Should I invest in Gold?

Lately, there have been tons of radio and television advertisements encouraging us to purchase gold. Is gold really a great hedge against inflation? Is there any truth to the commonly heard prediction that the price of gold will reach thousands of dollars in the near future? How accurate is advice from supposed financial pundits claiming that we should be purchasing gold coins or gold certificates?

Here is what we know. Based on data from the Austin Gold Information Network, the price of gold has increased thirty eight times between 1871 and 2009. We can compare this with inflation (CPI) and the performance of the S&P 500 index. Based on Professor Robert Shiller’s study, CPI increased seventeen times and S&P 500 (discounting reinvested dividends) has increased one hundred ninety five times. So yes, gold can be a good hedge against inflation but stocks are a better hedge in the long run. If you decide to invest in gold anyway, do not be disillusioned! Investing in gold also has its risks. In 1980, the price of gold was nominally roughly the same as now. Adjusting for inflation, people who invested in gold 29 years ago are actually losing money right now.

My advice would be not to purchase actual gold in the form of bullion, coins, or certificates. They are not liquid and can be a hassle to store securely. Furthermore, you are always running the risk of uninsured theft. The simplest way to invest in gold is to purchase Gold ETF. Like most investments, it works through a third party: you purchase shares and the fund company purchases gold bullion accordingly, storing it securely. You can sell those shares at any time. It is a very easily liquidated and secure investment. And you never need to worry about the logistics.

If you are still inclined to invest in Gold, definitely do not make it more than 5-10% of your portfolio. There are other ways to hedge against inflation: REITs, commodities, and other precious metals, for example. Remember, diversify!

Is Now a Good Time to Invest in Real Estate?

In today’s economy, I am often asked the same question: is now a good time to invest in real estate? Let us consider the factors that go into making this big decision by approach this dilemma from the perspective of the Average Joe. We will accurately assume that Joe does not have a spare billion dollars stuffed inside his mattress, itching to be invested in the real estate market.

Factor 1: Expectations.

It is important to be realistic about the appreciation, maintenance costs, and potential vacancy of any investment property. To help with this, I have done a little research. Based on the study of Professor Robert Shiller, the average U.S. home appreciated 3.78% a year between 1907 and 2007 and 4.87% between 1948 and 2007. This rate is nominal and does not account for inflation. When taking inflation into consideration, we are left with a one to two percent appreciation. Furthermore, real estate can be quite volatile. There are quite a few distributional peaks and valleys in Shiller’s real estate price data. Investing in real estate, even in today’s economy when real estate prices are low, might still not give you significant returns for quite a few years. Vacancy rates should also be an important part of your research. According to a recent article by Zack O’Malley Greenburg in Forbes Magazine, the average residential vacancy rate in the U.S. is currently 10.2%. Bloomberg.com shows a commercial real estate vacancy rate quickly approaching 16.7% this year. These high rates mean that the likelihood of you having to reduce your leasing costs to keep tenants on your property is also high. From this reduced profit, you will also need to maintain your properties to a satisfactory standard.

Factor 2: Leverage.

Real estate investors can rarely afford to shell out cash for the properties that they own. Even if they could, it would be an inefficient use of their resources as property appreciation can easily be eaten by maintenance, property taxes, insurance, and other similar expenses. Usually, investors put a down payment on the property and borrow the rest to make their property an asset. If the property appreciates and sells, the loan is paid off and the percent appreciation on the initial capital is quite high! On the other hand, property appreciation is not a guarantee and you can find yourself in a situation in which your home loan is being paid out of pocket.

Factor 3: Easy Access to Cash.

Unexpected things are always possible in the real estate market. You can end up with a vacant property or a laundry list of unexpected repairs. Not being able to afford these things can cause you to default on your mortgage and lose the property.
So regardless of the market, research your property and make sure that you understand what goes into managing a real estate asset. Assess your risk and be truly knowledgeable about what you are getting yourself into. If you find a property that suits your needs, don’t be lazy! Do the math to make sure it works. Double check to make sure that the rent you need to charge to make a profit is not exorbitant for the location or the property. Understand the duties of a landlord: late night phone calls, hunting down late rent, handling lawsuits of tenants who trip and fall on your property, etc.

Real estate is a risk and involves a lot of effort but there are things that you can do to reduce the risk like buying multiple properties. Hiring a managing company can help reduce the burden of landlord duties. More properties, however, means more loans. And hiring a manager means less profit. You need to decide what you are willing to put into this investment and what you would like to get out of it.

You might be thinking – what are my other options? You can also invest in real estate by investing in REITs, REIT mutual funds, REIT ETFs (indexes), and non-traded REITs. This will be the topic of a blog to come!

I am in my early 20s, isn't it too early to start saving for retirement?

My niece is in her early twenties and asked me whether or not it is too early to start saving for retirement. To answer her question, I ran some simple calculations.

Let us start with a few assumptions:
Let’s assume that she will not need the money for forty two years (she will be sixty five), that the annual average rate of return on her retirement savings is eight percent, and that the annual rate of inflation is three percent.

Now we can look at two possible scenarios:

She does nothing for the next twelve years, and begins saving at the age of thirty five. She saves $10 thousand per year, and in thirty years she will have saved about $513 thousand. Discounting inflation, that would equal about $150 thousand today.

Or

She saves $2 thousand for the next two years (she will be a starving graduate student and will probably not have more to save); and then $5 thousand per year, increasing for inflation for the next fourty years. In fourty two years, she will have saved about $1,891,000 , worth about $550 thousand today.

In the second scenario, she would accumulate three times more money when compared to the first. It would allow her withdrawing $25-33 thousand a year in retirement relatively safely (in today's dollars). This would be my advice to her for right now.

Is it realistic? I think so. In two years when she finishes her Masters Degree most likely she will find a job that might pay around $50,000. So her retirement contributions would be about 10% from her pay.

Though this may not be enough to allow my niece the lifestyle that she would like to enjoy, it will get her into the habit of saving. It will also give her first hand experience with investing and allow her to see the results. As time goes by, the plan will change. Most likely, her income will grow, her lifestyle will change, her household will multiply, and her assets and liabilities will alter. But overall, she will have a sense of security about her retirement savings and her financial future.