Monday, October 4, 2010

10 Exercises: A Fitness Manual for Random Walkers (Part 2)

STUFF I LEARNED FROM Burton G. Malkiel's "A Random Walk Down Wall Street"

6. Begin Your Walk at Your Own Home; Renting Leads to Flabby Investment Muscles

"A good house on good land keeps its value no matter what happens to money. As long as the world's population continues to grow, the demand for real estate will be among the most dependable inflation hedges available."

Land is a scarce resource whose supply is limited; demand for land goes up as the population grows. We all know from Economics 101 that this interplay between supply and demand could only lead to higher prices in the future; it's hard to argue with the soundness of this reasoning.

But as they say, the devil is in the details. Important issues continuously face the would-be real estate investor. For example, we all know that investing in real estate entails significant capital, usually upwards of 1 million pesos for any decent piece of property. As most investors don't have that kind of investable cash at hand, the only available recourse is debt. But borrowing at, say, 7% per year (roughly Pag-ibig's interest rate per annum for a 1 million peso housing loan) will only make sense if you anticipate that the value of your property will grow at least 7% per year, or if you think investments of comparable risk (like say, stocks) will yield higher annual returns in the long run. The point is that investing in real estate is not an automatic investment win, and is not always the best alternative under particular circumstances.

Second, as in all investment situations, the investor makes financial decisions in an uncertain environment. The housing bubble in the US which led to the financial crisis in 2008, and the devastating blow dealt by typhoon Ondoy on the Marikina and Pasig real estate markets last year, will make any investor think twice before making any real estate purhcase. But we have to remember that these things are part and parcel of investment dynamics, and that instead of ineffectively trying to preempt what can happen, maybe the best thing to do is protect ourselves with things like insurance and diversification.

7. Beef Up with Real Estate Investment Trusts

"If you want to move your portfolio toward terra firma, I strongly suggest you invest some of your assets in REITs."

A real estate trust fund or REIT (pronounced as reet) is a corporation that invests in real estate, and whose earnings are distributed to investors at a lower tax rate. Basically, a REIT is to real estate as mutual funds or UITFs are to stocks and other financial assets.

REITs may be public or private; shares of public REITs may be traded on public exchanges, like the Philippine Stock Exchange. REITs make investing in real estate easier for individual investors as real estate portfolios are divided into a number of shares, resulting in more affordable minimum required participation.

In July 2007, Senate Bill number 63 or the Real Estate Investment Trust Act was passed in congress. Big players in the real estate market are just starting to capitalize on this new way to attract investor funds, with Ayala Land recently setting up a REIT that will be offered to the public in the near future.

8. Tiptoe through the Investment Fields of Gold and Collectibles

"The Honda Accord in your backyard can rust, and the three-year-old TV dinner in your freezer may not taste very good. I tend to prefer the kinds of assets that produce a return while they are giving inflation protection."

Some people mistakenly believe that the best way to fight inflation is to buy stuff now, while prices are presumably lower, rather than later. The problem with this "strategy" is that not everything can be consumed all at once, and most "stuff" that remain lose a portion, and eventually all, of their value over time.

Investing, by definition, involves buying something that can either provide a stream of future income, or whose price can appreciate in the future, or both. Unfortunately, just buying any kind of good does not meet either of these criteria. One might argue that a valuable commodity like gold is not like other "stuff": while it does not generate periodic income, its price can definitely appreciate considerably at any given time. But because the price of gold is mostly determined by investor speculation, and thus can be very volatile, Malkiel recommends holding just a small portion (around 5%) in your portfolio by buying shares of funds that invest in gold.

9. Remember that Commission Costs Are Not Random; Some Are Cheaper than Others

"With the advent of competitive commission rates, it has now become possible to buy your brokerage services at wholesale prices."

As we've seen with UITFs in the Philippines, the fees fund managers charge can vary greatly and can even result in considerable differences in annual returns. Unfortunately, the same can also be said of mutual funds, stock brokers, and other entities that provide financial services for a fee. In availing of these services, then, be sure to do your homework and shop around for the lowest rates to maximize the fruits of your investment.

10. Diversify Your Investment Steps

"A biblical proverb states that 'in the multitude of counselors there is safety.' The same can be said of investments. Diversification reduces risk and makes it far more likely that you will achieve the kind of good average long-run return that meets your investment objective."

Diversification remains to be one of the most effective ways of managing investment risk. By investing in different asset classes -- stocks, bonds, real estate, etc. -- you lessen the chance of being wiped out in case something catastrophic happens. While this strategy may provide lower potential returns compared to, say, picking individual stocks, theoretical and empirical evidence continue to show that the trade off is well worth it.
Related Posts Plugin for WordPress, Blogger...