June 29, 2007, 1:47 am

Why most people think it is less risky to invest on the house market instead of the stock market

by: The Financial Blogger    Category: Investment, Market and Risk
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Several baby boomers take for granted that their property is the best investment that they could ever made. It is true that most of the time, they are making a good profit when they sell. Therefore, they plan on downsizing their house when they retire and they will be all set to play golf every single day. In fact, they would have probably made more money from investment than from their property. But why do they all have examples of people that made money form their property but not from their investments? The answer is simple; it is all about rationality. I read an article in Les Affaires (a French business related newspaper) about the perception of an individual’s property and his perception of his investments.

 

Imagine that, every morning, you could sit down in front of your computer, coffee in your left hand while you are surfing the internet. You go on Yahoo! Finance and the price of your property is listed. It fluctuates every single day like any other stocks or mutual funds. Then, imagine that you are back in the 80’s and your house value goes down month after month. At one point, you panic and you put your house for sale to minimize your lost.

 

This is exactly what is happening with most people when they look at their investments. Stocks do fluctuate on a day to day basis. Markets do go down for a long period of time. But in the end, if you keep your position during the storm, your investments will flourish again and you will end up making money.

 

As there are too much information available theses days, people analyze and over analyze as much as they can. The result; their thinking doesn’t make sense anymore and they buy and sell according to their feelings. This explains markets’ violent mood swings.

 

The purchase of a main residence is a long and complicated process. You have to visit properties, make offer, receive counter-offer, negotiate dates, go through the banks’ approval process for a mortgage, chose a lawyer and move all your stuff to another place. You will most likely buy three to four houses in your life because of the above mentioned reasons. However, trading is totally different. You can buy, sell, short within seconds. This is why you will take more time to choose a property that meets your need than buying and holding a strong company’s stock. At the first drop, you will be tempted to sell. It will never happen with your house as the process is way more complex and you can’t follow your property’s value on a daily basis.

 

The fact that individuals are more rational about transactions related to properties than stocks is an important factor in their overall investment return. As they don’t take the same time and energy (without mentioning patience) as they do for a house, they increase their investment risk of loss.

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Comments

FB, note that a primary residence is usually purchased based on emotional reasons and not because it’s a great investment.

by: The Financial Blogger | June 29th, 2007 (6:08 am)

MDJ, however, people will perform extensive researches before buying their house as it is a major purchase.

A house is typically a family’s single largest asset (and requires leverage to even purchase it). That’s A LOT of concentration risk!

FB, regular people don’t shop for their primary residence based on appreciation. They buy based on what they like, what they can afford, what’s good for their kids, and what’s pretty.

People buy their homes based on feelings just as much as people buy stocks on emotion.

For example, put an ugly house in a great appreciating neighborhood.. what happens? Nobody will buy except for the keen eyed investor.

by: The Financial Blogger | June 30th, 2007 (10:00 am)

FT, I agree that they don’t necessarily buy their house in an investment perspective.
The point was more to show that regular people would lose money on their property if property’s price would be listed on a daily basis.
Most people will buy and hold their property for a while and then make money. However, they can’t do that with their stocks!
Thomas : I’m glad to see that you consider a mortgage as a leverage loan. Most people don’t and I think that ignorance is a major risk.

Cheers,
FB.

Also, most people discount the costs of maintaining their investment. Stocks usually cost little to maintian, a home has many unrecoverable costs associated with it, that are not factored into the final tally.

by: The Financial Blogger | July 1st, 2007 (6:40 am)

David, this is definitely a huge debate to determine if you are making money or not with your main residence. Canadian Capitalist wrote about it about two weeks ago. I’ll probably revisit this topic in the future.
Cheers,
FB.

A home is emotionally attached very much to its owners. They are considering it as a primary asset. A comprehensive research is essential before buying a home.