I don’t know about you, but when I was a kid… I was promised we’d have jet packs by now!
Image Attribution Seg9585
Every night for the last 14 years, I’ve read a story to at least one of our kids. The days of them being too old for this will soon be upon us, but it’s a wonderful tradition we enjoy very much. We’ve read thousands of stories over the years, but inevitably, the family favourite is anything from Calvin and Hobbes, the legendary and timeless comic strip by Bill Watterson.
My favourite strip was written Dec. 30, 1989. In it, Calvin marks the new year of the decade with incredulity. In Calvin’s words: “Big deal! Where are the flying cars? Where are the Moon Colonies? Where are the personal robots and zero gravity boots?”
I can understand where he’s coming from. It’s been almost thirty years. I – sorry I mean Calvin – still doesn’t have zero gravity boots!
The one exception
One of the smartest investment managers I’ve ever met once commented that the only investment standard you can rely on to predict the future is that everything reverts to the average. The real challenge though is knowing what the average is, and being patient enough to wait for the valuation to return there.
What she meant by that was that sometimes prices for equities (or anything for sale, really) go way above or below what they should but, inevitably, will return to where they should be based on their long-term rates. It was probably the most astute piece of advice on investing I’ve ever been given.
Now, not everyone spends a lot of time looking at investment markets, so let’s use an example we’re all familiar with – housing prices. Over the last 100 years housing has increased at about the rate of inflation over the long term. In particular, a reasonable standard over that time period is that a house should be affordable if its cost is three to four times the household’s annual income. According to a very interesting article in the Globe and Mail in April 2017, housing in the GTA in September 2016 was more than eight times the average household income in the city at $627,395. Ironically, just after the article was written, the average price became $919,449, or 12 times the average household income in the GTA.
It doesn’t take a lot to imagine that 12 times family income is reaching a point where prices would have to lower. Sure enough, housing prices have started going down since last April, and the most recent data from the Toronto Realtor’s Association website shows prices started dropping over the fall.
So, knowing the value of items always reverts to the average, we know that either incomes have to increase significantly (by about 300 to 400 per cent) or housing prices need to drop. I don’t think it takes a lot to imagine which is the most likely scenario.
The problem is, I can’t tell you when that potential reversion to the average will happen – it could be tomorrow, or it could be in five years. But someday in the future, things will revert to normal and it’s likely to be painful for many GTA homeowners, unless they get some pretty hefty raises at work!
Applying this to your non-real estate investments
One of the most important fundamental aspects of investing is ensuring you rebalance your investments to keep your overall asset allocation on target. As some holding increase or decrease in value, your original allocation of investments will change. Rebalancing keeps taking you back to “the average” proportion of holdings in your portfolio with which you started. I build this into almost every portfolio I set up for our clients. If we believe that the only thing predictable about the future is that everything will eventually revert to the average, rebalancing is our only way to predict the future.
It’s not about what the hot pick is in your portfolio – it’s about ensuring your portfolio has the right balance of investments, based on your personal financial situation… In short, it’s boring investing. Not the sexy prediction of the future you likely wanted but, trust me, it’s the hottest investment tip I can give you.
In the meantime, please let me know if you hear of a company doing R&D on those zero gravity boots Calvin was talking about. Because, (and please forgive me the horrible pun) you know, that company’s stockings can only go higher, right?
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