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Posted about 10 years ago

The basic rules shared by all successful long term investors

You could argue that in every asset class there are investors and traders. Traders buy and sell assets quickly making a profit from the different price points. Most are full time professionals and know precise and minute details intimately and react rapidly to gain a profit (or loss).

Investors are different as they make investment decisions based on maintaining a long term strategy using rationalizations like value / cash flow / anticipated yield and appreciation over a period of years not days. Time and again it has been proven that these buyers will almost always profit when they take a long view. Why? Because jumping in and out can often lead to locking in losses and losing out on gains. I have illustrated this by way of example below.

In property, the outlook over the next few months is all important to a trader, but irrelevant to an investor. If you wait long enough, a well-chosen property purchased in a good location with a strong rental demand and positive cash flow will inevitably beat the activities of traders jumping in and out of the market using short term information and reacting to either fear or exuberance.

The Power of Long Term Investing

I have spoken to hundreds of prospective buyers this year (many based overseas) and a fair percentage felt that they had “missed the boat” as far as US property was concerned. Afterall, the average property price in a large US city has increased by 20% in the past two years.

Remember though, when prices were at rock bottom in 2009, so too was a 2 year old drumbeat of negative news and dire predictions. Many people thought that house prices would never recover and this fear pushed many to sell before they should have.

2009 mindset:

“Prices have fallen dramatically for the past two years, there´s no way I´m buying anything”

2013 mindset:

“Prices have risen by 20% in the past two years and I´ve missed the boat”

In both scenarios above, short term information is keeping potential buyers on the sidelines. On the other hand, a long term strategy, no matter when it is implemented, will always negate short term trends and make you money.

USA Property: Ten year history

2001 - 2013
Would you be surprised if I told you the average US property increased in value by 45% between Jan 2001 and July 2013? As you can see from the graph below, it has.

i67-schiller1

Out of the 20 cities tracked by the Case Schiller Index, Detroit was the only one where average property prices fell during 2001-2013.

The other 19 cities all posted double digit gains and this is incorporating the huge sell off and foreclosure crisis in 2007-2010.

2007-2013
We all know that people who purchased property at the top of the boom (say January 2007) would be sitting on significant losses today. The average loss would be 20%, although it would be more than double that in certain locations.

A more optimistic way of looking at it this period is that house prices today are significantly undervalued compared to their peaks. If you feel they were too high in 2007, fair enough, but we are still massively down in certain markets. For example, Miami, Phoenix and Las Vegas all have a long way to go despite their strong recovery over the past two years.

2011-2013
If you bought a property in 2011 and ignored all the negative sentiment you would have gained an average of 15% within 2 years, and significantly more in the cities that suffered the biggest falls during the recession.

Average House Price Trends in 10 Major Cities *

i67-schiller2

Don´t try to predict markets - let time do the heavy lifting

Unlike the computerized world of the stock market where huge chunks of your net worth or gains can be wiped out in minutes, small real estate buyers are not at a disadvantage to the “big guys”.

Investing in real estate also offers you direct control over the value of your property. Paint the home and it is worth more; create an open floor plan, install some marble countertops or add a new bedroom and the value goes up again.

If you accept the fact that you will need to generate residual income from a range of investments (including but not limited to real estate) for your future wellbeing, time literally is of the essence as it is time that does all the heavy lifting.

The key to successful investing is understanding the power of compounded growth. Albert Einstein called this "the greatest mathematical discovery of all time". Others call it "the 8th wonder of the world". Whatever way you want to phrase it, this is the engine that drives outsized returns for investors who start young or invest for long time.

If you can be patient and if your assets are reasonably well chosen, the economy and average economic growth will do the rest for you.

Let’s look at a cash purchase example:

You buy a property for $100,000 with no mortgage and you receive $500 per month in net rental income after overheads.

If you reinvested that $500 per month in a standard dividend paying bond providing 3% APR, you would have a staggering $165,500 in the bank after 20 years.

That´s just the income though. What about the asset value? We´ve had some major ups and downs over the last 12 years, but USA property prices have risen by 4.5% per year on average since 2001.

Let´s stay conservative and assume prices increase by an average of just 2.5% over the next 20 years. The value of your $100,000 property would increase to $163,860.

So your initial investment of $100,000 is now worth over $326,000 and I´m being deliberately conservative. This is why real estate should be part of your long term income and retirement plans.

And guess what? It keeps compounding even more aggressively from there, giving your family a head start in life. Do this three of four times over 25 years and you’re starting to talk about some real money!

Conclusion

Let go of short sighted quests to secure the greatest deal of your life, or what is happening to interest rates or government policy or todays valuations. That is a trader’s mindset. Real money is made by patient, steady & level headed people who understand long term growth and compounded interest.

Warren Buffet, the second richest man in the world, is your prime example. Mr. Buffett doesn’t check daily or even monthly stock prices. He doesn’t care because it’s all noise. His job is to buy great assets and hold them for a long time.

In my opinion, it is short term thinking, a fear of doing something different from the crowd and an impatience to “get richer now” that are the greatest barriers to wealth creation.

Despite recent gains, average property prices are still significantly lower than previous highs. There is a lot of room for growth in the next 2-4 years and a long term approach will produce significant returns and solid rental yields. Low inflation, low interest rates, limited supply and rising demand from renters are all moving in the right direction.

The data is there, you just need to act on it.


Comments (5)

  1. Thank you very much for the comments gentlemen, much appreciated. I think patience and playing the long game is fundamentally important. It´s very difficult to apply them in the heat of the moment though and I guess 95% of us (me included) learn how to control these instincts the hard way! Love the tortoise/hare analogy - I´ll have to use that in a future post!


  2. I found that article enlightening. Thanks for taking the time to write it. I find it good news, and I often get a little anxious about this detail or that one as I'm looking at my next purchase options. I think I will take James' advice and get a tortoise tattooed on my arm ;)


  3. For me, "patience" was one of the hardest lessons to truly learn. The other, which has no resolution, is that I should have committed to real estate 20yrs ago.


  4. Tortus beat the hair.


  5. Great Post Colin.