Economist's Commentary: March 28, 2008

Lost Decade

By Lawrence Yun, Chief Economist

Stocks Tarnished by ‘Lost Decade’ was the front page headline in Wednesday’s Wall Street Journal. The article essentially says that people did not make any money by investing in the stock market from 1999 to today. The message was wrongheaded and the analysis was a bit misguided. The article further hints at another Lost Decade ahead with falling or stagnant stock prices – and falling or stagnant home prices.

Short-term day-trading is fraught with risk, but a long-term investment strategy with a well diversified basket of holdings will provide a solid rate of returns. And the consistent long-term investor, despite the headline, did not encounter a lost decade.

A person who made a one-time investment in 1999 would not have come out ahead. A person who consistently invested over time, with a regular 401K contribution, would have seen a 9.3 percent growth on investment.

Let’s run the numbers starting with a $10,000 investment in 1999. A consistent investor will contribute, to say a 401K plan, every year – during both good and bad years. The table below shows the return on $10,000 for each of the years. For example, the contribution in 2003 would have provided a nice gain of $13,755 at today’s market valuation, resulting in a (paper) profit of $3,755. The profit from the 1999 original $10,000 investment yielded $0. The year 2000 investment resulted in a loss because the purchase occurred at the market’s peak. But the consistent investor would – adding up both profits and losses during each of the years – have netted a sum of $9,287 on a cumulative 401K contribution of $100,000. That is a return of 9.3 percent cumulatively, though only 0.9 percent on an annualized basis. But the bottom line is still higher because of consistent patient investment. A reckless spender who put nothing away for investment would have nothing to show at the end of the day.

A housing purchase should similarly be viewed with a long-term perspective. A long-term holding will provide significant financial benefits from sheer discipline alone. Let’s examine a homebuyer in Dayton, Ohio, a market that has experienced slow price growth in relation to the rest of the country. The home price today is one of the most affordable in the country at under $115,600, with only a slight increase from the 1999 level. Yet, over that time period, the housing wealth accumulation will have been $33,400.

To illustrate the importance of patience and discipline, let’s use an example of an even longer-term holder. For someone who purchased a home 20 years ago, the wealth accumulation from the home purchase is the difference between today’s price and what it was in 1987, and the principal mortgage debt payment over the 20 year time span. Amortizing mortgage payments are hard to show in a short article, but one will find that nearly 45 percent of the original mortgage debt would have been paid off. Thus, 45 percent of the original 1987 home price of $50,000 would amount to an additional $22,500 accumulation in wealth. Furthermore, the mortgage payment would have stayed stable over the years if the homebuyer used the common 30-year fixed rate mortgage, while apartment rents would have risen over the same timeframe. The bottom line is that this home buyer would have accumulated $86,600 in housing equity after a 20-year holding period – and without having to pay out-of-pocket rental expense.

For shorter holding periods, housing equity gains are less pronounced due to both lower home price appreciation and fewer payments on the principal portion of the mortgage debt. The gains are, nonetheless, there.

The long-term purchasers of investment properties will also accumulate housing wealth with the only difference being that mortgage payments are paid by renters. The returns will be different in cases where rents do not fully cover mortgage payments and other housing-related expenses, so investors need to work their calculators to assure the right trade-off between rental income and potential capital gains on the one hand and maintenance expenses and mortgage payments on the other.

The bottom line is that a consistent long-term investment – be it in the stock market or from homeownership or an investment property – encourages financial discipline and helps deter frivolous consumer spending. Diversification minimizes the risk in a downturn. As our grandmothers taught us, sacrifice and discipline, including saving for rainy days and doing our homework, can reap abundant awards in the future. Who can argue with that?

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

Comments? Questions? E-mail NAR Research.