Friction
I’m a visual learner. From my many years as a high school teacher I know that many of you are probably visual learners as well. I’ve found that once I have a mental “picture” of an idea then I really own it.
Picture a small snowball rolling slowly down a hill. The bottom of the hill is about 50 miles down. Parts of the hill are really steep, parts are pretty flat. As the snowball rolls down the hill it will continue to get a little bigger with each roll. When it’s rolling fast, it grows faster. When it’s rolling slow, it grows slower. But it’s just about always growing.
Now picture trees and rocks lining the sides of the hill. Down the middle of the hill it’s clear. Along the sides there are trees and rocks. When your snowball bumps up against a rock or tree part of the snowball falls off. Sometimes it’s a small piece, sometimes a big piece.
This is my understanding of Warren Buffet’s investment strategy and his concept of frictional costs. Everyone knows that Buffet is the buy-and-hold guy. Buy an undervalued company stock. Hold it for the long run. Big returns. Buffet warns investors to steer clear of frictional costs. What’s a frictional cost? Well, every time you trade a stock you are charged a fee. That’s a frictional cost. Maybe you don’t trade your own stocks, maybe you have someone manage your money. Your money manager’s fees are a frictional cost.
The rocks and trees in my little mental picture are the fund managers and trading fees. The snowball is my money. The 50 mile hill is my investment life. Start with a little snowball and get rolling. Over time it will get bigger. Just stay away from as many rocks and trees as you can.
This picture popped into my head today as I was reading a couple of blogs and real estate forums where people were asking if it was a good time to buy Denver real estate. So many of the respondents simply said that it was a good time to buy. It made me wonder. A brokerage house makes money every time an investor buys or sells a stock. Doesn’t matter if the stock went up or down. The house makes money.
I think a more honest answer to the question: is it a good time to buy real estate in Denver, is: it depends on you. I don’t know if the market is at a bottom. I do know that real estate generally goes up over time, and that if you as an investor are planning on holding real estate as part of your overall investment strategy then it might be a good time to buy. Especially if you are sensitive to your frictional costs. When you are selling real estate your major frictional costs are taxes and real estate commission fees.
Just think of the snowball. If you start rolling a little snowball down the hill and you only let it roll for two miles before it bumps up against a tree and a rock, how much of the snowball will be left? Depends on how steep the hill is, right? Yes, to a certain extent it does. But isn’t it also clear that if you simply let the ball roll for a few more miles that it will likely get a lot bigger?
I don’t think it’s a great idea to buy a house with the intent of selling it in a year or two. Especially now when we can’t tell how steep the hill is. Be smart about your investing. Avoid the trees and rocks as much as possible and let it roll for as long as you can. There’s no arguing that the odds will swing in your favor the longer you let that snowball roll.
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