What To Do This Mardi Gras

A house is an asset not an investment

This post originally appeared at Abnormal Returns. You can stay up-to-date with all of our posts via our daily e-mail newsletter.

A couple weeks ago Jason Zweig at WSJ wrote a personal and moving piece on selling the home where he was raised and where his mother had lived until recently. His experience is at-odds with the thinking of many Millennials who do not want to be weighed down by the cost and responsibility of owning a home. Zweig concludes his piece:

A home is more than an investment. It is the place that helps shape who we are. Your generation may well be thankful that you don’t have to bear the burdens of owning one — the mortgage, the maintenance, the pain of pulling up roots that run decades deep. My generation, and my mother’s, are thankful we had the blessings.

A home is often a blessing but it is not an investment. In a follow-up piece Zweig attempts to calculate the return on the aforementioned house and comes up with a disappointing number. He writes in a piece at MoneyBeat:

..I can make only a guess at their rate of return between 1961, when they bought, and this past week, when my mom sold. My very rough estimate is that it amounts to a rate of return of about 4% annually, roughly equivalent to the rate of inflation over the same period — in other words, a real return fractionally better than zero. Account for the money they might otherwise have incurred in rent, and the return would be slightly higher.

On the other hand, once you factor in repairs, routine maintenance and annual property taxes along the way, plus commissions and other costs on the final sale, the return after inflation would be negligible or even negative.

This result of moderate to negative real returns is in line with the Case-Shiller numbers on home price returns. Nir Kaissar at Bloomberg included the graph below to demonstrate that over time, except for a brief period during the housing bubble of the early 2000s, houses on a national basis have generated low positive real returns.

Source: Bloomberg

Despite the relatively poor performance of homes, Kaissar notes there is a persistent myth that homes are solid investments. For example the Case-Shiller indices don’t take into account the many other costs involved in home ownershiop. He like Zweig recognize there are non-financial reasons to own a home but there are much better ways to invest in real estate. Kaissair concludes:

There are numerous non-financial benefits, and some personal financial benefits (the mortgage interest deduction, for example) to buying a home. But if you want diversification, and if you want meaningful expected price appreciation from real estate, buy a REIT and rent your home. Homes are wonderful places to raise a family. They aren’t great investments.

One of the reasons why homes may be such a hot investment is that Americans continue to demand ever larger houses, and for now, home builders are willing to accommodate that demand. Rani Molla also at Bloomberg notes why builders are chasing the McMansion crowd but notes the eventual downside of focusing on an increasingly small demographic niche.

As noted above there are a number of reasons to own a home that have nothing to do with the dollars and cents of it all. It probably makes more sense to think about homes as assets and not investments. For instance, today it is easier than ever for those in retirement to get a reverse mortgage on their home to fund their ongoing needs for income. Scott Burns at AssetBuilder notes now the thinking has changed on reverse mortgages.

In my book I make this same distinction between asset and investment in regards to cash or more accurately cash equivalents like money market funds. I wrote:

Cash is an asset, but not an investment. On the face of it, this seems like a false distinction. In this formulation, an asset is anything of value. An investment, on the other hand, is something that is expected to produce real, after-tax returns over time. In this light, cash is something we should value, but we should not expect it to provide us with real returns over time, as should equities or bonds.

It is ironic that two assets that are so different like cash equivalents and a home would generate negative, real returns over time. But if you think a little bit more about it you can see these are two assets that have demands that have nothing to do with their prospective returns. Cash is held by highly risk-averse investors who are, by and large, price-insensitive. Since the outset of the financial crisis cash equivalents have had highly negative real returns but investors continue to hold significant balances.

The demand for homes is driven a whole host of factors that have nothing to do with prospective returns. There is nothing like a birth (or two) to prompt a couple to look for a larger home. Homes have in econspeak non-pecuniary benefits, or benefits that can’t be measured by money.

Zweig may very well be right that the latest generation will miss out on these benefits if they eschew home ownership. A better bet is that they come around to home ownership as they make a demographic transition. However they would be wise to think about their home as an asset and not an investment. Otherwise every call to the plumber or HVAC technician will feel like a loss and not a chance to keep your family warm and dry.

Never cut a tree down in the wintertime. Never make a negative decision in the low time. Never make your most important decisions when you are in your worst moods. Wait. Be patient. The storm will pass. The spring will come.

Robert H. Schuller (via quotemadness)

“The world only exists in your eyes. You can make it as big or as small as you want.” ~F. Scott Fitzgerald

When you find your reason for living, hold onto it. Never let it go. Even if it means burning other bridges along the way.

Abbi Glines, Forever Too Far (via wordsnquotes)

The Checklist Investor Crushing the Market by 1100%

By Jae Jun

What You’ll Learn

Mohnish Pabrai’s uniquely not so unique investment framework

How Pabrai crushes the market with checklists

Pabrai’s investment advice

Recommended books on Checklists

With an outperformance of 1100% compared to the market since inception in 2000, Mohnish Pabrai is a classic value investor and household name.

I heard about Mohnish around the time he and Guy Spier famously won a lunch with Warren Buffett for $650,100 in 2008.

One of the reasons why we like Mohnish Pabrai at Old School Value is that he is the perfect model of what ordinary people can do when they find something that they love and have the plan, perseverance and discipline to do it.

If you don’t know what I mean, here’s a quick background on how Pabrai became an investor.

Mohnish Pabrai: The Relatable Super Investor

Mohnish Pabrai is an Indian born investor, came to the United States to attend Clemson University in North Carolina in 1983.

He didn’t major in finance.

Pabrai was an engineery by trade and running a successful IT business and never heard of Buffett until he was 30. In fact, the first investor Pabrai discovered was Peter Lynch, not Buffett.

Anyway, here’s the part of the story that resonates with me and a lot of other DIY investors.

I found very strange was how you can have an entire industry which does not function with a solid framework. To me, it is like people doing brain surgery by just ‘winging it’.

That is how I saw mutual funds work – they were just winging it, or they come up with any nuance or ‘flavor of the day’ they want to pursue.

I had a thought that if novices like me simply adopted Buffett’s approach and invested in the equity markets with a concentrated portfolio, etc. that I was likely to do better than most of the industry professionals.

So I said it was worth testing this hypothesis out. I was lucky at the time in 1994; I had about $1 million in cash. I had just sold some assets of my business and I decided to go ahead and manage that in a Buffett-style concentrated portfolio, buying things I understood, etc. That is how I got into value investing.

He was an immigrant, didn’t have any formal investing training and realized how nonsensical the investment industry was.

Starting with his own money to launching a fund, it’s a good thing Pabrai “got” into value investing.

Pabrai’s long-only equity fund has returned a cumulative 517% net to investors vs. 43% for the S&P 500 Index since inception in 2000. An out-performance of 1,103%. - H/T Valuewalk.

Did he have a unique process to achieve such returns?

No.

If you go through the material available on Pabrai, you’ll realize what a diehard Buffett and Munger fan he is. From an old interview in 2008, he said that he read Poor Charlie’s Almanack 7 times.

And if you listen to any of his interviews, it’s full of Buffett and Graham lessons.

Monish Pabrai’s Investing Philosophy

In a nutshell, Pabrai’s investment framework is:

focus on long-term investing and the power of compounding based on Warren Buffett’s “moat-based,” Graham’s “Special Situations” and Munger’s “Latticework of Mental Models” approaches to investing.

Pabrai lays out his framework in his book The Dhando Investor (highly recommended in my must read book list) where he discusses the Dhando framework.

Focus on buying an existing business

Buy simple businesses in industries with an ultra-slow rate of change

Buy distressed businesses in distressed industries

Buy businesses with a moat

Bet heavily when the odds are overwhelmingly in your favor

Buy businesses at big discounts to their underlying intrinsic value

Look for low-risk, high-uncertainty business

Nothing new.

Just super common sense along with application of Buffett’s timeless principles.

The difference is that he stuck with it while his peers were rushing to find the next shiny object, the next big thing.

One of the takeaways he got from his lunch with Buffett was this very idea when Buffett asked him:

‘Would you prefer to be the greatest lover in the world and be known as the worst, or would you prefer to be the worst lover and be known as the greatest?’ And [Warren Buffett] said, ‘If you know how to answer that correctly, then you have the right internal yardstick.’

Mohnish Pabrai: The Checklist Investor

Pabrai probably talks about checklists the most (along with Guy Spier).

He is known to have page an intense set of checklists accumulated throughout his investment career. He stated that he doesn’t talk about too many specific parts of his checklist because it is his competitive advantage.

Makes sense.

However, he provides plenty of high level information on how you should build a checklist and the types of things he looks at.

Here’s a one of his checklist presentations you should check out and a quick summary of how Pabrai and Munger use checklists from The Checklist Manifesto .

It just comes down to putting in the time to create your own checklist.

Instead of constantly being on the lookout for new stocks to buy, take a step back and go over your past mistakes.

Pabrai simply started making his checklist by studying the mistakes of Warren Buffett and as of 2013, he had 97 or 98 broad questions on his checklist that takes about 15-20 minutes to run through.

He also saw that most of the mistakes made by the guru investors fell into five groups.

valuation

leverage

management and ownership

moats

personal biases

A good starting point, if you don’t use a checklist, will be to focus on these five parts.

So for example, Berkshire Hathaway lost money on Dexter Shoes, when they bought Dexter Shoes. A question that comes up on the checklist is, is this business a business that can be affected negatively by foreign competition? Can it be affected negatively by low-cost labor in other countries? Those came out of, for example, the Dexter Shoes example. - source

Since I put the checklist in place, in 2008 till today, we have made I think more than 30 different investments in the last five years or so. We only have so far, we invested about $200 million. We’ve already exited a bunch of positions and we’ve exited with about $500 million on those positions, and we only lost money on two investments. And the total amount of money we lost from those two investments is less than 5 or 6 million dollars. And I think a large part of that is the checklist significantly brought down the error rate.

If you need some guidance on how to build a checklist, or want a template to start, I have a checklist collection that I share with people

If you want to make it easier on yourself, you can download a collection of checklists that I’ve compiled. Just click the image below and enter your email to get the download link.

Mohnish Pabrai’s Holdings

What you also have to know about Mohnish Pabrai is that he has nerves of steel and has conviction in his own ideas.

He only holds seven total positions total with his biggest position being Fiat Chrysler, followed by GM warrants making up close to 70% of his portfolio.

A lot of people on boards on the internet criticize Pabrai for continually averaging down on ZINC – which goes back to that lover analogy Buffett told Pabrai and Spier during lunch.

Everyone thinks he is a loser for holding and buying ZINC, but he believes otherwise.

The other thing to remember is that you also have to put things into context.

Ridiculing an investor like Pabrai by isolating ZINC is ridiculous. Whether it’s a mistake or not is yet to be seen. Everybody is going to make mistakes, but the key is whether you make a mistake with your 48% holding or your 5% holding.

Must Read Books Related to This Article

The Dhandho Investor: The Low-Risk Value Method to High Returns

The Investment Checklist: The Art of In-Depth Research

The Manual of Ideas: The Proven Framework for Finding the Best Value Investments

Further Reading and Related Links

Mohnish Pabrai, Guy Spier and Michael Shearn on investment checklists

How Mohnish Pabrai crushed the market by 1100% since 2000

Pabrai Funds Annual meeting notes 2014

Making Heads and Tails of Mohnish Pabrai

Mohnish Pabrai 2015 Investor Meeting

Pabrai’s Checklist presentation

Valuewalk Pabrai resources

A checklist for investors

How Mohnish Pabrai and Charlie Munger use a checklist

Checklist investing and how to avoid errors and learn from mistakes

Interview and Talk by Mohnish PabraiAdditional Articles I Recommend

The Education of a Value Investor

7 Low Risk Investments Strategies You Should Apply Today

15 Words of Wisdom on Finding an Edge

My Answers to 12 Important Investing Questions

10 Investing Principles Every Value Investor Should Live By

The Finest Collection of Value Investing Checklists

Get our free newsletter , follow us on Twitter, Yahoo Finance/Tumblr, like us onFacebook, connect with us on Linkedin

[Photo Credit:  Alan Cleaver, Flickr]

Stay In and Save

Stay In and Save

Its that time of year when tons of movies are coming to theaters near you…but who has the money to see every one? With sites like Netflix/Hulu, or accessing HBOGo through your cable provider, you can have access anywhere to consistently updated movies for as little as $7.99/month. So sit back, pop some popcorn, and keep that $40 you would’ve spent on one movie outing in your pocket! Movies to…

View On WordPress

Retirement Planning Starts Now: 07 Mistakes to Avoid

Retirement Planning Starts Now: 07 Mistakes to Avoid

http://time.com/money/3546592/ira-rollover-mistakes-retirement/ http://www.bankrate.com/finance/retirement/7-retirement-investing-mistakes-1.aspx http://financialmentor.com/retirement-planning/mistakes/18212

View On WordPress

Blast From the Past: Quick Tips Before Purchasing Your College Textbooks

Blast From the Past: Quick Tips Before Purchasing Your College Textbooks

Summer’s almost over and school’s about to start. Before you head to the bookstore, we wanted to to pull from one of our favorite posts in the past about saving money on textbooks. We all know that going to college can put a major strain on your finances. On top of tuition, housing, and meal plans, the cost for textbooks can be high. A new trend for students with textbooks is to rent instead of…

View On WordPress

Is College Worth the Expense?

Everyone’s path in life is and will be different, and college may not be for everyone – it is

A new Wall Street Journal article shows that Americans are losing faith in the value of a college degree. With the rising yearly costs of tuition and fees, many do not feel as if the cost is worth it. With government budget cuts and the burden that student loans can place on you, it is easy to feel like skipping out on college may be the best option, but is it really? Everyone’s path in life is…

View On WordPress

Managing Fiances Can Be Hard Just Look at These Celebrities Who Struggled!

Managing Fiances Can Be Hard Just Look at These Celebrities Who Struggled!

When it comes to money, celebrities are just like the rest of us-they spend too much, save too little, and make a number of poor financial decisions. There are many celebrities that you would think would be financially well-off that are struggling. Some of them are better at saving, while others are spend-happy. Although their incomes may be large, their expensive lifestyles will oftentimes…

View On WordPress