Thursday, May 15, 2008

Don't get caught in a bubble - Part 1

Investing in stocks or real estate or any other asset class is a good thing most of the time. Over time, most "well-known" investable asset classes give a good real rate of return (ie a return that can beat inflation lah). Ok the other caveat here is "well-known" asset classes, ie dont go and invest in wine or art, jewellery etc, chances are you are likely not to see your money again.

Just some ballpark no.s to play with, historically these asset classes have been able to generate these returns (nominal not real and they also include dividend or other forms of yield, real return will be these no.s - inflation rate)

Stocks 10%pa
Real Estate 12%pa
Private Equity 15%pa
Bonds 5%pa
Commodities 8%pa

However, as we all know, these are historical AVERAGE returns, There is no guarantee that the future will be like the past. It may not be possible for us to enjoy these returns going into the future. In fact if you had invested at the wrong time, there is a chance that you will never get close to these rate of returns.

Of course the wrong time willl be ********drumrolls******** investing at the peak of some bubble. I shall highlight three real life examples on how investing at the peak of some bubble will make sure that you will earn a meagre return over a long period of time.

The first bubble that we are going to introduce here is probably the biggest bubble in recent history (yes even bigger than the dot com bubble) in terms of magnitude. There are two asset classes involved: real estate and stock market (as usual btw) and sadly these asset classes never ever recover close to its peak even after 19 long years.

Yes this is the Japanese bubble which ended in 1990 when everything collapsed. At the peak of the bubble, the Nikkei was close to 40,000 and real estate prices in Tokyo reached close to USD 140,000 psf. (Okay so Singapore is not so bad lah, only SGD 3,000+ psf this time round, we are about 2 more digits away).

Today the Nikkei stock index hovers around 13,000 levels and Tokyo real estate prices are on par with Singapore's SGD 3,000+ psf. A lot of Japanese that invested in real estate near the peak had to finance their mortgage with maturities stretching 2 lifetimes ie the sons have to continue to pay the father's mortgage.

Imagine if you have bought stocks or real estate even at 30% below its peak level, you will still not see your capital today, and the sad truth is, perhaps you will never ever see your capital again.

As for the stock market, the Nikkei declined steadily over the next 13 yrs after it cracked in 1990 and eventually reached a bottom at around 8,000 in 2003. So even if you DCA all the way down, you may not have broken even today. Subsequently, it rebounded to 18,000 before declining back to 13,000 today.

Moral of the story: Don't get caught in a bubble, but easier said than done right?

To be continued...
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