Real estate vs. Stocks Smackdown – Why Houses Are A Bad Investment

Every now and again my parents ask me “so, have you thought about buying a house and settling down?”

Every time my answer is the same “it’s not the sort of investment that interests me”. And that’s the polite way of putting it.

Here are the reasons I can’t bring myself to buy a house:

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1) Middlemen trying to scam you. In real estate, everywhere you look there is a middle-man trying to take your money. Attorneys to the left of me, accountants to the right. According to Zillow, the average closing costs are 2% to 5% of the cost of the house. Let’s say you’re going all out and getting a $500k house. That’s up to $25k of your money that’s just disappeared in “fees”. Alternatively, you can log into Interactive Brokers and buy $500k of a real estate investment trust for a commission of just a few bucks.

2) You have to put up a chunk of your own cash as a deposit. If we say 25% for this $500k house, that’s another $125k out of your account. The reason this annoys me is that I’m a strong believer in having your money work for you, not vice versa. This money you just plopped down will be the laziest money you’ve ever invested. It will do absolutely nothing because your house is not a productive asset. Your house is a wasting asset. If you do not continually spend money on your home, it will eventually be worth nothing. If you buy a stock you can hold it your entire lifetime without having to spend another dime on it.

3) You’re going to be spending money on it all the time. Just when you think everything works fine you’ll need to fork out a wad of cash for a new boiler. Then there’ll be a problem with the plumbing. Then the electricity. Then your basement will flood and you’ll realize what crappy insurance you have. Oh yeah, I forgot to mention that you have to pay insurance every month too. More paperwork. Whenever anything goes wrong in my current place, I call the landlord and he fixes it for me. I’m the boss.

4) Poor growth history. Ok, you might say it’s worth paying all these fees because you’re getting a good investment. Wrong. Robert Shiller, a Yale economist and coiner of the phrase “Irrational Exuberance” found that between 1890 and 2004 real house returns were just 0.4% a year. All that money that you could have compounding away in a productive asset (like a company) is doing virtually nothing for you. People who seem to think that real estate is a better investment conveniently tend to focus only on what has happened to house prices during their lifetime. They are confusing their own luck (investing in real estate during the biggest boom in history) with skill.

5) Your house will become an albatross around your neck. A long time ago a friend of mine was living with his girlfriend, when he came to me and said “you know, if we weren’t living together we’d probably have broken up by now”. And he only RENTED. If he had bought a place with his girlfriend there’d be no way to get away from her. What happens if your marriage goes south? What happens if you just fancy going to live in India for a few years? A house is an anchor that is very difficult to pull up if you ever decide you want to set sail.

6) Taxes. Unless you live in a caravan, your house is rooted to the ground. This makes it a very easy thing to tax. If a government changes tax policy on liquid assets, then people can move those assets pretty quickly. If a government changes tax policy on houses, that’s just tough for you. You can’t move a house unless it has wheels. But tax breaks are also one way that real estate closes the gap with stocks. The main tax advantages of real estate (mortgage interest deduction and no federal tax up to $500k on your principal residence) are pretty awesome. But just remember, stocks aren’t taxed every year, houses are.

7) High leverage. Every time I argue with real estate professionals about houses vs stocks, the effect of leverage invariably comes up. Everyone knows that you can get a huge amount of leverage when you buy a house. In fact, because houses are so expensive, you pretty much HAVE to use leverage. If house prices go up, this will benefit you. Real estate evangelists seem to think that this means the returns on homes will always be better than stocks, because stocks are frequently bought without leverage. Well, this argument is idiotic. With houses, you are pretty much forced to use leverage, which has its advantages and disadvantages. With stocks, you can CHOOSE to lever up if you want. Pretty much all brokerage accounts let you lever 2:1 (Reg T), and larger accounts let you use portfolio margining (up to around 7:1, equivalent or better than in real estate).

8) Low Diversification. Most people who own houses have way too much of their net worth invested in a single residence. If anything happens to this investment, they are out of luck. Because houses are so expensive, and pretty much demand leverage, you will find yourself pulling your hair out if it absolutely anything happens to it.

9) Terrible liquidity. A house will probably be the most illiquid thing you will ever buy. Selling it will take time and money, so you’d better be 100 percent sure you are buying the right home. If you mess up, you will have just lost a boatload of money. I like the fact that when I buy a stock, I can sell it a week later. Or a month later, or whenever I want the money back.


As a rule, I like my life to be easy and stress free. All the paperwork, middle-men, obligations, and stress that come from owning real estate is just not my idea of fun. If you invest in real estate, you need to know what you are doing. You need to have trusted partners. You need to do your research. Even then, if you use the same leverage as you would with stocks, you will underperform the stock market. With stocks, information is everywhere. If you want a passive investment… just whack your cash in an S&P500 ETF… and relax.

Girls Just Wanna Have Funds – Why You Should Invest Like A Lady (INFOGRAPHIC)

To the ever-lengthening list of things that women do better than men, it looks like we have to add the art of investing. Men are supremely, but mistakenly, confident of their abilities in the market, and it is this confidence that leads us down the path to ruin. So just relax, get your nails done, have a bubble-bath with a mimosa, and come back to the market when you can think like a woman. And above all – trade less often!

 

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6 Things Options Services Do To Turn You Into A Sucker

Thinking of joining an options advisory service?

Sorry guys. The sad news is that you’d almost certainly be better off just sticking your cash in a bank account.

Take a look at the guy over at Terry’s Tips, who was sued by the Securities and Exchange Commission (SEC), after he allegedly lost between 60% and 100% of his clients’ money. And he’s still in business…

In fact, CNN Money says that you’d be better off just throwing your money in the nearest dumpster than subscribing to investment advisory newsletters. Mark Hulbert of Dow Jones Marketwatch notes that if you had invested $10,000 in a portfolio in 1980 following the advice of the best performing advisory service of the previous year, and then changed it each year to the top service of the previous year, you would have lost pretty much all of your money.

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Here are some of the tricks these guys use to try to turn you into a sucker:

  1. They focus mainly on things which sound positive but generally don’t mean much in options trading, like the win/loss ratio. Who cares? When I was in the graduate training class for the global markets division of a bank, some big-wig came in and asked us all “how often do you need to be right about the market to make money?” The answers we gave generally ranged from 50% of the time or more, but the guy just barked back “No. You only need to be right once”. And he’s right – who cares if you’re profitable on 80% of your trades, if you lose ALL your money on losing 20%? People who sell systems on the internet, that’s who.
  2. They have huge drawdowns but then “learn their lesson”. e.g. 5PercentPerWeek.com lost nearly 95% of its money in just a few days in June of 2011 (and they charge you $239 per month!). Even if you earned 30% per year (considered an EXCEPTIONAL return by absolutely anyone who trades professionally), it would take you nearly 12 years to make back this loss. And just think how much you’d hate yourself for those 12 years knowing what a sucker you were. These services always say they’ve “learned their lesson and changed their approach” after these huge losses… and then a couple of years later the same thing happens. They just lost nearly all your money – anyone who does that should be out of business, end of story.

  3. They hold losing positions indefinitely. Services will frequently “roll out” losing positions until they finally turn around. In the meantime these services give out new recommendations which you can’t act upon because your money is tied up in the losing trade. What’s worse is that they often don’t account for these losses in their monthly returns that they report on their website, because they don’t consider them actual losses until they exit the trade! If a hedge fund guy did this the SEC would ban him from trading and throw him in jail.

  4. They base returns on unrealistic entries and exits, and do not account for commissions. Unless the returns are audited by an accounting firm, there are no checks on the fills obtained by the service. They can pick a day in the past and then they can say they entered on the high or low of the day. What’s worse is that the more people who join the service, the worse the fills you are going to get – Take a look at the option chains for the RUT. You can see the herds of people rushing in and out of positions recommended by these services on the daily volume or open interest metrics. If you get caught in a fast market and need to exit a position quickly, good luck! Hundreds of other subscribers with the same positions need to exit too. And what about commissions? If you have a small account with a broker like OptionsXpress, then you are going to have a big chunk of you money disappearing in commissions (part of the reason I recommend Interactive Brokers and Options House), especially if the services insist on trading a lot.

  5. They assume you can invest 100% of your money in their winning trades. If you’ve ever traded Iron Condors before, you’ve probably learnt that you need to keep the majority of your account in cash for adjustments. That’s not the way the services work though – they’ll calculate their returns based on full investment of the account. If you try and do the same, you will get screwed when it comes to adjusting

  6. And worst of all, they back-test results. This is the most brazen way option services can convince you to join their sites. They simply find a “rule” that has worked in the past, and then post that they’ve made money every year with this rule. It looks great, but how many actual, real dollars have they made? None.

Unfortunately there will always be people peddling these services for as long as there are people willing to pay for them. I’m sure there are people out there who can beat the market, but those people generally aren’t running investment advisory newsletters – they’re running their own funds. Don’t be a sucker.

As always, remember the informal motto of Wall Street – CAVEAT EMPTOR (buyer beware!).