Friday, September 9, 2011

An Analogy to Help Deal with Market Volatility

A financial planner whom I respect, Michael Zhuang of Washington DC, had a great analogy regarding market volatility in a recent post to his blog:
Imagine your house has a ticker symbol, and it scrolls along the bottom of CNBC together with other ticker symbols. The price of your house, like a stock price, is set by a bunch of people you’ve never met making apparently random bets based on a combination of intuition, general economic statistics, output of an automatic-trading program, and, a couple of times a year, the real price achieved by one of your neighbors actually selling a house.

Minute by minute, the price of your home would gyrate wildly. If you are a nervous type, you might lie awake at night wondering if its value would cover your mortgage in the morning.

Of course, no one frantically checks their home value every day, wondering if he should sell.  But if we had minute-by-minute reporting of real estate values, your house would be every bit as volatile as your stocks.

Granted, your house is not just an investment, it is your home which has more than financial value.  But the same principle applies if the real estate in question was a rental duplex or an office building.  Thinking of your investment balances as something to update on a year by year - or even over multiple year - basis, like your real estate, will help keep your emotions on par with your plan.

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