Moreover, for whatever complex of reasons-psychological as much as economic-we advisors simply find our retiring clients more comfortable with solid real estate investments than they are with shares in portfolios of superior companies. You may feel, as I certainly do, that this makes little objective sense. But it is somehow fundamental to human nature in our time-and human nature, more than we may care to admit, is the business we're in.
Please note that the posture I take here is not at all predictive: I have no more idea where we are in the real estate cycle than I do where we are in the equity market cycle. Nor am I even remotely suggesting that real estate "outperforms" quality equities in some way-a notion I regard as meretricious. Rather, I'm all but pleading with the advisor community to see that the retiring boomers must have adequate exposure to rising income and asset values if they are to survive three decades of rising living costs. I'm not advocating for real estate versus equities; I'm advocating strenuously for both, and against an over-reliance on fixed-income investments.
Yes, real estate is an "alternative investment." But it's not an alternative to mainstream equities, to which it is both a complement and a historically powerful diversifier. It's an alternative to bonds.
This is true in the long run for all the reasons I've been at pains to elucidate. But it may also have some resonance in the "here and now," as well. For if today's retiring boomers are apt to overestimate the "safety" of fixed-income investments because their basic definition of safety is flawed, it's also the case that they have never really seen a major decline in bond prices.
With the arrival of short-term interest rates at zero in the wake of the financial crisis, the bond market may be seen to have completed a 30-year bull market-perhaps its greatest ever-that began in 1981 when Paul Volcker at the Federal Reserve just about single-handedly broke the back of inflation. Interest rates have fallen-and thus bond prices have risen-throughout the intervening three decades, with few interruptions and none in recent memory.
But I invite the career-oriented advisor to observe what happened to bond prices in 1987, when the fed funds rate jumped from 5.88% to 7.31% in nine months. The resultant crash in stock prices was one outcome of this sudden rate spike-but it wasn't the only one.
And I especially recommend a hard look at the devastation in bond prices when-in seven relentless rate hikes over 12 months-the Fed jerked the funds rate from 3% all the way to 6% between February 1, 1994 and the same date the following year.
Again, I make no attempt to predict the timing or shape of the interest rate cycle. I say only what I believe to be true. (1) Just as the boomers tend to overestimate the effect of equity volatility on stock values, they may very well be underestimating the effect of rising interest rates on bond prices. (2) With the short end of the yield curve at zero, it is simple arithmetic that the next major move in bond prices-whenever and however it comes-probably can't be up. (For a fuller discussion of these phenomena, I recommend advisors look at Forbes bond columnist Marilyn Cohen's recent book, Surviving the Bond Bear Market: Bondland's Nuclear Winter.)
In light of all these factors, I believe it's time for advisors to reassess the place investment real estate should have in their long-term planning for boomers reaching retirement. Just make sure it's real estate for the right reasons.
© 2011 Nick Murray. All rights reserved.