Pete Wargent blogspot

CEO AllenWargent Property Buyers, & WargentAdvisory (institutional). 6 x finance author.

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Thursday, 23 June 2016

Market myths #7: Buy & hold is a piece of cake

Buy and hold - must be easy!

Another day, another property market myth!

And today it's a look at why buy and hold property investing cannot be as simple as most people seem to think...

Long run prices

Each time the official housing market figures are released, a mini-debate is sparked about whether housing markets are doing well. Or badly. Or indifferently!

The answer largely depends upon your perspective and your selected time horizon - within reason you can torture the short term data to say pretty much whatever you want it to.

In the chart below the long run capital city house price data has been dragged all the way back to 1987 and indexed to 100 at that time. No inflation adjustments. No cherry picking. No log scales.

The graphic shows that Sydney has historically appeared to "lead" housing market cycles, but over the very long run, the capital city housing markets have all performed well in nominal terms. 

With house prices having continued to rise - in spite of several corrections along the way - it is often said or commonly believed that those already in the market must surely have had it all easy.

Not necessarily true!

The statistics show that comparatively few investors ever own more than one or two investment properties, and even fewer achieve financial independence through property. Logically, therefore, buy and hold investing cannot have been as easy as it seems. 

Very straightforward, tactically - certainly! - but psychologically and practically speaking not that easy at all. Otherwise many more people would have been successful at it. 

Asset selection

One factor that brings long term buy and hold property investment undone is poor quality asset selection, which can lead to vacancies, repairs costs, levies, and other ownership headaches.

When these penalties are added to the transaction and other holding costs, the investor begins to fall behind the expected rate of return.

Furthermore land and property prices just don't rise as fast over time in some areas.

While a few per cent per annum might not sound like much of a difference, over the longer term it can become a vast gulf due to the compounding effect - the difference between a good investment and a poor one which fails to beat inflation. 

Such under-performance can lead investors to chop and change their investment strategies, often at precisely the wrong time, resulting in more taxes and more transaction costs - and often the investor moves on to the next poorly performing investment.

Nerves of steel?

A passive or buy and hold investment strategy involves buying quality assets and holding on to them for the full duration of your investment time horizon. 

Pretty simple in theory - and most of us reckon it should be a piece of cake - yet for many people life can get in the way, forcing a sale at an inopportune moment. A lost job, a divorce, or a long vacancy period could be one of any number of deciding causes.

Moreover, a successful buy and hold strategy requires the investor to "tune out" of the daily market commentary which is often unilaterally negative in nature (not that the housing market itself has ever bothered listening to it, recording a seven-fold increase in capital city house prices since 1987). 

There's nothing new about this, of course. Remember when lower inflation was going to kill off property as an investment asset class in the mid-1990s, for example? Then there was a guy in Britain predicting that London prices would fall to three times incomes in 2002 - he advised everyone to sell their homes. And so on.

As a general rule, it may be true that property investors have found the buy and hold strategy to be a somewhat easier proposition than share market investors or speculators, who seem to be adopting ever shorter time frames.

And maybe you're one of the mentally tough ones. Nerves of steel! 

Even so, most average investors are not at all well wired to deal with market downturns, even though we should all intuitively know that all asset classes have summer and winter seasons, up cycles and down cycles, even booms and busts.

It's not always easy to stay the course when all the talk is of the next hot property investment (off the plan units in tropical north Queensland, or "replacing your salary" with a house in a mining town, or Gladstone, or...). Or the next hot stock tip, such as penny dreadful mining, tech, or healthcare stocks.

Unfortunately, most investors - even experienced investors - also suffer from loss aversion: we feel the pain of losses more than twice as much as we enjoy positive gains. And it's not unusual for market to experience 5 to 10 per cent drops through a cycle, perhaps more.

If you're able to buy well and "switch off" the market noise for the full duration of your investment time horizon, you may well be able to join the small group of investors that does well from a passive investment strategy.

But most don't manage to do this. The statistics don't lie!