recapture if you stop using them and roll them into like-kind exchange arrangements. You avoid liabilities for the venture, being a “limited partner,” but the biggest detriment is lack of transparency, which annual appraisals do not solve—especially at first sale.
Timeshares
The sales pitch makes sense, it’s affordable, and even inflation in the non-guaranteed association management fees looks fine. And the comparison between expensive trips and hotels against timeshare use all works out perfectly. Except that the assumptions are all wrong, and you have no idea whether this purchase is priced to “market” the way normal real estate and leasing is. Hmm … same problem as new-issue REITs. In fact, there is a competitive market for timeshares! And it is online and has dramatically better deals! If you want a timeshare, especially because you love the area and the ability to trade or lease out, then get these used. It makes sense to enjoy your investment before passing it on or liquidating it. But go to the Internet and find bargains; they’re all from people who lost money and overpaid buying it new.
Penny Stocks, Derivatives, Precious Metals, Day Trading, Short Selling, and Options Trading
So you’re all excited about that “Trading Academy” that offers discounted software, custodial services, and ongoing mentorship. Wow, and one of its graduates even teaches now! Here’s my question. If he’s teaching, and not spending all his time trading, which makes him more money: new tuition or trading profits? Is gold guaranteed, or do you detect hype about fears that the US dollar is about to collapse? ’Nuff said. Let the pros do what the pros do. You focus on composite investments like managed accounts, mutual funds, exchange-traded funds, annuities, and other well-regulated and fair-market-valued assets in your portfolios.
Margin
You get to buy extra stock with money borrowed from your brokerage; up to half the value of your own assets in the account. There are pros and cons here. Sure, you buy securities with other people’s money and so it appears that you do not risk your own; the cost is just the interest paid until you make enough gain to sell and pay off the lower debt than the net proceeds of your leveraged stock purchase. But it is not really true that you don’t risk your own assets: there is a lien on your entire account for the loan, and that loan will be called if you are late in paying it off or—gasp!—the market corrects. Then, you cannot control the sale of your other assets if they are needed to meet the margin call. All the while, interest accrues and you must clear both that interest and the buy and the sell commissions, just to break even. Sounds closer to lottery tickets than prudent investing. Likewise, borrowing against any other asset, such as your home, in order to invest is dubious to say the least.
Reverse Dollar Cost Averaging
The effect of seeking extra aggressiveness with new savings (small amounts, compared to your existing large lumps that need diversification to help protect them) is this: You buy more shares whenever prices decline and fewer when prices rise, resulting in a low average price. That helps when you’re investing. But while you are liquidating a fund, as with paying for college or drawing income, the reverse occurs. This is the main reason why, as you take income or money out of funds that can vary in value, your asset allocation needs revision to enhance protection of that nest egg. You don’t want to sell out cheap—maybe even sell out substantially after a market decline—then move back into the market once it proved it could rise in price.
Confidence and Attitude
Avoid checking balances frequently; you’ll only torture yourself. Avoid watching too many sensational commercials (buy gold, the sky is falling; buy silver, the upside is unprecedented!). Likewise, don’t torture yourself by reading too-gloomy or too-exuberant financial articles. I have observed and read about aging investors who do not realize that their judgment and perspective is slipping; they panic or wring their hands, just on the edge.
Avoid the assumption that “what goes down must come back soon” because many recessions deepen and persist, and so do the fortunes of individual companies, even in a boom. Fear a bust? Well, never sell out more than a third when you have real evidence that there is a significant chance of loss (that research department again is your best, but still imperfect, crystal ball). Wait a few months and sell out a third of the remainder if you continue to see evidence of more downside risk. This is really the best one can do without being able to truly predict the future. Do the same on the way up, avoiding the temptation to “call the bottom.” Avoid the panic sell-out and avoid the greedy grab.
This excerpt is taken from “The Secrets of Successful Financial Planning: Inside Tips From an Expert,” by Dan Gallagher.
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