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The Buy-and-Hold Connection: Investing Fundamentals Courtesy of the American Homeowner

If you can truly understand the dynamics and payoffs of buying and living in a home, you will stand on a rock solid foundation from which to invest in the stock and bond markets. Victor Canto explains in a chapter from his book, Cocktail Economics.
This chapter is from the book

This book has a good deal to do with the fundamentals of investing, and a good deal more to do with how to perform at a higher level than the great herd of investors who settle for average results. But before turning to above-average performance, my first duty is to convince you that even average investing is well worth your time. In this chapter, we investigate the very concept of average investing—and from what I believe to be a very distinctive and instructive point of view: I believe that if you can truly understand the dynamics and payoffs related to buying and living in a home, you will stand on a rock-solid foundation from which to invest in the stock and bond markets. In other words, this foundation is the average on which we build an above-average strategy.

When stacked against each other, home-owning and stock market investing form a weighty parallel because each activity so completely instructs the other. You see, homeowners and stockowners are identical in many ways. They desire the returns that their investments will generate and, more important, believe that these returns will, in fact, materialize. They display levels of risk that, in relation to returns, are satisfied by their investments—basically, their fear of "getting burned" is low. The lingo attached to each of their activities is much the same as well. Let me throw a few terms at you, all of which we discuss in this chapter: buy-and-hold, price appreciation, transaction costs, capital gains, imputed income, leverage, and total returns. Taken together, these terms set the parameters of performance for investors of all stripes. And for homeowners in general, they set the parameters for average performance.

When it comes to buying and living in a home, average is the established and profitable American way. Think of it this way: If you invest in something and it appreciates in relation to a historical average that has proven to deliver substantial positive returns, then you win. You make money. Average, here, equates with success—and with homeownership: In general, the prices of all homes go up over time. So if you invest in a home, you stand to gain on that investment. This is why you "buy," and it is one of the two dominant forces that drive homeownership. The second force has to do with why you "hold" that investment. For now, I state plainly that you hold it until it becomes profitable to sell it.

Already you should sense a parallel between owning a home and owning a portfolio of stocks and bonds. Each you buy, and each you hold. Simple enough. But simple will empower you in the pages ahead as we transfer the fundamentals of home-owning into the foundational rules for investing in the stock and bond markets.

The American Dream: As Real as Ever

Millions of Americans understand the value of investing in residential real estate. They start small, and when the time is right, they sell, at a profit, and move to a bigger place. Some call this the American Dream, but it's not a dream at all. At this writing, homeownership in the U.S. stands near 69 percent—up from 63 percent in 1970, 55 percent in 1950, and 48 percent in 1930.[1] That's an impressive climb. At no time in history have more Americans owned homes—that's yet more evidence that this is not only the land of opportunity, but also the land of personal responsibility. After all, what's more responsible than taking advantage of an investment that's almost certain to make you better off? True, no investment is 100 percent guaranteed. But historically, homeownership comes pretty close.

Most Americans know this. They know that home prices usually go up over time, so much so that the fears attached to home-owning relative to other forms of investing are very low. They know that if they hold on to their properties long enough, they might very well enjoy a nice payday if they decide to sell. The data backs this up, and conversations at the kitchen table verify this reality every day: "You paid how much for your house 20 years ago? And now it's worth how much? Holy cow." Americans also know that owning and living in a home is a low-tax activity; in fact, for most Americans, it is a tax-free activity, a tremendous incentive to buy rather than rent.

These are the basics of the buy-and-hold strategy as it relates to residential real estate. But with participation rates in this strategy near 70 percent today, buy-and-hold becomes an authoritative force worthy of deeper investigation. Who are these buyers and holders, and what are the range of factors that both motivate and guide their actions?

In what follows I'll introduce you to two: Their names are Jennifer and Carlos, and their actions in relation to the buy-and-hold formula are like a textbook.

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