As I write it this, the national housing market seems to be recovering slowly, although it is showing signs of slowing down again.

But certain markets seem to be going crazy.

Southern California, where I live, is one of them and the real estate market is on fire right now.

I’m currently in the market for a house myself, and I’ve also received several queries from clients asking if it’s a good time to buy real estate.

My misgivings about the real estate market in Southern California have been building over the past year, during which time home prices (and rents) have jumped about 20-25%. Despite the rental price increase, it is cheaper to rent than it is to buy.

My major concern was that Private Equity firms bought more than 20,000 homes last year as investments.  While this forces prices upward in the short-term, I worry about what will happen if they decide to sell them all at once.

Private Equity firms are not long-term investors. Highly opportunistic, they’ll bail as soon as something else looks better. Even if nothing does, they probably will start looking to liquidate in about three to five years.

On the negative side, the median wage has been roughly flat for the past five years – and 11% of LA County residents are on food stamps.

Mortgage applications have also been declining every month for a year, as fewer people now qualify for mortgages.  However, this has been offset by an increase in the number of all-cash home purchases.

Currently, 30% of all home sales are to all-cash buyers. Based on anecdotes from real estate agents, investors and lawyers, it seems like there are a large number of rich business owners from South East Asia are looking to park money in the SoCal real estate market.

If history is our guide, then foreigners are more likely to invest in real estate at market peaks rather than market bottoms.

The last time we saw a large influx of foreign buyers was during “Baburu Keizai”, or Japan’s bubble economy in 1990. It was said that a square inch in Tokyo’s Ginza district was more expensive than a square mile of land in the US.

And it ended badly for Japanese investors.

With home prices reaching astronomical levels all over Asia, could it be we’re going to see history repeat itself?

Given this economic backdrop, why would I be willing to buy a home in this market?

Why would I be willing to tie up a major portion of my networth in an illiquid asset with uncertain prospects?

Why would I be willing to join the 39,000 foreigners who moved to Los Angeles County in the past year and maybe buy at the top of the market?

Why would I be willing to pay 20% more to own a home vs. renting it (even after factoring in the tax break)?

Why would I promote the current home-buying frenzy that has resulted in 87.8% of homes having multiple offers, and 53% of them selling for over the asking price?

Is it because I think home ownership is a good investment?

Do I think that paying 4.7% over list price and besting four other offers is the hallmark of a smart investor?

No, not at all.

The best reason to buy your own home is for your own personal reasons, not economic ones.

Despite what the media tells you, your home is not your largest investment. If it is, it just means you’ve done a lousy job of saving and investing for your future. Catherine Rampell over at the Washington Post has an excellent article on the “fetishization” of home ownership.

Over the past century, homes appreciated at 0.3% over inflation, and far, far less than the 10.11% of stock market returns.

Your home is not an investment. It’s a money pit.

You buy it because it provides shelter, warmth and a safe, stable place to raise a family. And especially for men (who become more grouchy as they get older), it provides a place to barricade themselves from their neighbors!

Your home is your largest liability, and should be treated as such.

As a liability, you need to make sure you don’t become house-horny and bite off more house than you can afford. (House-horniness is an emotional condition that stems from lusting over champagne homes on a beer budget, and often results in misery: source Dr Housing Bubble)

Keeping your loan balance under 3.5 or 4 times your annual household income will help prevent becoming house-poor. (Ideally, you want it around 3 times household income).

When considering your purchase, don’t forget to include property taxes, insurance costs (which should also include an umbrella policy), HOA fees or maintenance, and larger utilities & water bills.

Since you can no longer complain to your landlord or building supervisor if something breaks, it’s now your responsibility to fix everything. So count on additional headaches too.

As embarrassing as it is to admit that we got in to a small bidding war during what’s possibly a market peak, at least we are in a position to afford it and not be house poor.

And unlike the previous bubble, I can take solace in the fact that I’m competing with all-cash buyers and not minimum wage workers with NINJA loans (No Income, No Jobs or Assets).

But that still doesn’t make it a good investment!

The point is not to confuse a home purchase with an investment.  Unless you’re planning to rent out all the spare bedrooms and cover all your costs. (Something I would have considered if I was 20 and single).

With an investment, you expect to make money, either through regular dividends or interest payments, or when you sell.

With your own home, the best you should expect is to break even when you sell (after considering inflation and opportunity costs).

I don’t expect to sell this home for decades, but when I do I know inflation will have boosted its value. It’ll probably sell for five times it’s currently worth – but that will be because everything will cost five times more, not because it’s a great investment.

So if you’re in the market for house as well, make sure you buy something that won’t make you house poor and because it’s the right time in your life to make that sort of long-term commitment.

Also be cognizant of the fact that you could be living in your house for a lot longer than you realize.

If property prices drop you could find yourself underwater with no down payment for a larger home. Alternatively, if the economy recovers causing a spike in interest rates, you might not be able to afford a bigger house with the larger mortgage payment.

Owning a home also limits your mobility in terms of future employment opportunities.

But so long as you have a stable job, can afford the payments and are okay with the possibility of having to stay put for longer than expected, you should be fine.

Five years, Bloomberg ran a special about the hidden fees in nearly all 401(k) plans.

Most participants thinks that there no fees in these plans. Over half of HR managers also think the same thing.

Since then, things have gotten slightly better, but not by much.

Congress has since mandated that all plans disclose the fees charged to the participants in 401(k) plans, it’s still notoriously hard to figure out.

One way the average user can figure out their fees is using Brightscope.com. While it may not be 100% accurate, it’s still a step in the right direction.

According to Bloomberg, Hedge Funds underperformed the S&P 500 for the fifth year in a row. On average, they delivered 7.4% vs. nearly 30% for the S&P.

This isn’t surprising.

Several years ago, legendary investor Warren Buffet bet $1 million that the S&P 500 index would bet Hedge Funds over a ten year period. At that time, the index was deep in the hole, having been down about 38% in 2008. Hedge Funds were slightly ahead, being only 24% down that year. (To see the arguments on both sides of the actual bet , click here).

But since then, the index has pulled ahead.

And that’s not surprising either.

Hedge funds are designed to make their managers and employees rich – not the investors.

Even if it were possible to accurately predict the future, repeatedly and consistently over a long period, the exorbitant fees charged by Hedge Funds make it unlikely the investors would actually prosper.

Hedge Funds usually charge a flat 2% per year of assets under management. Additionally, they levy a 20% performance fee on top of that.

Even if you were naïve enough to believe that a superior manager could outperform the market by 2-3% a year, paying 2-and-20 in fees would put you behind.

No wonder Buffett made a $1 MM bet.

In case you’re still debating whether to put your hard-earned money in a Hedge Fund, I strongly recommend this book: The Big Investment Lie: What Your Financial Advisor Doesn’t Want You to Know by Michael Edesess.

The US stock markets have been on a tear this year, with the S&P 500 up about 30%.

However, world stocks have lagged in performance, and are currently over-sold. Over-sold is a somewhat ill-defined term, and in this context means the price of a stock is selling at less than 1 standard deviation below it’s 50 day moving average. Stocks that are oversold are more likely to undergo mean reversion, and the prices will increase.

Here’s an interesting chart from Bespoke Investments.

As I mentioned in my last post, interest rates are likely to stay low for quite a while.

Investors are starved for yield, and have been bidding up the prices of dividend-paying stocks.

Boring stocks of electric companies and consumer staples (companies that make toothpaste, soap and cereals) usually have limited growth opportunities. Instead of reinvesting their earnings, they tend to pay it out to investors in the form of dividends. As a result, these stocks have slightly higher dividends, and trade at a slight discount to the market (based on their Price/Earnings ratios).

Investors in these sectors are exchanging growth for income.

However, in today’s environment, these stocks are trading at a premium to the average market. Overpaying for income is not how investors make money in the long run.

On the contrary, mature technology companies with massive profit-margins, steady growth prospects, but low dividends, are trading at a discount to the market.

So there is definitely some dislocation in the US markets. But based on continuance of quantitative-easing and the super low interest rates, this trend is likely to continue.

Looking at the foreign markets, we see better valuations in general.

At 14 times forward earnings, European stocks are currently 12% cheaper than their US counterparts, and have 50% higher yields too. However, they’re cheaper than they look on the surface.

Profits at US companies are hitting record highs, whereas in Europe they are at market cycle lows, and are on the upswing. As profits expand, so will the stock price and the yield.

The emerging markets are even cheaper. At less than 12 times forward earnings, they’re more than 25% cheaper than US stocks.

While emerging markets have been the sore spot in investor portfolios, significantly underperforming US stocks for the past three years, they are currently so cheap they warrant inclusion. Here’s an excellent paper by Vanguard on this topic.

But investors can do better than just buying cheaply here.

According to research by Jim O’ Shaughnessy, author of What Works On Wall Street, tilting towards undervalued, dividend-paying stocks in emerging markets beats the category by 10.6% per year over the long term.

As I’ve said before, maintaining a globally diversified portfolio is the key to long term wealth.

And global stocks definitely looks primed to perform well in the coming year.

But be sure to see our disclaimer.

The US stock market returns has certainly had a banner year, so far.

We’ve certainly had a lot to worry about such as the fiscal-cliff tug-of war, various European government and political scares, capital flight from emerging markets, tapering of the Federal Reserve bond-buying program, and the US Government shutdown.

And yet the market has maintained its solid march upwards, hitting new highs last week.

But while the stock market has been climbing higher, people looking for income to live on are stuck.

Right now, it’s the toughest environment for generating income in over 100 years.

According to data from Global Financial Data, a portfolio consisting of 60% stocks and 40% bonds has historically generated an average 4.4% yield. Right now you’re looking at an all-time low of less than 2.0%.

Janet Yellen, the new Federal Reserve Chairman, said she’s going to maintain this low interest rate environment.

An astute observer might think that low interest rates seem like a punishment for savers and especially for retirees. And they’d be right.

When faced with a similar question, Yellen said “we have to consider the role of people who have significant savings and their responsibility in society, that it really is selfish to be hoarding it and that we need to create incentives through government for people to spend their savings,  because that’s exactly what we need in order to rejuvenate the economy.”

Yes, the new Federal Reserve Chairman thinks people who save their money are selfish. And they need to spend their savings to help boost the economy.

Not only that, at a recent Senate Banking Committee hearing, she said if she could figure out how, she’d even introduce negative interest rates. This means you’d have to pay the bank to keep your money in a savings account, while those taking out a loan would be paid interest by the bank.

 You might think this is an incredibly stupid idea. I do.

Regardless of whether she’s right or wrong, the truth is that interest rates are going to stay close to zero for a very long time.

The Federal Reserve is going to maintain its loose monetary policy, which means the bond buying program is going to stay strong.  This bond buying injects money in to the economy, and it’s going to end up in stocks and real estate, and continue to push the prices higher.

Meanwhile, the US stock market has gone more than 18 months without a 10% correction. While we are not in bubble territory, as a whole, they are fairly valued.

But that doesn’t mean that prices are going to stop rising here.

Most likely, they’re going to continue their rise for quite a while. As previously explained, rising interest rates won’t stop this increase either.

As always, the best course is to keep calm and stay invested!

Based on my prior experience buying nearly two dozen homes across the country, I’m frequently asked for advice on buying real estate.

The attraction to real estate investing is easy to understand. Although real estate can’t be expected appreciate more than the rate of inflation (unless you have the vision to buy in to an area where demand is about to take off, such as Southern California circa 1960), the leverage and tax breaks make it look promising.

And the recent downturn, coupled with the ultra-low mortgage rates, have made real estate a hot investment in the past 12 months.

In Los Angeles, the median home price has jumped an eye-popping 23% in the past year, from $422,000 to $520,000.

So what does the future hold?

While it’s always hard to predict anything, it definitely looks like housing is getting overvalued in some areas.

Looking at the ratio of Median Home Prices/Median Household Incomes, we can see that California is getting expensive on a historical basis.

According to John Burns Real Estate Consulting, it’s 50% higher than the historical average in Los Angles, Orange County, San Diego and San Francisco.

[Click to enlarge]

That’s not to say you can’t find a good bargain in this market. But they’re becoming a lot harder to find.

Unless you’re buying a house to live in yourself, it might be better to look in Florida, Arizona or  Nevada to get a better deal.

Wow, it’s been five years already. Five years ago it looked like the entire financial industry was about to collapse.

Major financial institutions, global banks, and hedge funds of assorted varieties went bankrupt. Companies like Bear Sterns, Washington Mutual and Lehman Brothers are no longer around. They either went out of business, or were acquired by other firms with assistance from the Federal Reserve.

The common thread was excessive leverage, and a lack of understanding of the underlying investments.

The resulting economic meltdown caused the biggest recession since the Great Depression, and a 43% decline in the S&P 500 (a broad index of the US stock market). Between March 2008 and February 2009, many investor portfolios that weren’t properly diversified across different asset classes saw declines of 50% or more.

Since then, the US economy has been slowly grinding forward. It no longer seems like we’re on the verge of economic collapse, but we’re not in a booming environment either.

Unemployment is still high (Forbes has a good article on why unemployment is higher than you think). The median household income, adjusted for inflation and seasonality, is 7% lower than it was in 2007.

But the US stock market has been on a tear and has achieved new highs several times this year. In the past 3 years, the S&P 500 is up 55%.

Some investors believe that the recent rise in stocks in not reflective of the current economic situation.

If you add the fear of rising interest rates to this mix, you wouldn’t be surprised if they though a sharp decline in the stock market is imminent.

And in fact, the stock market has drifted lower over the past weeks – rare for this year, although not uncommon for the month of August.

One question I’m frequently asked is whether it’s a good time to invest or not? I get asked this question, regardless whether the stock market is up or down, after all,  there’s always something to worry about.

But this time, it’s prefaced with one scenario we haven’t seen for an entire generation – the real threat of rising interest rates.

 “Stocks are at an all-time high, and interest rates are definitely going higher. The stock market is going to collapse. I’m scared about my future!”

What Happens To Stocks When Interest Rates Rise?

While history doesn’t always repeat itself, it often rhymes with the past. So let’s look back at the last time we were in a similar situation to see what happened to stocks.

We have to look back a really long time –  nearly 60 years.

Back in 1950 the Federal Reserve had manipulated interest rates to keep them artificially low and bottomed around 2.3% (not too far from where they are this time around).

But in 1955, the interest rates reversed their trend and started moving upwards. It wasn’t until 1969 (nearly 15 years) that interest rates hit 6%.

Between January 1^st 1995 and December 31^st 1969, the stock market had a compound annual return of 10.02%. (Note, compound annual return is the geometric return, and not the somewhat misleading simple average or arithmetic return which was 11.16%)

The last time interest rates went from 2.7% to 6%, the stock market went up four-fold!

Were stocks much cheaper in 1955 than they are today? Not really.

In 1954, the stock market rose 56%, and by 1955 stocks were trading a Price/Earnings multiple of 13. We’re currently trading at a P/E of 16, and if you believe 2014 estimates then we’re only at a P/E of 14.

And if you’re investing in a globally diversified portfolio, you’ll be buying international as well as emerging market stocks – all of which are currently cheaper than they’ve been in the past few years.

A lot of my favorite large-cap dividend-paying international stocks are trading at P/E multiples between 9 and 12.

Prudent investors buy stocks when the P/E is historically low.

So while no one can reliably predict the future, I expect the future long-term returns of a well-balanced and globally diversified portfolio to be quite good. We might see some ups and downs, but we’re still a long way away from being ridiculously over-valued.

Sticking to your predetermined investment plan regardless of short-term events is the best way of reaching your long-term goals. As always, keep calm and carry on!

Sometimes the direction of the market can change with just a few words.

That was certainly the case on June 19^th, when the Federal Reserve Chairman Ben Bernanke mentioned the possible end of QE3 in 2014 and the prospect of reducing the central bank’s monthly bond purchases later this year.

Almost immediately, nearly all global asset classes started to sell off. Including the ones that are supposed to be uncorrelated.

Choosing uncorrelated asset classes is the cornerstone for a well-diversified portfolio. History shows that over the long term, this helps smoothen investment returns, which are usually quite volatile.

But once in a while, everything correlates to the downside.

The week after June 19^th was one of those times. Stocks, bonds, commodities – everything got hit pretty hard.

Investors often get caught up in the fluctuations of the market. They panic and sell when prices drop, then fall victim to “irrational exuberance” and buy when prices soar.

This is a sure way to lose money.

And research from Dalbar shows us how much this behavior costs.

During the 20 year period ending in 2012, the S&P 500 index returned an average annual 8.21%. But the average person who invested in stock mutual funds earned only 4.25% – trailing the stock market by almost 4% a year.

While part of this loss can be attributed to high mutual fund fees, most of it is due to investors jumping in out of the market at “bad” times. For investors in bond funds, the returns are even worse.

The best course of action for investors is to accept that markets cannot be timed, and build the expectation of unexpected events (also called black swans) occurring from time to time.

Investors don’t earn returns smoothly over time. Instead, they earn them largely as a result of unpredictably bursts and crashes. Given that much of the action happens on such a small number of days, the odds of successfully predicting the days to be in and out of the markets is close to zero. The real danger is not being there when the big moves occur.

Predicting market tops to sell and bottoms to buy back in is an impossible feat. It’s entertaining, but not a good way to make money.

The only way to “beat the market” is by keeping calm and using these pullbacks as an opportunity to rebalance your portfolio to your predetermined asset allocation.

In theory this can be tough to accomplish.

Especially when so-called “safe” investments like bonds and bond funds declined more than 5% in just a few weeks.

Bonds are one of the beneficiaries of the Fed’s Quantitative Easing or bond buying program. The Fed’s consistent buying keeps the demand strong, the prices high and the yields low. Withdrawal of this support would cause demand to decline and interest rates to spike.

And if interest rates (and yields) go up, bond prices will fall in proportion to the duration.

Duration is the amount a bond (or bond fund) would decline, if interest rates rose 1%. For a bond fund with a duration of 5 years, a 1% increase should correspond to a 5% decline in the price.

Last month, the yield on the 10 year treasury rose about 1%.

However, a lot of bond funds lost more than the anticipated amount you would expect. In the case of certain closed-end funds, the decline was significantly more. In some cases, it was closer to 8 or 9%.

This is like selling a dollar for 92 cents! And it leads me to believe that the selling is probably over-done in the short term.

In the long term, you don’t have much to worry about either. As your interest from bonds gets reinvested, it will buy bonds with a higher interest rate, generating a higher future income.

So, as hard as it sounds, stick to your investment allocation.

Hopefully your bond exposure is limited to funds to short durations, limiting your risk to rising interest-rate.

Otherwise, there’s not too much to be worried about. As I mentioned in May, the summer stock swoon was expected. Just keep calm and carrying investing.