Most people are very familiar with the traditional investing axiom of ‘buying low’ and ‘selling high’ that is rooted in experience with the stock market. Because of this, many equity market investors choose to hold their capital on the sidelines waiting for prices to hit a cyclical bottom before buying-in. At the Financial Freedom Report, we understand this sentiment in regards to stock market investments, due to the increasing volatility of market values in recent years. The orthodoxy of ‘buy and hold’ worked very well for stocks through the 1990’s, but has subjected investors to large downside risk in the last decade if they bought at the wrong time.
The stock market movements of the last fifteen years are a testament to the growing volatility and flattening long-term rate of appreciation for the stock market. The compounded growth rate for the S&P 500 over the last 20 years look much more modest than most financial planning models assume after the effect of two market bubbles are backed-out. This leaves us with the inescapable conclusion that success in the current stock market is achieved by the strategic buying of stocks when their values are depressed and systematic liquidation when values expand.
By graphing the index value, earnings per share, and dividends per share of the S&P 500 index over the past 20 years, it becomes quite apparent that the major source of returns after backing out the two market bubbles has been dividends. Another thing that becomes quite apparent when comparing the stock market against its fundamentals is that market values are much more volatile than the underlying data that is the ultimate basis of market valuations. These gyrations in market prices have prompted many investors to diminish the importance of fundamentals and cash flow in favor of trying to pick stocks that are about to go up in value.
Unfortunately, experience with financial assets like stocks and bonds have caused many investors to treat income properties similar to stocks or bonds. The unique aspect of income property is the cash flow generated by rent income. Since the returns from income property are not solely dependent on gyrations in market prices, there is a much greater cost associated with waiting for the perfect buying opportunity. The reason for this is because waiting for conditions to be perfect for buying could cause us to miss out on profits from cash flows on deals that we didn’t execute because we were waiting for something better.
Analyzing the cost of waiting shows that every year you delay taking action increases the effective rate of return that is required to achieve the same-compounded results as
if action had been taken earlier. For example, if you can earn a 15% compounded rate of return today and wait for 2 years, you would need a 16.2% rate of return to be in the same place after 30 years. If you decide to wait for five years, the required return increases to 18.3%. After ten years, it increases to 23.3% and after 15 years, it stands at 32.3%.
As we can plainly see, waiting too long requires that we earn impossibly high rates of return simply to match the compounded impact of starting today and growing our wealth steadily. This is where the true power of prudent income property investing comes into play. Since much of the value comes from cash flow, which is much more stable than market values, returns are less dependent on buying right before the market rockets up and more dependent on finding deals that are attractively priced relative to their cash flow.
Many people in the ‘baby boom’ generation are in the midst of this problem. They waited too long before beginning to plan for retirement, and had much of their wealth wiped away in the financial crisis of 2008 and subsequent economic recession. For many of these people, their previous vision of retirement is no longer a reality. It is not possible for them to earn enough to retire comfortably before reaching what was previously thought to be ‘retirement age’ . . . this will ultimately mean that they must work much longer than they had previously imagined would be necessary. It is frequently commented; “luck favors the prepared” . . . it is equally true that “luck favors those who take action.” By taking decisive action, it allows us to harness the power of compounding and create a bright future for ourselves and the people we care about.
Action Item: Do not wait to begin investing. Once you have access to the necessary capital and have become sufficiently educated to make an informed decision, take action!!! When your investments begin to bear fruit, continue to take action by re-investing your profits until a holistic wealth portfolio has been constructed. (Top image: Flickr | greggoconnell)
The Jason Hartman Team
