Tag Archives: Real Estate

Chinese Communist Government Economic Strategies Baffle Economists

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In the capital city of Beijing, the Chinese Communist authoritarian regime is grappling with the harsh reality of self-inflicted economic struggles.

The ongoing real estate crisis in China presents a significant challenge to the Communist Party, with industry giants like Evergrande and Country Garden facing liquidation orders. Chinese citizens heavily were invested in real estate, with approximately 70 percent of their investments allocated to this sector, twice the amount seen in the United States.

The long-term real estate fundamentals have changed — China’s population has likely peaked, urbanization is slowing and home ownership is already very high.

Moreover, official economic figures released by the People’s Republic are often met with skepticism from experts, who believe gross domestic product (GDP) numbers are fantasy. For example, Foreign Policy reported that China’s economic growth in 2023 may have been significantly lower than the stated 5.2 percent, possibly around 1.5 percent.

China’s overall debt-to-GDP ratio is about 300% and rising, which is the highest among emerging markets and higher than most advanced economies. While China’s central government debt is relatively small at just above 20% of GDP, debt at the local government level is estimated to be more than 70% of GDP.

A debt crisis is typically a liquidity crisis  

Additionally, China’s government has substantial assets that can help pay debt. More importantly, a debt crisis is typically a liquidity crisis, and in the case of China, high domestic saving kept by capital controls at domestic banks means that more than 95% of China’s debt is domestic debt, financed by relatively stable domestic deposits and not subject to sentiment change of international investors.

Despite the Chinese Communist regime’s message of China being “open for business” to the global business community and financial elites, the reality paints a different picture. Beijing’s autocratic government enacted a draconian law that requires domestic and international companies operating in China to share business secrets and intellectual property with the Communist Party. This policy has raised concerns about the country’s investment and business environment. While the intention behind such measures may be national security and autocratic control related, it also poses challenges for companies operating in China.

Bottomline, the Chinese economy is plagued by a litany of challenges.

Local governments are struggling with financial difficulties after three years of pandemic spending and declining land sales. Some cities in China can’t repay their debts and have hadto cut basic services or reduce medical benefits for seniors.

The real estate crisis has deepened. Plunging home sales have pushed developers like Country Garden to the brink of collapse. The crisis has spilled over to the massive shadow banking sector, causing defaults and sparking protests across the country.

Youth unemployment has become so bad that the government stopped publishing the data.

Foreign companies have grown wary of Beijing’s rising scrutiny and are pulling out of the country. In the third quarter, a measure of foreign direct investment (FDI) into China turned negative for the first time since 1998.

Foreign investors beware when investing capital in an communist and autocratic country.

References:

  1. https://www.msn.com/en-us/news/world/xi-s-economic-strategies-baffle-even-chinese-economists/ar-BB1jpZa9
  2. https://www.npr.org/2023/08/16/1193711035/china-economy-tao-wang-interview
  3. https://www.cnn.com/2023/12/27/economy/china-economy-challenges-2024-intl-hnk/index.html

Falling Home Sales and Rising Mortgage Rates

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Existing home sales have declined for seven straight months as the rising cost to borrow money puts homes out of reach for more people.

Many potential homebuyers are opting out of the housing market as the higher 30-year mortgage interest rates add hundreds of dollars to monthly mortgage payments. On the opposite side of the transaction, many homeowners are reluctant to sell as they are likely locked into a much lower rate than they’d get on their next home mortgage.

Rapidly rising 30-year mortgage interest rates threaten to sideline even more prospective homebuyers. Last year, prospective homebuyers were looking at 30-year mortgage rates well below 3% APR.

Mortgage buyer Freddie Mac reported that the 30-year rate climbed to 6.29%. That’s the highest it’s been since August 2007, a year before a crash in the housing market triggered the Great Recession.

“The rising mortgage rate has clearly hampered the housing market,” said Lawrence Yun, chief economist. “The housing sector is the most sensitive to and experiences the most immediate impacts from the Federal Reserve’s interest rate policy changes.”

Sales of existing homes fell 19.9% year-over-year from August last year, and are now at the slowest annual pace since May 2020, near the start of the pandemic, according to NAR.

The national median home price jumped 7.7% in August from a year earlier to $389,500. As the housing market has cooled, home prices have been rising at a more moderate pace after surging annually by around 20% earlier this year. Before the pandemic, the median home price was rising about 5% a year.

The August home sales report is the latest evidence that the housing market, a key driver of economic growth, is slowing from its breakneck pace in recent years as homebuyers grapple with the highest mortgage rates in more than a decade, as well as inflation that is hovering near a four-decade high.

Higher home prices and mortgage rates have pushed mortgage payments on a typical home from $897 to $1,643 a month, an 83% increase over the past three years, according to an analysis by real estate information company Zillow.

Some 85% of US homeowners with a mortgage now have an interest rate well below 6%, according to Redfin. The disparity gives less incentive to these homeowners to sell and buy another home, because taking on a higher mortgage rate would mean paying more over the life of the loan and also as bigger monthly payment.

By raising federal funds borrowing interest rates, the Federal Reserve makes it costlier to take out a mortgage loan. Consumers then presumably borrow and spend less, cooling the economy and slowing inflation*.

Mortgage rates don’t necessarily mirror the Fed’s interest rate increases, but tend to track the yield on the 10-year Treasury note. That’s influenced by a variety of factors, including investors’ expectations for future inflation and global demand for US Treasurys.

References:

  1. https://www.nar.realtor/newsroom/existing-home-sales-slipped-0-4-in-august
  2. https://nypost.com/2022/09/22/mortgage-rates-jump-to-6-29-highest-in-15-years/
  3. https://www.zillow.com/research/august-existing-home-sales-2022-31458/
  4. https://nypost.com/2022/09/21/existing-home-sales-drop-for-7th-straight-month-in-august/

*August’s CPI data showed that inflation is not slowing as expected and required the 75-basis point interest increase from the Federal Reserve. In addition, jobless claims showed a persistently tight labor market, which could drive up costs of goods and services as wages increase.

U.S. Housing Market

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Updated: July 22, 2022

Home sellers are contending with apprehensive buyers amid rising mortgage rates and the possibility of an oncoming recession. RedFin

Single family home sales in June showed the first signs of leveling off after steady monthly increases for more than a year, according to the Jacksonville Daily Record. Although, sellers still were receiving slightly above 100% of asking price in June in certain housing markets, the general trend is mixed nationwide.

Price drops have become a common feature of the cooling housing market, particularly in places that were popular with homebuyers earlier in the pandemic, writes Dana Anderson, a data journalist at Redfin. Nearly two-thirds (61.5%) of homes for sale in Boise, ID, had a price drop in June, the highest share of the 97 metros in RedFin’s analysis. Next came Denver (55.1%) and Salt Lake City (51.6%), each metros where more than half of for-sale homes had a price drop. 

Home prices rise in June

In June 2022, home prices were up 11.2% compared to last year, selling for a median price of $428,379, according to Redfin.

On average, the number of homes sold was down 17.4% year over year and there were 609,147 homes sold in June this year, down 737,598 homes sold in June last year. The national average 30 year fixed rate mortgage rate is at 5.5% and is up 2.5 points year over year.

While also in June 2022, the number of homes for sale was 1,647,846, up 1.6% year over year.

The number of newly listed homes was 782,083 and down 4.4% year over year. The median days on the market was 18 days, up from 3 year over year. The average months of supply is 18 months, up from 3 year over year.

Additionally, 55.5% of homes sold lower list price, down 0.86 points year over year. There were only 17.9% of homes that had price drops, up from 9.0% of homes in June last year. There was a 102.3% sale-to-list price, down 0.24 points year over year.

Moreover, inflation and higher mortgage rates have slowed sales and priced out of the housing market many potential home buyers. As a result, the inventory of homes are beginning to pile up on the market and prices are slowly falling nationwide.

Takeaway…the once red hot U.S. housing market is showing signs of cooling and housing prices are contracting. Instead of over eager buyers and multiple offers on listed homes for sale, buyers are canceling sales contracts in increasing numbers and walking away from earnest money. And, what was unthinkable just a year ago, home sellers and builders are cutting home prices to entice potential home buyers and close sales.

For sellers, there is still money to be made in the housing market, but asking prices need to be very attractive to home buyers.

References:

  1. https://www.redfin.com/us-housing-market
  2. Dana Anderson, More than 60% of Boise Home Sellers Dropped Their Asking Price in June Amid Cooling Market, Redfin.com, July 14, 2022. https://www.redfin.com/news/price-drops-cooling-market-june-2022/
  3. Dan MacDonald, Northeast Florida home prices dip after months of increases, Jacksonville Daily Record, July 22, 2022, pg. 4. https://www.jaxdailyrecord.com/article/northeast-florida-home-prices-dip-after-months-of-increases

Home Buyers Cancelling Contracts

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Home buyers are increasingly canceling home purchase contracts citing a slowing housing market, and rising mortgage rates as biggest factors

Approximately 60,000 home purchase agreements were canceled last month by homebuyers, about 14.9 percent of homes that went under contract that month, according to a report from Redfin.

The cancellation rate is the highest percentage since Redfin began collecting the data in 2017, excluding March and April 2020, the first two months of the pandemic.

The percentage of canceled contracts compared to homes put under contract is up from 12.7 percent in May and up from 11.2 percent year-over-year.

Prospective homebuyers are canceling contracts for two primary reasons:

  • Some are exercising contingency clauses, which were waived by many buyers to increase their offer’s chances of being accepted when the market was hotter.
  • Others are backing out because of rising mortgage rate. In mid-June, the average 30-year fixed-rate loan flew past 6 percent, significantly higher than it was at the beginning of the year, when it was at an average of 3.22 percent.

Housing prices are still rising but less than they were, and signed contracts indicate the number of sales will drop in the coming months.

The housing market has cooled in recent weeks as the Federal Reserve has boosted interest rates in an effort to quell four decade high consumer price index (CPI) inflation. That has given house hunters more freedom to seek concessions from home sellers, but higher rates also make housing less affordable for average Americans.

References:

  1. https://therealdeal.com/2022/07/11/deal-or-no-deal-home-buyers-increasingly-canceling-contracts/amp/
  2. https://www.redfin.com/news/home-purchases-fall-through-2022/

Nearly 22 Million Americans are Millionaires

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There are nearly 22 million individuals in the U.S. with financial and real assets to fit the definition of being a millionaire, according to a 2021 Credit Suisse Global Wealth Report. Overall in 2020, total global wealth grew by 7.4% and wealth per adult rose by 6% to reach another record high of USD 79,952, according to the report.

Net worth, or “wealth,” is defined as the value of financial assets plus real assets (principally housing) owned by households, minus their debts.

The core reasons for asset price increases which have led to major gains in household wealth are a result of significant monetary and fiscal intervention by governments and central banks, like the U.S. Federal Reserve. Many governments and central banks in more advanced economies have taken pre-emptive action to prevent an economic recession in two primary ways: first, by organizing massive income transfer programs to support the individuals and businesses most adversely affected by the pandemic, and second, by lowering interest rates – often to levels close to zero – and making it clear that interest rates will stay low for some time.

There is little doubt that these interventions have been highly successful in meeting their immediate objectives of countering the economic impact of the pandemic. However, they have come at a cost. Public debt relative to GDP has risen in the U.S. and throughout the world by 20 percentage points or more, according to a 2021 Credit Suisse Global Wealth Report.

In essence, there has been a huge transfer from the government coffers to household net worth, which is one of the reasons why household wealth has been so resilient. In one respect, these transfers generously compensated households.

Generous payments have meant that disposable household income has been relatively stable and has even risen. In combination with restricted consumption opportunities, this has led to a surge in household saving, which has inflated household financial assets and caused household debts to be lower than they would be otherwise. This increase in savings was an important source of household wealth growth last year.

The lowering of interest rates by central banks has probably had the greatest impact on the growth in household wealth. It is a major reason why share prices and house prices have flourished, and these translate directly into our valuations of household wealth.

However, there are inflation implications in the long term from lowering the interest rates and also increased equity market volatility linked to expected future rises in interest rates. However, these were deemed relatively unimportant at the time compared to the more immediate economic challenges caused by the pandemic.

Household wealth appears to have simply continued to grow, paying little or no attention to the economic turmoil that should have hampered progress. Effectively, financial assets accounted for most of the gain in total household wealth accumulation.

The wealth of those with a higher share of equities among their assets, e.g. wealthier households in general. And, home owners in most markets, on the other hand, have seen capital gains due to rising house prices.

Wealth is a key component of the economic system. It is used as a store of resources for future consumption, particularly during retirement. Wealth also enhances opportunities when used either directly or as collateral for loans. But, most of all, wealth is valued for its capacity to reduce vulnerability to shocks such as unemployment, ill health, natural disasters or indeed a pandemic.

The contrast between those who have access to an emergency buffer and those who do not is evident at the best of times. Household wealth has played a crucial role in determining the resilience of both nations and individuals

Roughly 1% of adults in the world are USD millionaires.

Global household wealth may well have fallen. But aggressive governments and central banks to intervene help mitigate the economic impact of the pandemic. These have led to rapid share price and house price rises that have benefited those in the upper wealth echelons. In contrast, those in the lower wealth bands have tended to stand still, or, in many cases, regressed. The net result has been a marked rise in inequality

In many countries, the overall level of wealth remains below levels recorded before 2016. Some of the underlying factors may self-correct over time. For example, interest rates will begin to rise again at some point, and this will dampen asset prices.

References:

  1. https://www.cnbc.com/2021/12/22/heres-how-22-million-americans-became-millionaires.html
  2. https://www.credit-suisse.com/media/assets/corporate/docs/about-us/research/publications/global-wealth-report-2021-en.pdf
  3. https://www.credit-suisse.com/about-us/en/reports-research/global-wealth-report.html

Tax on the Sale of a House (Primary Residence)

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If you sell your home for a profit, some of the capital gain could be taxable. Capital gains are the profits from the sale of an asset — shares of stock, a piece of land, a business — and generally are considered taxable income.

The IRS and many states assess capital gains taxes on the difference (profit) between what you pay for an asset — your cost basis — and what you sell it for. Capital gains taxes can apply to investments, such as stocks or bonds, and tangible assets like cars, boats and real estate.

To minimize your tax burden, the IRS typically allows you to exclude up to:

  • $250,000 of capital gains on your primary residence if you’re single.
  • $500,000 of capital gains on real estate if you’re married and filing jointly.

You will have to meet certain criteria in order to qualify for this exclusion, so be sure to review them before you sell. You might qualify for an exception, and adding the value of home improvements you’ve made could help.

For example, if you bought a home 10 years ago for $200,000 and sold it today for $800,000, you’d make $600,000. If you’re married and filing jointly, $500,000 of that gain might not be subject to the capital gains tax (but $100,000 of the gain could be), according to NerdWallet.com. What rate you pay on the other $100,000 would depend in part on your income and your tax-filing status.

The bad news about capital gains on real estate is that your $250,000 or $500,000 exclusion typically goes out the window, which means you pay tax on the whole gain, if any of these factors are true:

  • The house wasn’t your principal residence.
  • You owned the property for less than two years in the five-year period before you sold it.
  • You didn’t live in the house for at least two years in the five-year period before you sold it. (People who are disabled, and people in the military, Foreign Service or intelligence community can get a break on this part, though; see IRS Publication 523 for details.)
  • You already claimed the $250,000 or $500,000 exclusion on another home in the two-year period before the sale of this home.
  • You bought the house through a like-kind exchange (basically swapping one investment property for another, also known as a 1031 exchange) in the past five years.
  • You are subject to expatriate tax.

If it turns out that all or part of the money you made on the sale of your house is taxable, you need to figure out what capital gains tax rate applies.

  • Short-term capital gains tax rates typically apply if you owned the asset for less than a year. The rate is equal to your ordinary income tax rate, also known as your tax bracket.
  • Long-term capital gains tax rates typically apply if you owned the asset for more than a year. The rates are much less onerous; many people qualify for a 0% tax rate. Everybody else pays either 15% or 20%. It depends on your filing status and income.

References:

  1. https://www.nerdwallet.com/article/taxes/selling-home-capital-gains-tax

Buying Homes During Covid

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People Rushed to Buy Homes During COVID-19. Now, They Regret It.

The hot real-estate markets across the U.S. led to a number of buyers to purchase homes without performing due diligence

A cardinal rule of home buying is that you shouldn’t rush into a purchase of a home. But in 2020 and now in early 2021, millions of Americans did and are doing just that…rush into purchasing a home, occasionally sight unseen or without a thorough home inspection.

Fleeing small apartments, buying vacation homes or simply looking for a change of scenery amid the crushing boredom of lockdowns, people scrambled to buy houses amid the pandemic, spurring bidding wars and supercharging real-estate markets across the country, according to Candance Taylor*, reporter with the WSJ. Now, many are discovering the pitfalls of these hasty purchases, ranging from buyers’ remorse and financial strain to damage caused by unexpected problems.

At the same time, inventory dropped as many homeowners hesitated to list their properties in the pandemic.  The pandemic has aggravated the housing market’s longstanding lack of supply, creating a historic shortage of homes for sale. The shortage has pushed home prices higher, stretching the budgets of many middle-class and first-time home buyers. The median existing-home price crossed above $300,000 for the first time ever in July, up 8.5% from a year earlier, according to NAR.

The result is that much of the country saw a price spike and bidding wars, brokers said, leaving buyers with little to choose from. In these conditions, many are tempted to waive inspections or skip other due diligence they would normally perform before buying a home.

Over the past two years, the insurance company Chubb has seen large, non-weather-related losses increase in frequency and severity, according to Fran O’Brien, division president of Chubb North America Personal Risk Services. She attributed these losses in part to hasty home purchases: Buyers moving from a small city apartment to a large home in a rural area may not be well versed in how to prevent the pipes from freezing, for example.

“People are moving to places that they don’t know a lot about,” Ms. O’Brien said. “They’re thinking, ‘this looks like a nice place to live’ for amenities it may have. They don’t understand what risk there could be with that home.”

People are even more likely to overlook those risks, she said, when they are in a hurry to snap up a home before someone else does. “You run into this lack of awareness and lack of time, which is not a good combination.”

A HomeAdvisor report found that Americans did an average of 1.2 emergency home repairs in 2020, up from 0.4 in 2019, while emergency home spending jumped to an average of $1,640, up $124 from the 2019 average.

References:

  1. https://www.wsj.com/articles/these-people-rushed-to-buy-homes-during-covid-now-they-regret-it-11613062856
  2. https://www.wsj.com/articles/americans-want-homes-but-there-have-rarely-been-fewer-for-sale-11600680612?mod=article_inline

* Candace Taylor, Real Estate Reporter and Editor at The Wall Street Journal

Capital Gains Taxes on Real Estate

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“For a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.” Winston Churchill

If you sell your home and make a profit, you will pay taxes for the capital gains on your home sale if you can’t qualify for an exemption or defer paying taxes through a 1301 Exchange.

Capital gains are the profits you make from the sale of a capital asset, such as a home or stocks, according to the Internal Revenue Service (IRS). When selling your home, the amount of money you pocket after paying off your mortgage and related obligations is considered a capital gain. If you sell your home for less than it’s worth, then it’s considered a capital loss.

Two types of capital gains and losses…short-term and long-term.

  • If you own the asset for less than a year, that profit is taxed as ordinary income or at your normal income tax rate. This is referred to as short-term capital gains.
  • If you own the asset for more than a year. Instead of being taxed at your normal income tax rate, these profits are taxed at the lower tax rate for long-term capital gains.

Capital gains are considered income by the IRS and may be taxed. Short-term capital gains tax rates match standard income tax rates, while long-term capital gains tax rates vary by filing status and income. And, long-term capital gains tax are significantly lower than normal income tax rates.

Capital gains tax exemption

Capital gains of up to $250,000 ($500,000 for joint filers) on the sale of a principal residence may be excluded from gross income every two years.

You can sell your home and not pay capital gains tax based on rules in the 1997 Taxpayer Relief Act which exempted from taxation any capital gains on the sale of a primary residence.

For a capital gains tax exemption, you can exclude up to $250,000 of gain on the sale of your main home. Certain joint returns can exclude up to $500,000 of gain. You must meet all requirements to qualify for a capital gains tax exemption:

  • You must have owned the home for a period of at least two years during the five years ending on the date of the sale.
  • You must have used it as your main home for at least two years during the past five-year period after the sale or exchange.
  • You can’t have used the exclusion for any home sold or exchanged during the two-year period. This period ends on the date of the current sale or exchange.

If you don’t qualify for the full capital gains tax exemption exclusion, you’ll be able to get a reduced exclusion with an exception. There’s an exception if all of these apply:

  • You sold the home due to a change in employment.
  • You didn’t meet the ownership and use tests.

This applies if you started work with a new employer or continue working with the same one in a different place. It also can mean the start or continuation of self-employment.

If the change occurred when you used the home as your main home, this can be considered the reason you sold your home. Your new place of employment must be at least 50 miles farther from your former home than was your former place of employment.

And, if you can exclude all of the gain, you do not need to report the sale on your tax return. If you have gain that cannot be excluded, it is taxable. Report it on Schedule D (Form 1040).

If you own multiple homes, you’re required to pay capital gains taxes on the sale of any home that isn’t your main residence. The act applies to only the dwelling that you consider your primary residence.

“Taxes are your largest single expense.” Robert Kiyosaki

Understanding capital gains exemptions for real estate

You may qualify to either fully or partially exclude the capital gains on your home sale from being taxed. Below, we break down the eligibility requirements for each exemption type.

IRS full exemption

You must meet the IRS eligibility test to be eligible for the full capital gains exemption on your home sale. The eligibility test requires you to meet the following requirements.

  • Ownership. You must have been the owner of the property for at least two of the last five years. If you’re married, only one spouse needs to meet this requirement.
  • Residence. You must have used the home as your primary residence for at least two of the last five years. The residency does not have to be completed consecutively, but both spouses must meet this requirement.
  • Look-back. You must not have used the capital gains tax exemption on another home sale within the past two years.

Borrowers who meet these criteria may take advantage of the maximum exemption allowed by the IRS.

The 1031 Exchange.

One option to avoid paying taxes on capital gains is a “like-kind exchange” per Section 1031 of the tax code. In short version, you can take the proceeds from selling one property and use them to buy similar property, and defer paying the capital gains taxes on the sold property.

A “like-kind” property usually means a property used similarly. For example, you can sell a property used as rental property and use the profits to buy another property to be used as rental property.

There’s a time limit. Within 45 days of selling the original property, you have to “nominate”—identify to the IRS—the new replacement property you’ll be buying. Then, you have to actually buy it within a total of 180 days from when you sold the old property.

A 1031 exchange doesn’t mean you avoid paying taxes on your gains. When and if you ever sell the new property for a profit, you’ll owe capital gains taxes on it.

Once you sell the property, you’ll owe capital gains taxes on the property, unless you do another 1031 exchange, in which case you can keep buying higher-priced properties and keep deferring capital gains taxes indefinitely.

1031 Exchange Rules

If you plan to use a 1031 exchange, understand that there are some pretty strict rules that mus be followed. If you don’t, you won’t get the tax-deferred exchange.

  1. Properties Must Be “Like-Kind”. The IRS requires that the property being sold and the replacement property must be “like-kind assets.” Also, keep in mind that the property must be an investment, not your primary or secondary home.
  2. The Replacement Property Should Be of Equal or Greater Value. In order to completely avoid paying any taxes upon the sale of your investment property, the IRS requires that the replacement property being acquired is of equal or greater in value than the property being relinquished. And, the replacement property price must be greater than the sale price of the relinquished property, not just the profit you made.
  3. 45-Day Identification Window. You must identify the property you plan to close on within 45 days or lose the entire benefit of the 1031 exchange. The timer doesn’t start until the day you sell your property.
  4. The 180-Day Closing Window. The clock for the 45-day window starts ticking the moment the relinquished property is sold. At this same moment, another clock begins counting down. Its known as the 180-day closing window. The IRS requires that the new replacement property be fully purchased (the title officially transferred) within 180 days of the sale of the relinquished property. This rule, along with the 45-day rule, is strictly enforced. Your entire 1031 exchange will fail if you do not meet both rules.
  5. Qualified intermediary. One of the most important rules governing the entire 1031 exchange process is that you must not touch the money of the sold property to avoid the taxes. Although there may be up to 180 days in between the sale of the sold property and the purchase of the replacement property, the proceeds may never enter your bank account or an account controlled by you. Instead, you are required to use a qualified intermediary who is someone who holds onto your money while you wait to buy the new property. A qualified intermediary cannot be you, your agent, your broker, your spouse, your family member, your investment banker, your employee, your business associate, or anyone who has had one of these roles in the past two years.

In summary, a 1031 exchange allows you to “defer” paying any property taxes on the investment property when it is sold, as long as another “like-kind” asset is purchased using the profit received.

References:

  1. https://www.msn.com/en-us/money/realestate/how-to-avoid-capital-gains-taxes-on-real-estate/ar-BB107jT3#:~:text=You%20could%20partially%20or%20fully%20avoid%20a%20capital,fall%20below%20the%20threshold%20for%20your%20filing%20status.
  2. https://www.biggerpockets.com/blog/real-estate-investing-legally-avoid-capital-gains-taxes
  3. https://www.biggerpockets.com/blog/2015-09-24-1031-exchanges-real-estate

Asset Allocation

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Asset allocation is one of the most important factors in your success as a long-term investor according to many financial experts. It’s a hundred times more important than any stock pick and more important than knowing the next hot country to invest in… what option to buy… what the housing market is doing… or whether the economy is booming or busting.

Asset allocation is how you balance your wealth among stocks, bonds, cash, real estate, commodities, and precious metals in your portfolio. This mix is the most important factor in your retirement investing success.

Ignorance of this topic has ruined more investment and retirement portfolios than any other financial factor. Many investors have no clue on what a sensible asset allocation should be. So they end up taking huge risks by sticking big chunks of their portfolios into just one or two investment assets.

For example, people who had most of her wealth in real estate investments in 2008 experienced significant losses when the market busted in 2009. Or consider employees of big companies that put a huge portion of their net worth or retirement money into their company stock. Employees of big companies that went bankrupt, like Enron, WorldCom, Bear Stearns, and Lehman Brothers were totally wiped out. They believed in the companies they worked for, so they kept more than half of their retirement portfolios into company stock.

And it’s all because they didn’t know about proper asset allocation. Because of this ignorance, they lost everything. These examples demonstrate why asset allocation is so important because keeping your wealth stored in a good, diversified mix of assets is the key to avoiding catastrophic losses.

If you keep too much wealth – like 90% to 100% of it – in a handful of stocks and the stock market goes south, you’ll suffer badly. The same goes for any asset… gold, oil, bonds, real estate, or blue-chip stocks. Concentrating your retirement nest egg in just a few different asset classes is way too risky. Betting on just one horse or putting your eggs in a single asset basket is a fool’s game.

Spread your risk around.

A sensible asset mix should include five broad categories… cash, stocks, bonds, real estate, and precious metals. And, a favorite asset of all long-term investors should be cash. “Cash” simply means all the money you have in savings, checking accounts, certificates of deposit (CDs), and U.S. Treasury bills. Anything with less than one year to maturity should be considered cash.

It’s best to keep plenty of cash on hand so you can be ready to buy bargains in case of a market collapse. Investors flush with cash are often able to get assets on the cheap after a collapse – they can swoop in and pick things up with cash quickly, and often at great prices.

Generally, it’s recommended to hold between 10% and 15% of your assets in cash, depending on your circumstances. In fact, one of the major tenets of good financial planning is to always have at least 6 to 12 months of essential living expenses in cash in case of disaster. If you haven’t started saving yet, this is the No. 1 thing to start today.

Next, you have conventional equity stocks. These are investments in individual businesses, or investments in broad baskets of stocks, like mutual funds and exchange-traded funds (ETFs). Stocks are a proven long-term builder of wealth, so almost everyone should own some. But keep in mind, stocks are typically more volatile than most other assets.

Just like you should stay diversified overall with your assets, you should stay diversified in your stock portfolio. Once, a well-known TV money show host ask callers: “Are you diversified?” According to him, owning five stocks in different sectors makes you diversified. This is simply not true. It is a dangerous notion.

The famous economist Harry Markowitz modeled math, physics, and stock-picking to win a Nobel Prize for the work on diversification. The science showed you need around 12-18 stocks to be fully diversified.

Holding and following that many stocks might seem daunting – it’s really not. The problem is easily solved with a mutual fund that holds dozens of stocks, which of course makes you officially diversified.

Next you have fixed income securities, with are generally called “notes” or “bonds.” These are basically any instrument that pays out a regular stream of income over a fixed period of time. At the end, you also get your initial investment – which is called your “principal” – back.

Depending on your age and tolerance for risk, bonds sit somewhere between boring and a godsend. The promise of interest payments and an almost certain return of capital at a certain fixed rate for a long period of time always lets me sleep well at night.

Adding safe fixed-income bonds to your portfolio is a simple way to stabilize your investment returns over time. For people with enough capital, locking up extra money (more than 12 months of your expenses) in bonds is a simple way to generate more income than a savings account.

Another asset class is real estate. Everyone knows what this is, so we don’t need to spend much time covering this. If you can keep a portion of wealth in a paid-for home, and possibly some income-producing real estate like a rental property or a farm, it’s a great diversifier.

Precious metals, like gold and silver, an important piece of a sensible asset allocation

Precious metals, like gold and silver, are like insurance. Precious metals like gold and silver typically soar during times of economic turmoil, so it’s wise to own some “just in case.” Avoid the mindset of the standard owner of gold and silver, who almost always believes the world is headed for hell in a hand basket. You should remain an optimist, but also a realist and own insurance. Stay “hedged.”

For many years, the goal with hedging strategies was to protect wealth and profits from unforeseen events. Wealthy people almost always own plenty of hedges and insurance. They consider what could happen in worst-case scenarios and take steps to protect themselves. Poor people tend to live with “blinders” on.

So just like wearing a seat belt while driving or riding in a vehicle, it’s important to own silver and gold – just in case. For most people, most of the time, keeping around 3% to 5% of your wealth in gold and silver provides that insurance.

Asset allocation guidelines

There’s no “one size fits all” asset allocation. Everyone’s financial situation is different. Asset allocation advice that will work for one person, can be worthless for another.

But most of us have the same basic goals: Wealth preservation… creating safe consistent income… and safely growing our nest egg. We can all use some guidelines to help make the right individual choices. Keep in mind, what I’m about to say are just guidelines…

If you’re having a hard time finding great bargains in stocks and bonds, I think an allocation of 15%… even 20% in cash is a good idea.

This sounds crazy to some people, but if you can’t find great investment bargains, there’s nothing wrong with sitting in cash, earning a little interest, and being patient. If great bargains present themselves, like they did in early 2009, you can lower your cash balance and plow it into stocks and bonds.

As for stocks, if you’re younger and more comfortable with the volatility involved in stocks, you can keep a stock exposure to somewhere around 65%-80% of your portfolio. A young person who can place a sizable chunk of money into a group of high-quality, dividend-paying stocks and hold them for decades will grow very wealthy.

If you’re older and can’t stand risk or volatility, consider keeping a huge chunk of your wealth in cash and bonds… like a 25%-35% weighting. Near the end of your career as an investor, you’re more concerned with preserving wealth and keeping up with inflation than growing it, so you want to be very conservative.

As a guideline, the big thing to keep in mind with asset allocation is that you’ve got to find a mix that is right for you… that suits your risk tolerance… your station in life. Whatever mix you choose, just make sure you’re not overexposed to an unforeseen crash in one particular asset class. This will ensure a long and profitable investment career.

In summary, asset allocation is how you balance your wealth or net worth assets among stocks, bonds, cash, real estate, commodities, and precious metals in your portfolio. It is the single most important factor in your success as an investor.

References:

  1. https://stansberryinvestor.com/media-article/328231?fbclid=IwAR2z_5CGah4ZGsSJPoMsSX8Tb9jExRTJIWmedbMI7Il18Wjii8RtjzFTDLg
  2. https://www.investopedia.com/terms/h/harrymarkowitz.asp