Wednesday, May 18, 2011

Bursting Bubbles

I was a retirement advisor at Fidelity Investments in 2006, just as the housing bubble was being inflated. Here's a typical client conversation during this time:

 "I want to withdraw $30,000 from my 401k."

"Why do you want to withdraw the money?"

 "I'm making a down payment on an investment property in Phoenix. My neighbor bought one a year ago and just sold for a 90% profit! Everyone is getting rich in real estate and I don't want to miss out."

I would run through the list of reasons why this may be a bad idea (tax consequences, asset allocation, real estate transaction costs, etc.). But almost everyone opted to chase the real estate dream.

We know how the story ended.

Financial bubbles are always forming. Human nature dictates it. If you want to make money investing, you need to zig while others zag. Those who rushed into real estate and got burned are the same ones who have been on the sidelines for the equity markets recent run up.

Once CNN reports on how well the market's doing, it's too late. But John Q Public will see the CNN report, talk to his neighbor, and hear how he made 30% in the market last year. JQP takes the cash he's had on the sidelines, earning next to nothing, and plows it into the market...at or near the top. The cycle continues.

Guess what asset class looks the cheapest right now? Yep, real estate. Once everyone starts zigging into equities you should be zagging out. Not completely, of course. You should have most of your money in a well-diversified portfolio with appropriate holdings among all asset classes.

But if you want to beat the market with your play money, then you must zig while everyone zags.

Up next...how to hedge against inflation. IT IS COMING!