Author Topic: Investing in stocks or real estate based on the current p/e ratio  (Read 3592 times)

cburton103

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I'm still pretty new to the savings/investing/Mustachianism game, so I wanted to run my rough plan by some people smarter than me.

A little about us financially. My wife and I both have high W2 incomes, max out our 401(k) plans (I can put in $53,000 per year because I am self-employed, the wife gets about $25,000/yr including her match), and we just finished paying off my $150,000 in student loans back in September of 2015. Ever since then, we've been accumulating money in our bank accounts deciding what to do next. We currently don't have an HSA as an option, and we're beyond the income level where we can contribute to a traditional IRA with tax deductions.

Goals:
Likely retire early or cut back to part time work at some point in our early thirties (I'm 28 and the wife is 26). We plan on starting a family soon, and we love to spend time with family and camp (mostly backpacking or canoe camping).
Pretty passive income. I don't mind the idea of looking for rental properties, but we almost definitely do not want to manage them. We value our free time a lot, and aren't looking for property management to be a part time job.
Reasonably stable cash flow, but without overly sacrificing long-term total returns.

Rough plans:
Max out both 401(k) plans (~75-80K/yr). Mine is invested in VTSAX(60%), VTIAX(30%), and a small position in VGSLX. My wife's options aren't as good, but she has hers in a higher fee index fund and about 25% in XOM.
With after tax money (probably around $80-100K/yr), we would like to invest in taxable Vanguard accounts and in real estate. Does it make sense to have a rough guideline of buying VTSAX when the p/e ratio is below 18, and buying real estate when we find a particularly good deal and/or when the stock market p/e ratio is higher than 20 or so? I'm moderately leery dumping a ton of after tax money into index funds currently with the high valuations. Like everyone else, I would like my money working as hard for me as possible.

I realize my wife and I are in a great position with our incomes, and I don't want to waste this potential. We both have pretty simple tastes, and like simplicity and freedom more than the allure of fancy stuff. How can we best take advantage of our situation? By the way, we live in Houston, TX, and would likely be investing in real estate locally. Thanks for the help!

matchewed

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #1 on: January 08, 2016, 09:55:42 AM »
Not in any particular order

1) Don't try to time the market. If the market is good enough for your pre-tax dollars it's good enough for your post-tax dollars.

2) Learn about Real Estate. Read some books, figure out what you want, and ask some questions. Then determine if it's good for you.

3) Write an IPS. This will guide you in your investing regardless of random variables outside of your control.

4) Read http://jlcollinsnh.com/stock-series/

Edit* Also do you know how many different topics have been asked about the p/e ratio and what people should invest in when you take it in regards? Tons. And for quite a few years. What has the market done since then? Gone up. What will the market do over the next 60+ years of your life? Go up.
« Last Edit: January 08, 2016, 09:57:14 AM by matchewed »

nereo

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #2 on: January 08, 2016, 10:56:14 AM »
+1 to everything matchewed said. 
Don't try to time the market.  Invest the money as soon as it's available (or at least within a month or so) - that's the easiest strategy and and perfectly acceptable form of dollar-cost-averaging.  Once you've written your IPS you will know where to invest each month. 
Then periodically rebalance to maintain your asset allocation.  You can do this once a year.  That's about all there is too it.

Kudos to your massive saving strategies.  I wish I could sock away $150k+/year.  You'll be FI in your early 30s for sure if you keep on this path.

hodedofome

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #3 on: January 08, 2016, 03:10:37 PM »
I'm guessing your wife works for Exxon?

I understand they have a pretty incredible retirement plan. As in, you have to work for them until you're 50 but if you do then you'll be able to retire exceptionally well.

My uncle never wanted to move up the ranks in XOM but he still retired in his 50s and spends his time traveling all over the place.

MustacheAndaHalf

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #4 on: January 08, 2016, 06:12:31 PM »
My wife's options aren't as good, but she has hers in a higher fee index fund and about 25% in XOM.
If she does work at Exxon, as another poster suggested, that's strange because Exxon's 401k plan receives good marks:
http://www.brightscope.com/401k-rating/55063/Exxonmobil-Corporation/55974/Exxon-Mobil-Savings-Plan/

I suppose it's too late to warn you about the danger of investing in one company's stock: Exxon lost -20% in 12 months.  Why invest 25% in Exxon in your wife's retirement?

Also note you have 0% allocation to bonds, so your retirement will be at the mercy of the stock market.  Main purpose of bonds in an asset allocation is to reduce portfolio volatility, and give you something besides stocks to sell when you need to pay for rent and other costs in retirement.

Zx

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #5 on: January 08, 2016, 07:19:41 PM »
My wife's options aren't as good, but she has hers in a higher fee index fund and about 25% in XOM.
If she does work at Exxon, as another poster suggested, that's strange because Exxon's 401k plan receives good marks:
http://www.brightscope.com/401k-rating/55063/Exxonmobil-Corporation/55974/Exxon-Mobil-Savings-Plan/

I suppose it's too late to warn you about the danger of investing in one company's stock: Exxon lost -20% in 12 months.  Why invest 25% in Exxon in your wife's retirement?

Also note you have 0% allocation to bonds, so your retirement will be at the mercy of the stock market.  Main purpose of bonds in an asset allocation is to reduce portfolio volatility, and give you something besides stocks to sell when you need to pay for rent and other costs in retirement.

It is? Crap. I have 25% of my 401k in my company's stock. The other 75% goes to what I think you call a retirement index fund 2020. I'm 51 and plan to retire, I hope, at 60.

cburton103

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #6 on: January 08, 2016, 10:16:18 PM »
Not in any particular order

1) Don't try to time the market. If the market is good enough for your pre-tax dollars it's good enough for your post-tax dollars.

2) Learn about Real Estate. Read some books, figure out what you want, and ask some questions. Then determine if it's good for you.

3) Write an IPS. This will guide you in your investing regardless of random variables outside of your control.

4) Read http://jlcollinsnh.com/stock-series/

Edit* Also do you know how many different topics have been asked about the p/e ratio and what people should invest in when you take it in regards? Tons. And for quite a few years. What has the market done since then? Gone up. What will the market do over the next 60+ years of your life? Go up.
Thanks for all of the replies. I know it sounds a lot like market timing (and it probably is), but I'm not considering selling any stock I've already bought due to the current p/e ratio of 20.25, I would just invest more of my additional cash into real estate when the p/e ratio is unusually high, and into stocks when the p/e ratio is closer to a historical norm (say 18 or lower). I understand that any given p/e ratio doesn't tell us anything about what's going to happen in the short term, but isn't it reasonably predictive about likely market returns over a longer upcoming period of time? i.e. higher valuations mean likely lower returns over the next "extended" period of time. That's what I understood MMM to mean in this article: http://www.mrmoneymustache.com/2011/06/09/how-to-tell-when-the-stock-market-is-on-sale/

So if I were to make an IPS, I could say that I want 30% real estate and 70% stock (65% of stock in VTSAX, 25% VTIAX, 5% VGSLX, and 5% other stock), but that I wouldn't "rebalance" in my accumulation phase unless those percentages get out of whack by 10%. So I would have a fair amount of play in the numbers such that I could add more heavily to real estate when the p/e ratio is above 20, but not so much that my real estate would ever be over 40% of my portfolio. Or are these terms too loose for an IPS?

I've read the stock series before a couple of times, it's great stuff. Part of the reason for my large cash position currently is that I've been specifically saving up for a down payment on a real estate property, since I've done a good amount of research and decided that I want to invest in a few SFRs to give it a try.

cburton103

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #7 on: January 08, 2016, 10:20:33 PM »
I'm guessing your wife works for Exxon?

I understand they have a pretty incredible retirement plan. As in, you have to work for them until you're 50 but if you do then you'll be able to retire exceptionally well.

My uncle never wanted to move up the ranks in XOM but he still retired in his 50s and spends his time traveling all over the place.

Correct, Exxon does still have a good pension plan. Like other pension plans, however, it doesn't really ramp up in worth until you've worked there for quite some time. We don't plan on working that long :)

cburton103

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #8 on: January 08, 2016, 10:26:34 PM »
My wife's options aren't as good, but she has hers in a higher fee index fund and about 25% in XOM.
If she does work at Exxon, as another poster suggested, that's strange because Exxon's 401k plan receives good marks:
http://www.brightscope.com/401k-rating/55063/Exxonmobil-Corporation/55974/Exxon-Mobil-Savings-Plan/

I suppose it's too late to warn you about the danger of investing in one company's stock: Exxon lost -20% in 12 months.  Why invest 25% in Exxon in your wife's retirement?

Also note you have 0% allocation to bonds, so your retirement will be at the mercy of the stock market.  Main purpose of bonds in an asset allocation is to reduce portfolio volatility, and give you something besides stocks to sell when you need to pay for rent and other costs in retirement.

I suppose her plan is better than I give it credit for. They have a really nice employer match for sure. Being a small business owner, I guess I'm just spoiled that I got to pick out my own plan, and as such can invest in the same funds in my 401(k) as I do in my taxable account.

And your point is definitely taken on individual stocks. We'll likely ride out the current cycle with XOM (and probably even pick up a Vanguard energy ETF) and then sell after they've gone back up, reverting back to our index funds indefinitely.

We've chosen to have a 0% bond allocation for our accumulation phase for simplicity and growth potential. We'll have around a 20-25% bond allocation if/when we retire early and need to live off our portfolio.

matchewed

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #9 on: January 09, 2016, 07:52:54 AM »
Not in any particular order

1) Don't try to time the market. If the market is good enough for your pre-tax dollars it's good enough for your post-tax dollars.

2) Learn about Real Estate. Read some books, figure out what you want, and ask some questions. Then determine if it's good for you.

3) Write an IPS. This will guide you in your investing regardless of random variables outside of your control.

4) Read http://jlcollinsnh.com/stock-series/

Edit* Also do you know how many different topics have been asked about the p/e ratio and what people should invest in when you take it in regards? Tons. And for quite a few years. What has the market done since then? Gone up. What will the market do over the next 60+ years of your life? Go up.
Thanks for all of the replies. I know it sounds a lot like market timing (and it probably is), but I'm not considering selling any stock I've already bought due to the current p/e ratio of 20.25, I would just invest more of my additional cash into real estate when the p/e ratio is unusually high, and into stocks when the p/e ratio is closer to a historical norm (say 18 or lower). I understand that any given p/e ratio doesn't tell us anything about what's going to happen in the short term, but isn't it reasonably predictive about likely market returns over a longer upcoming period of time? i.e. higher valuations mean likely lower returns over the next "extended" period of time. That's what I understood MMM to mean in this article: http://www.mrmoneymustache.com/2011/06/09/how-to-tell-when-the-stock-market-is-on-sale/

So if I were to make an IPS, I could say that I want 30% real estate and 70% stock (65% of stock in VTSAX, 25% VTIAX, 5% VGSLX, and 5% other stock), but that I wouldn't "rebalance" in my accumulation phase unless those percentages get out of whack by 10%. So I would have a fair amount of play in the numbers such that I could add more heavily to real estate when the p/e ratio is above 20, but not so much that my real estate would ever be over 40% of my portfolio. Or are these terms too loose for an IPS?

I've read the stock series before a couple of times, it's great stuff. Part of the reason for my large cash position currently is that I've been specifically saving up for a down payment on a real estate property, since I've done a good amount of research and decided that I want to invest in a few SFRs to give it a try.

No those terms aren't too loose. But I still think the p/e ratio is not the metric you should be utilizing. You should use the % and %deviations like you proposed. Remove the market timing.

JetBlast

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #10 on: January 09, 2016, 09:58:00 AM »
I'm not sure I'd have a hard rule about P/E ratio, but it makes sense to compare the expected returns from different investments and invest where your money will work its hardest for you, keeping in mind your own goals and personality.

If the market is sitting at a 20 P/E you are essentially buying 5% earnings on your cash plus market returns as time goes on.  It seems rational to me to compare that to other investments like real estate and see if another investment makes more sense. Of course you will have to compare the drawbacks to real estate (less liquid, more hands on, etc...) with the positives (leverage to enhance returns, easier for many to understand, no daily price quotes tempting you to sell).  Whether it makes sense will depend on the numbers and your temperament.


Woody Viet

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #11 on: January 09, 2016, 08:48:10 PM »
The first thing you need to do is build a solid knowledge of the fundamentals of investing. This will take time but the results will help you avoid a lot of mistakes. The biggest danger you have right now is there are probably a lot of things you haven't even thought about which can harm your investment results. You said you have read Jim Collins' stock series already which is great! Other things I have found helpful and you might want to read:

  • This post on the different kind of investment approaches http://www.joshuakennon.com/mail-bag-buying-stock-when-valuations-are-high/
  • The Intelligent Investor by Ben Graham and Warren Buffet's Shareholder Letters t (How to be a value investor)
  • A Random Walk Down Wall Street by Burton Malkiel and The Little Book of Common Sense Investing by John Bogle (How to be an index investor)
  • The Millionaire Next Door by Thomas Stanley (Who gets rich and why)

Your strategy to only buy the index when it's below a certain P/E suggests you are thinking like a value investor. Unfortunately the long run returns for this particular strategy aren't any better than just owning the stock index over time because:
  • The long run return of the stock market is so much higher than that of bonds or other cash investments. The time you spend out of the market means missed dividends and missed earnings growth
  • You can miss out on major periods of economic expansion where P/E rations happen to be high, see the 1990s
  • You miss out on periods where the underlying economy is severely depressed which create extremely low earnings, see the financial crisis (P/E rations got up into the 130s)
  • You still buy into markets with significant downside risk, see the 1970s and early 1980s

As others have said, unless you believe you have a significant edge over the global financial industry, market timing is a fools gambit. However, market pricing, which is buying assets which are cheapest relative to their underlying value, isn't necessarily in the same boat. In order to really succeed at this I believe you need to have alternative sources of assets which generate risk premiums similar to the US stock market. Something which I do is I only invest in the cheapest countries worldwide as measured by fundamental measures such as P/B, P/E and CAPE. You can find such information here https://www.researchaffiliates.com/AssetAllocation/Pages/core-overview.aspx and here http://www.starcapital.de/research/stockmarketvaluation. This involves investing in countries undergoing severe stress and usually a major crisis. Think Russia, China, Brazil, and the Eurozone a few years back. Not for the faint of heart. Again, you need to understand the risks involved. For example, here are a couple of risks that most beginner international investors would never consider:
  • Dividend witholding tax http://monevator.com/withholding-tax-on-dividends/
  • Most financial markets outside the USA have on average traded at discounts to the USA of around 10-30%. This includes developed nations such as the UK, Japan, France, Germany etc. This is reflected in the 'normal' or 'convergence' P/E for these countries being 10-30% lower. These countries are often not as cheap as they look
  • Unfriendly shareholder policies, mainly share dilution. This has been especially problematic in the fast growing economies in Asia
  • Concentration risk, where the index you are buying is dominated by a few very large companies. Take a look at this for an idea https://www.msci.com/resources/factsheets/index_fact_sheet/msci-russia-index-rub-gross.pdf
I guess the point of that list isn't necessarily to scare you away from investing. Rather to show that there are a lot of things to consider when starting out and everything you don't consider will end up costing you money.

In my opinion, the biggest decision you have to make is "how much time and energy am I willing to invest into learning about investing in order to potentially generate returns which are in excess of what I could get being an index investor." If the answer to that question is not much, then split your money between the Vanguard USA and Vanguard International Total Stock Market funds and get on with the rest of your life. If the answer is a lot, then start building your investment knowledge and don't deviate from indexing until you think you are informed enough to make intelligent decisions.

That turned out to be quite a long post! I hope it helps.
« Last Edit: January 09, 2016, 08:51:19 PM by Woody Viet »

cburton103

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Re: Investing in stocks or real estate based on the current p/e ratio
« Reply #12 on: January 10, 2016, 11:36:38 AM »
Thanks again for all of the replies and help. These are all things I've heard, but it's easy to see my hard-earned cash fall 10% a couple of times in the last few months and think, "Darn these high p/e ratios, they must be finally catching up with the market". As all of you have said, you really can't time the market. And that's almost a good thing, because it takes the pressure off of me in a way.

I'm going to adjust my IPS a bit (yes, I had a basic one, but this conversation is causing me to adjust it slightly), and just put money into my different asset classes as it becomes available. Then I can just get on with the rest of life doing things I can actually add value at and enjoy my hobbies. Thanks again everyone!