Hope and Gambling are not Strategies

Hope does not make for a great strategy, as any biography of Ben Franklin will remind us. But, many people do hope for such luck. This is reflected by the number of people who play the lottery, slot machines, or any other activity where the expected value of the payoff is far less than their bet. With a good, carefully planned investment, the expected value of the investment (or money put down) is far greater than the capital they’re tying up.

The chances of achieving wealth through luck alone are almost nothing. Sure, there are those who earn wealth ethically where luck was part of the equation. The point here is that luck is only part of the story. Abe Lincoln once said that if I prepare myself, perhaps my chance will come. Preparing yourself will reveal the “lucky” opportunities. In reality, people seldom build wealth from chance alone.

Good financial planning is a practical way to accumulate wealth over time. This is a slow, steady, and boring process. Yes, boring. Building wealth in a sensible manner doesn’t mean flipping houses and buying “dot com” stocks. This is just another form of gambling. Instead, it consists of having a plan that incorporates investing with regularly, diversification, and limiting risk.

As we have seen from the housing bust, it is important to take all assets into consideration. People traditionally thought of their house as being an investment. The reality is houses are a depreciating asset just like any other consumer item. These items get used and wear out. Therefore, there is considerable expense to owning a home. Inflation, over time, distorts housing prices.

In nominal (meaning not adjusted for inflation) dollars, real estate prices tend to rise over very long periods. This refers to spans of 20 years plus. However, when you adjust for inflation, resale value for the home remains fairly steady. The only exception is the recent real estate boom and bust cycle. Although the resale price is roughly the same after factoring in inflation, remember all the costs associated with maintenance and repairs. This equates to a large sum of money over a period of time.

When looking at all your assets, it’s vital to understand which ones are long term investments and which are consumer items. Although buying a home is often a great choice, it should not be classified as an investment. If you rent it out in the future, then you can re-categorize it at that point. Until then, it’s important to recognize it for what it truly is.

If you reach a point where that particular home gets rented, and it meets all the expenses, then you have a real investment. If you keep it hoping for the price to go back up or are looking for capital appreciation, then it is only a game of speculation.

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