Investment Losses

Jennet asked:


If you’ve found your way here to this article, chances are you’ve either got some money socked away or you’re planning to do so.

 

But first things first. Why is investing a smart idea?

 

Simply put, you want to invest in order to create wealth. It’s relatively painless, and the rewards are plentiful. By investing in the stock market, you’ll have a lot more money for things like retirement, education, recreation — or you could pass on your riches to the next generation so that you become your family’s Most Cherished Ancestor. Whether you’re starting from scratch or have a few thousand dollars saved, Investing Basics will help get you going on the road to financial (and Foolish!) well-being.

 

Know your goals

 

What are you saving for? Retirement? College for the kids? A new speaker system complete with woofers and tweeters? An exotic animal menagerie complete with Chihuahuas (woofers) and canaries (tweeters)? A retirement villa in the sun-baked hills of Tuscany?

 

Say you take $2,000 of your savings and put it into the stock market. If your money returned 10% a year (the S&P 500’s historical average), two grand would be worth $34,898.80 after 30 years. That might not get you the perfect retirement home, but it’ll at least give you a down payment.

 

Maybe you don’t have $2,000 burning a hole in your bank account, but perhaps you can afford to invest your lunch money. Brown-bag your lunch and sock away just $4 a day, 250 days a year. It’s not a lot, but if you’re in your early 20s, you’ve got the investor’s best ally on your side — time. If you invest $1,000 once a year in an investment that averages a 10% annual return — the average annual stock market return since 1926 — it’ll grow to more than $1 million after 46 years, which is right around the time you’ll be ready to retire.

 

Of course, as you get older and more financially stable, you should be able to put away more to invest. Upping the ante to just $166 a month — which is probably less than lunch money plus what you pay for cable TV — would put you at the million-dollar mark in just 39 years.

 

The power of compounding

 

The table below shows you how a single investment of $100 will grow at various rates of return. Five percent is about what you might get from a certificate of deposit (CD) or with a government bond over time, 10% is about the historical average stock market return, and 15% is what you might get if you decide to learn how to pick your own stocks and take advantage of some of our lessons in advanced investing techniques.

 

Growing At

Year    5%    10%    15%    20%       

1    $100    $100    $100    $100       

5    $128    $161    $201    $249       

10    $163    $259    $405    $619       

15    $208    $418    $814    $1,541       

25    $339    $1,083    $3,292    $9,540

 

Why is the difference between a few percentage points of return so massive after long periods of time? You are witnessing the miracle of compounding. When your investment gains (returns) begin to earn money, and then those returns start to earn money, your investment can mushroom very quickly. Extend the time period or raise the rate of return, and your results increase exponentially. For instance, if you start young, say at 15 years of age, note how quickly a single $100 investment grows, especially in the later years.

 

Growing At

Age    5%    10%    15%    20%       

15    $100    $100    $100    $100       

20    $128    $161    $201    $249       

25    $163    $259    $405    $619       

30    $208    $418    $814    $1,541       

40    $339    $1,083    $3,292    $9,540       

50    $552    $2,810    $13,318    $59,067       

60    $899    $7,298    $53,877    $365,726       

65    $1,147    $11,739    $108,366    $910,044

 

Looking at it another way, let’s compare two teenagers and their lifetime savings habits. Bianca baby-sits a lot and spends most of her spare time reading. She saves $1,000 a year starting when she’s 15 and invests it in the stock market for 10 years earning 12% per year on average. After 10 years, she comes out of her shell, stops adding money to her nest egg, and spends every penny she earns club hopping and on trips to Cancun. But she keeps her nest egg in the market.

 

Compare her account to that of her friend Patrice, who squandered her early paychecks on youthful indiscretions. At age 40 Patrice gets a wake-up call when her parents retire on nothing but Social Security. She starts vigorously socking away $10,000 every year for the next 25 years. Guess who has more at age 65? That’s right, Bianca. (You figured it was a setup, didn’t you?) Her 10 years of saving $1,000 per year (just $10,000 total — the same amount Patrice put away in just one year) netted her $1.8 million by age 65. Patrice, on the other hand, scrimped for 25 years to invest a quarter million dollars out of her own pocket and ended up with just under $1.5 million. Neither will be going to the poorhouse, but you see our point: Bianca’s baby-sitting money grew for 50 years, twice as long as Patrice’s, and Bianca barely missed it.

 

(It’s almost not fair to mention this, but if Bianca put her money in a Roth IRA, that whole $1.8 million would be tax-free. On the other hand, Patrice couldn’t put her full $10,000 in a Roth, so Patrice will pay capital gains tax on a good deal of her gains.)

The power of compounding is the single most important reason for you to start investing right now. Every day you are invested is a day that your money is working for you, helping to ensure a financially secure and stable future.

 

Common pitfalls to avoid

 

Before you race off through the rest of Investing Basics, there are some cautionary points to consider before you proceed. These are common mistakes many people make when considering what to do about investing.

 

1.    Doing nothing. There is no guarantee that the market will go up the first day, month, or even year that you invest in it. But there is one guarantee: Doing nothing at all will not provide for a comfortable retirement.

2.    Starting late. Postponing your investing career is second only to not investing at all on the list of investment sins. You already know that the earlier you start the better off you are. (Take another look at the compound return example we gave above.) If you’re already past those formative twenties (you don’t look a day over 32 to us), we’ll reword this first pitfall to read: “Not starting now.”

3.    Investing before paying down credit card debt. If you have money in your savings account and you have revolving debt on your credit card, pay it off. Many credit cards have an annual interest rate of 15% or more. Let’s say you have $5,000 to invest, but you also have $5,000 debt on your credit cards with an average annual interest rate of 18%. It doesn’t take an astrophysicist to figure out that you’re going to have to get an 18% return after you pay taxes just to break even on that $5,000. Pay the debt off first, then think about investing.

4.    Investing for the short term. Only invest money for the short term that you’re actually going to need in the short term. Invest money in the stock market that you won’t need for at least three years, and preferably five years or longer. If you’ll need your cash next year for a down payment on a house or for the family Caribbean cruise, use one of the shorter term and safer havens for your cash, such as money market funds or CDs.

5.    Turning down free money. You’d never turn down a dollar if it was offered with no strings attached. That’s what you’re doing if your company offers a 401(k) or similar retirement savings plan with an employer match and you’re not participating. Take advantage of all tax-advantaged, employer-matched savings programs.

6.    Playing it safe. If you’re young, most of your investing dollars should be in the stock market. You have enough time to weather any dips in the market and to reap the rewards of long-term gains. Although you may want to transition into bonds later in life as you depend on your investments for income, stocks should make up a large portion of the portfolio of every investor.

7.    Playing it scary. Not every investment is for everyone. Even if you’re a daredevil, you shouldn’t pour all of your money into something that could end up going down the drain.

8.    Viewing collectibles or lottery tickets as investments. If old comic books, Barbie dolls, and abandoned exercise equipment could be used to fund retirements, do you think the stock market would exist? Probably not. Don’t make the mistake of thinking your jewelry, those Beanie Babies, or the lottery will provide for you in your latter years.

9.    Trading in and out of the market. We believe the best approach to investing is the long-term one. Pick your investments well and you’ll reap greater rewards over the long term than you had ever dreamed possible. Trade in and out of the market and you’ll be saddled with fees that chip away at your returns, and you’ll potentially miss out on gains that long-term investors enjoy with much less effort.

 

Congratulations mate! You’ve made it through the first part of Investing Basics. (Bet you didn’t even break a sweat.) You’ve witnessed the power of compounding and you understand how some common pitfalls can ruin even the healthiest investing plan.

 

______________________________

 

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WILEY

satelite bomb asked:


Things did not go quite as planned. You invested $30,000. Part of it in a stock that paid 12% annual interest. However, the rest of the money suffered a 6% loss. If the total annual income from both investments was $1890, how much was invested at each rate?

MERRILL

tiju_9845862621 asked:


I am in India but I dnot like to join investments or fund in India that always loss points or less gain points .. What is BSE and NSE ? First time I learns about Investment but I have not yet join investment .. I think NYSE is best investment which can help me more return earn for few days or months . I check NYSE website but i have difficutl how to put in amount to International companies before i only investing amount $ 100 for them . But i have not credit card . Please explain me .

GUADALUPE

Satya Iluri asked:


By understanding the performance of socially responsible stocks, individual socially responsible stock, the socially responsible investor can gain the profits of socially mindful investing, either through individually socially responsible investments, or by engaging with socially responsible investment funds and socially responsible funds. In addition, the article also confers the sustainable investing approach in investing with ethics, green investing, values investing, and socially responsible investments.

Although socially responsible investing has expanded dominance in the last numerous decades, countless socially responsible investors are still under the feeling that to invest in social good, they must decline certain levels of portfolio performance. However, with the confirmation escalating that socially responsible investment funds strictly match, if not surpass, their market counterparts, many socially responsible investors are capitalizing their earnings – and their involvement to social good.

Long-term vs. short-term corporate focus

Socially responsible investing (SRI) takes the long term vs. short term investment discussion to a socially alert investing level. In comparison to countless corporations who take advantage of natural assets and human labor for short-term profits, a socially responsible stock drives under long-term natural sustainability, lending itself well to green investing. For example, the oil magnates such as Exxon-Mobile and Chevron have experienced exponential expansion in the last numerous years. However, where will these corporations be in 10 or 20 years – when the oil rigs are pumped dry and clients have switched over to hydrogen-fuel cars? In stark contrast, green investing stress the long-term sustainability of corporate social responsibility on the environment, society, and monetary well-being.

 

Overarching SRI principles

The extensive investment ideology of socially responsible investing are conceptualized based upon unstable techniques of social investing analysis. The execution of social investing in Europe is usually diverse than in the United States, but the underlying essentials are based upon using a set of foundation values. Depending upon the socially responsible investments portfolio or socially responsible funds, the SRI analysis may be based on one or several of the following criteria:

1. Sustainability Practices : This socially conscious investing perspective analyzes whether a company’s business practices are sustainable in the long term. If the business operations negatively impact the environment, economy, communities, or human welfare, then it is not considered sustainable investing for long term profitability.

2. Corporate Governance : This socially responsible investing component analyzes the company’s policies on employee, community, investors, stakeholder, and environment relations. Social investment’s mutual authority analysis is a separate process from the company’s financial outlook.

3. Religious Beliefs : Considered the original father of socially conscious investing, religious beliefs have screened many portfolios. For example, a Catholic screened socially responsible investing portfolio may divest companies that produce contraceptives. Both Christian and Muslim screened socially liable funds are prevalent, imparting strong religious beliefs onto the social investing analysis of opportunities.

4. Public Policy : Geared for socially responsible stock portfolios that include international holdings, the public policy filter analyzes foreign governments’ actions, either on an individual country case-by-case basis, or based upon an international mandate, such as a ban by the UN or NATO.

Socially responsible investment funds’ performance

Beyond the desire to contribute to social good, socially responsible investors are seeking SRI investment performance. Values investing demonstrate that socially conscious investing can be done quite profitably. In fact, in some market conditions, socially responsible funds outperform their market counterparts.

The Domini 400 Social Index (DS 400), the socially responsible investing industry benchmark, has outperformed the S&P 500 since its inception in 1990. According to KLD Indexes, as of November 30, 2007, the DS 400 has enjoyed 11.75% annualized returns, leading ahead of the S&P 500’s 11.21%. The DS 400 screens its index for socially responsible stocks based upon environmental, governance, and social filters, and within its index, there are 250 S&P 500 represented companies, 100 companies not on the S&P 500, and another 50 socially responsible stocks that have demonstrated significant strength in social investing filters.

With the sustained long-term SRI investment returns in the socially responsible investment funds, such as the DS 400, socially conscious investing can match or outperform its market counterparts – dispelling the myth that a socially responsible investor must sacrifice performance for social consciousness.

 

The risk exposure of socially responsible stocks

However, when comparing SRI indexes against market benchmarks, the question begets: does the performance of socially responsible investment funds come at a higher portfolio risk than its market counterparts?

Considering the rigorous screens of socially responsible investing portfolios, the socially responsible stocks are naturally geared towards companies with smaller market caps. Theoretically, the lower market caps contribute to a higher volatility and beta for the overall socially conscious investing portfolio. For example, the Domini 400 has a weighted average market cap of 83% of the S&P 500.

Beta Coefficient: measurement of an investment’s volatility against the market

However, instead of reducing the overall beta, the socially responsible investments screens minimize the individualized corporate risk. By evaluating a socially responsible stock based upon its governance, sustainability and relationship with stakeholders, social screens reduce the economic risk of the individual corporate holding. For example, by not choosing to invest in tobacco, socially responsible investors shield their portfolios from the negative performance factors of lawsuits. Or, by selecting companies that have good relations with their employees, the negative financial reprimands of strikes are curtailed from the socially responsible investment portfolio.

Risk and volatility are not necessarily synonymous in the world of financial portfolios. Whereas beta may be a good indicator to evaluate the short-term probability that a negative event may occur, this does not specifically analyze the individualized corporate risks. Though socially conscious investing portfolios may have higher betas, the risk of the socially responsible stocks in the portfolios experiencing financial degradation is more limited than the market benchmarks.

Alpha: risk-adjusted measurement of an investment’s excess return over “risk-free” instruments

One of the most compelling factors of socially conscious investing is that despite its demonstrated increased returns, the risk does not necessarily increase. Social investing may be one of the few exceptions to the risk-to-reward ratio. In fact, the performance of the socially responsible funds may not be fully indicative of its true earnings, once the lowered individualized corporate risk is weighted. After adjusting for both short-term and long-term risk, social investing’s alpha may be stronger than the numbers indicate. For more information visit our website http://www.sristocks.com



MARSHALL

Clay M asked:


I build new houses and remodel existing ones to own and rent out. During the construction process I have expenses uncommon to managing rentals. Even though I take no salary and do as much work as possible on each project, we still have a negative cash flow. After adding up the losses and deperciation, it offsetts my wifes income so we get all of her taxes back. Based on rental rates in our area, we calculate that it will take about 3 years for a property to break even. So we should be turning a profit in tax year 08. To take full advantage of the tax code while depreciating the buildings and then selling them in the future, Is there an advantage to holding these properties as personnel investments or should I form a business that builds and manages real estate?

MONTE

J.S. Kim asked:


Defined within the realm of the statistical Bell Curve, the long tail would reside in the skinny tail at the borders. The long tail, in regards to goods and services, refers to the evolution away from mainstream offerings towards more niche products and services. With the internet drastically reducing the costs of establishing distribution channels, the ability of entrepreneurs to focus more on the longtail sector to fit their customized needs is gaining increasing appeal.

However, almost no one speaks of the longtail of investing. To me, longtail investment strategies are the strategies that do not heavily rely on fundamental or technical analysis, but exploit other strongly predictive factors to produce not only superior returns to traditional investment strategies but also investment opportunities with far better risk-reward paradigms than those produced by traditional investment strategies. Here are 10 reasons why the longtail of investing is the only way to build wealth.

(1)You will never achieve the level of wealth you desire by handing your money over to a large investment firm.

The vast majority of private investors hand their money to large institutions and allow them to invest their money for them. If this were truly the best way to achieve financial freedom, then almost every one you know would be ecstatic with their financial consultant. Think of how many people you know that absolutely rave about their financial consultant.

The fact that 90% of people you know do not rave about their financial consultant should tell you that niche investment strategies, or longtail investment strategies, are far superior. The ones that are happy with the large investment houses already were independently wealthy before they sought out their help. Think about how many people you know that have ever told you, “I wasn’t wealthy before, but thanks to my investment firm, I am wealthy beyond my dreams now.”

(2)Thanks to evolving information technology, there are many better and more highly predictive means of making investment decisions than just utilizing fundamental and technical analysis.

Though people have been really slow to grasp this, once they do, longtail investment strategies, like those invented by SmartKnowledgeU?, will boom. There is no doubt that the level of top-notch financial, political and corporate information available to the average investor has increased by leaps and bounds within the past decade.

There is a virtual treasure map that was created by the flattening of the world over the past decade to selecting stocks that are poised to explode. However, because the largest, most powerful investment institutions in the world have kept the masses of investors fixated on traditional investment techniques such as value and fundamental analysis, the longtail of investment strategies is currently much further behind in its developmental phases than it should be.

The best analogy I can use when explaining why people have ignored the long tail of investment strategies is to compare it to the incredibly slow adoption of Internet Protocol Version 6 (Ipv6) by the United States. When China started preparing its country for Ipv6 a decade ago, the benefits in increased security and its added value properties in e-commerce were evident even back then. However, people in the U.S. were comfortable with the lesser Ipv4 so did not take any action until the progress and superior internet and business capabilities of China, Korea, Taiwan, and Hong Kong finally embarrassed the U.S. enough to move forward and catch up with Asia.

I see the same thing happening in the educational realm of investing. Everyone is comfortable with the traditional investment strategies that have been propagated for the last several decades so nobody sees a need to move forward even though much better strategies exist today. Just as with Ipv6, the world will eventually realize that the safest and best means of investing money reside in the longtail, and they will eventually adopt these strategies.

(3)With so much investor skepticism of corporate integrity sparked by past accounting scandals at Enron, WorldCom, General Motors and the like, and the current, ongoing backdating option scandals, investors will increasingly seek alternate means of making investment decisions other than crunching numbers that they feel are untrustworthy.

Furthermore, technical analysis often yields false positives as well. A chart will show indexes that appear bullish having just broken through a ceiling of resistance only to have the index turn back downward for a prolonged period of time, or a chart will appear bearish having just broken through a floor of resistance only to turn around and begin another bullish ascent.

In fact, you have seen some of these turnaround trends with some of the technical posts that I’ve placed on my blog in previous months. In fact, that is why I always state that I never rely solely on technical indicators to make my decisions. I rely only on technical indicators to confirm or dispel what my long tail investment strategies tell me. Of the three types of analysis, fundamental, technical and long tail, long tail investment strategies yield by far the least amount of false negatives and false positives. That’s why I rely on them so heavily.

This sentiment will lead to an evolution of longtail investment strategies, and the discovery of more efficient and better predictive means of making investment decisions than even those that already exist. Even current longtail investment strategies, such as those utilized at SmartKnowledgeU? are constantly evolving as access to reliable information increases every year. Making decisions as if you were a fly on the wall of boardrooms is no longer a fantasy. It is possible, thanks to the evolution of the information landscape.

(4)With the growth of blogs and pure information sites on the web, the stranglehold of global investment myths, including the Modern Portfolio Theory of diversification, will soon be exposed for what they are - cleverly disguised sales strategies posing as investment strategies.

Once people realize this, longtail investment strategies will gain wider acceptance, much like acupuncture and herbal medicine eventually gained credibility as healing regimens in the schools of Western medicine.

The new information age has stripped many accepted investment strategies such as diversification of much utility when attempting to build wealth. Furthermore, it has also rendered such beliefs as an inability to time the market and the efficient market model as mere myths. This has been proven time and time again by investment sites such as SmartKnowledgeU? that have called for steep market corrections in certain global markets and in asset classes like gold with consistent accuracy.

(5)Wider acceptance of alternative, longtail investment strategies that far outperform those utilized by global investment firms will happen as word of successes via these strategies spread throughout the world via the internet.

The internet distribution channel can and will be used to change the mindset of investors.

(6)The Do-It-Yourselfers are Growing - With the success of books such as Stephen Covey’s “The Eight Habit” that emphasize personal accountability to achieve excellence versus handing control over to someone else, cultural shifts will happen whereby people will seek to seize control over their own financial future versus just handing their money to a firm to manage.

As this cultural shift happens, multitudes of people will realize that they are shorting their returns significantly every single year by handing their money to global investment houses.

(7)The flattening of the world and accessibility to previously inaccessible investment information will undoubtedly yield an increasing amount of investment strategies that reside in the longtail.

People will realize the foolishness of believing in the one investment strategy thrust upon them by global investment houses for the past half of century as “the only viable and safe way to invest.” If the younger generation takes an interest in investing, adding their creativity to the investment arena will result in explosive growth in the longtail of investment strategies. However, since the odds of this occurrence are quite low, a more gradual shift towards niche investment strategies is much more likely.

(8)The explosion of social networking sites like YouTube, MySpace, Friendster, Squidoo, Digg, and so forth, will amplify the viral marketing of longtail investment concepts.

Again, ignorance of longtail investment strategies causes fear and hesitancy to use them. Viral marketing of longtail investment concepts will increase millions of investors’ comfort level with these different and unique concepts.

(9)People are ultimately interested in returns, no matter how much global investment firms try to separate themselves from their competitors with smoke and mirror service claims.

All the gratitude for luxury box suites at Los Angeles Lakers games, suites at the Four Seasons Hotel, conferences at world-class golf courses and resorts will quickly wither once people realize how much more money they are earning with longtail investment strategies.

(10)Again, because people will readily abandon all the perks they get as a preferred client at a large investment firm for far superior returns on their portfolios, longtail investing will eventually reach a critical mass.

Eventually the longtail of investing will migrate towards the center and become the mainstream methods of investing, though this may take several decades to occur.



LOUIS

Greg asked:


I voluntary walked from a deposit and incurred legal fees from a Condo I was purchasing as an investment. Had no intention to live there. I’m thinking the total loss can be claimed on schedule D as a short term loss subject to $3K a year. I’ll need 18 years to recover. Am I correct on this and where on schedule D does this go?

CHESTER

mdlewisshonuff asked:


I am looking for some good high yield investment options that are legitimate. I don’t mind the risk of potential loss with potential high returns. I just don’t want to be scammed out of my money. Any suggestions?

VALENTIN

Simon Giannakis asked:


Intended Audience

Individuals looking to purchase a home for personal use or as an investment. As well, looking into conventional wisdom’s statement that buying a house is one of the best investments someone can make.

Summary Points to Take Away

Why a House is good investment: (1) Forced Savings Plan (2) Leverage (3) Inflation Resistant (4) Tax Free Capital Gain (5) Control over Asset. Points against a House as an investment: (1) Lack of Diversification (2) Maintenance Costs (3) Historically lower returns than equities (4) Unavailable to take advantage of other opportunities (5) Limited Scope. Additional points to consider if planning on purchasing property for personal use: (1) Doesn’t provide any cash flow (2) No tax shelter from interest expense (3) Can get personal joy out of investment.

Analysis

Conventional wisdom states that buying a house is one of the smartest and best investments an individual can make. This article is geared towards challenging this conclusion to see whether this statement rears any truth to it.

Why a House is a Good Investment?

Forced Savings Plan

Most individuals claim that the purchase of their personal home was the best investment they’ve ever made, which is true in most cases because it is the only investment they’ve ever made. The general public struggles with saving for retirement; thus, purchasing a house assists in that problem as it forces individuals to continuously pay down the mortgage (or lose the house in a foreclosure to the bank); therefore, allows the storing of equity for the owners. This built up equity (i.e. market value of home minus remaining mortgage) can be borrowed against during their retirement years or they can downgrad into a less expensive house in order to provide some retirement funds to the owner. If individuals take a disciplined approach to saving, then the benefit of being forced to save in order to pay for a house diminishes

Leverage

Typical real estate purchase require only a 5% deposit, while the remaining amount can be borrowed through bank debt. Few alternative investments outside of real estate can the acquirer obtain such significant leverage, which can enhance investment returns.

Example, suppose that you purchased a home for $200k, for which you made a 5% deposit down ($10k). During the next few years the house appreciates in value and you sell it for $220k (10% higher than the level you purchased it). Though the return on the house is only 10%, the return to the investor based on invested funds sunk into the home ($10k) is 200% ($20k earned over $10k investment) -  that is the power of leverage. On the negative side, more debt means higher fixed monthly mortgage payments; thus, higher risk of being able to make the monthly mortgage payments. As long as cash flow is not a concern and the mortgage payments can be met – investments should be leveraged to maximize returns to the investor. Could you imagine walking into a bank and asking for $100k to invest in equities while only putting 5% down – likely to never happen, this is a major benefit of real estate ownership.

Inflation Resistant

Real estate holds its value during inflationary periods; thus, acts as a hedge against the investors other assets that aren’t protective against inflation (ex. Currency). The asset will continue to hold its buying power (store of value), which is difficult to get outside of investing in precious metals. The reason real estate holds its value is there is the same number of houses that the increased monetary supply of dollars are chasing; thus, it’ll take more dollars to purchase the houses as the supply of houses stays stagnate while the demand rises (due to the increase in the number of dollars in everyone’s hands). This can become critical given the current economic times and numerous expansions of monetary supply across many nations, which will have the aftermath affect of higher inflation.

Capital Gain is Tax Free

In Canada, every home owner is provided with a capital gain exemption on amounts earned in excess of cost for their principal residence. Only one piece of real estate can be claimed as the principal residence per individual. For example, if you owned a home and a cottage, only one of those houses upon selling could take advantage of the principal residence exemption. No other asset class has such advantageous tax reduction characteristics. Unfortunately this is a onetime event; thus, those holding numerous pieces of real estate can only apply it to one property.

Allows for Control over the Asset

Real estate is typically an investment an individual has control over (assuming you’re the majority owner – which is typically the case) by the means of the owner has the ability to increase the value of the asset, which may not be the case in most other investment opportunities. When purchasing real estate, owners can make capital improvements to the home (ex. Finished basement, new porch, etc.), which will increase the value of the property (capital appreciation) as compared to purchasing stocks or mutual funds as assets where the owner can’t take action to increase the value of those assets (unless they’re a significant owner, greater than 20% - which is typically unlikely). The ability to control an asset adds value to the owner through what is known as a control premium, as a real estate asset may be more valuable in the hands of some individuals over others.

Why a House is a Bad Investment

Lack of Diversification

Average individual thinks the stock market is very risky while investing in real estate is more of a certainty. Purchasing equities allows the owner to conveniently hedge their risk amongst various companies in numerous industries, countries, etc. The purchase of real estate doesn’t provide the ability to diversify risk away as easily unless an investor plans on owning numerous pieces of different types of properties (ex. residential, commercial, resorts, etc) across various markets (North America, Europe, etc) – which is probably very unlikely for the average investor. Purchasing real estate prevents the diversification of risk because it’s dependent on the economic, migration, and regulation trends of the local area.

For example, assume you purchased a home in Oshawa, Ontario – which is a town extremely reliant on the large manufacturing facility of General Motors (GM). Should GM cut back on production or move their facility housing prices would fall sharply as it is the biggest employer in the area; thus, demand from individuals will decline as unemployment rises and real incomes fall. With a decline in demand and supply staying stagnate (as you typically can’t “un-build” a house once it’s constructed) the price will have to shift towards in order to align demand with supply.

Real estate doesn’t allow the investor to diversify away the specific risks in the local area as compared to purchasing equities, which allows the investor to spread risk amongst investments that perform differently during different points along the business cycle. Most individuals when purchasing real estate have all their eggs in one basket.

Maintenance Costs

Transaction and maintenance costs are significantly higher for real estate investments than stocks, mutual funds, etc. When purchasing stocks costs are typically broker commissions ($20 per transaction if using an online discount broker), while when purchasing a home it is typically 2% commission on the transaction value, significantly higher than purchasing equities.

Once you purchase shares, no further cash is required from the investor unlike real estate, which requires constant annual expenditures that continue to increase the investors cash committed towards the property, such as property taxes, insurance, utilities, maintenance and repairs of the asset, etc. These are costs that real estate investors or home purchasers don’t factor into their expected return, but play a significant role as the payment of property taxes (etc.) doesn’t contribute to the value of the property for eventual sale in the hopes of capital appreciation.

Historical Lower Returns Compared to Equities

During any 20 year period throughout history, no other asset class has outperformed equities, which includes real estate. This is from the perspective of asset vs. asset without consideration of leverage and how that may enhance returns (as discussed earlier). While it is true that over the long run real estate prices go up in value, this is typically due to inflation incurred. Recent spikes in housing prices seen in the past 10 to 15 years has been due to changing demographics, specifically the baby boomer generation (who makes up largest segment of the population in North America) go through life stages at the same time (same goes for starting a family and purchasing a home and real estate investment property). The result was a large influx in demand without a corresponding increase in supply as construction requires lead time; thus, leading to rising real estate prices.

Will this high demand continue? That’s where the argument lies. Likely there will be softness felt in overall real estate demand as baby boomers already have their homes and they’re likely to either stay put, move to retirement homes or downgrade into a smaller place in order to obtain some retirement income. Immigration will continue into North America that will prop up demand, but likely not the extent to fulfill the whole in demand left by the baby boomer generation; therefore, the future appreciation in real estate properties is likely to flatten out.

Can’t Take Advantage of Available Opportunities

The purchase of a home or real estate property requires the individual to tie up a significant portion of their net worth into the property (in a lot of cases, all of it). Having all your net worth in real estate is a risky strategy as you’ll be severely impacted by movements in real estate prices as compared to having your cash tied up into several asset classes; thus, less vulnerable to swings in any one asset class. Similar to the discussion had under the “diversification” section of this article.

With the majority of an investors net worth tied up in a real estate property, there isn’t available cash to take advantage of other opportunities that come along; thus, significant opportunity costs are involved in venturing into real estate. This should be considered before purchasing an expensive personal home or making a real estate investment.

Limited Scope

Real estate is a local good, unlike gold for example – which can be bought and sold throughout the year for the same market price. An individual looking to buy a personal home or make a real estate investment doesn’t have access to all available properties as there are physical limitations to contend with. It comes down to wanting to live where you grew up or currently work or not wanting to buy a rental property far from your home in order to reduce logistical issues. For example, if you live in Toronto, Ontario and are looking to make an investment in a rental property, you’re unlikely to consider properties in Paris, France though the opportunities may be better than those surrounding Toronto due to language and logistic issues. Equities (and etc.) are globally traded and available; thus, users can take advantage of opportunities around the world; thus, their scope is not limited to the local area of their current surroundings like real estate is.

Additional Points to consider if you’re purchasing a Home for Personal Use.

Doesn’t Provide Any Cash Flow

An asset typically provides you with cash flow, i.e. puts cash in your pocket. When purchasing a home, cash only flows out (property taxes, repairs, etc.); some would argue that if it appreciates in value then it is an asset. In this instance it is only an asset when converted into cash and if that is the case, where will you live? Likely end up buying a new house, which has also gone up in value similar to your house.  This makes it difficult to realize the value of your personal home appreciation, which acts more like a liability than an asset since it takes cash out of your pocket instead of putting some in there.

Tax Deductibility of Interest

Interest expense paid due to bank loans taken to finance investment properties is deductable against income because the investor is pursuing income and tax legislation allows deduction of any expenses incurred in the pursuit of income. This is not the case for a mortgage taken out to purchase a house for personal use as the individual is not in the pursuit of income; thus, interest expense is paid with after tax dollars, with no tax shelter provided. If those funds had been borrowed to invest in equities or mutual funds, the interest would be deductable because again that would count towards the theme of pursuing income.

Can Get Personal Joy Out of It

Unlike equities and other alternative investments, the investor can’t personally use or get joy out of it as compared to purchasing a home, which the individual can live in and enjoy during the investment process. An investor who purchases shares in General Motors (GM) can’t exactly borrow and test drive cars whenever they please simply because they’re a part owner. This is a qualitative benefit that is difficult to quantify, but should be considered.

Where to go from here?

The main reason to purchase a house is to have somewhere to live and enjoy their life, don’t think of it as an investment. Buying a home isn’t a bad decision; it is the investor’s perception that may be tainted because it is important to realize that there are many arguments against a home as an investment to be considered. Don’t buy real estate property with the mindset that an individual can’t lose and that there is no better investment opportunity than to purchase a home, etc. Beware of conventional wisdom that states there is no better investment than purchasing a house.

THANKS,

SIMON GIANNAKIS



OSVALDO

angel_rat_83 asked:


(a) Accrued interest will be received be the seller even though it is not an interest payment date.
(b) An entry must be made to amortize a discount to the date of sale.
(c) The entry to amortize a premium to the date of sales includes a credit to the Premium on Investments in Debt Securities.
(d) A gain or loss on the sale is not extraordinary…I know it’s not this one.

WILLIAM