What Happens When the Boom Goes Bust?

According to the National Association of Home Builders, the average price for a new home in 1980 was $76,400. By 2005, it had climbed to $295,100.

That's incredible! $218,700 in caaash ...
Before you get too excited thinking about investing in real estate and flipping houses, ponder this: Over a 25-year period, that $218,700 gain comes out to a 5.6% annualized return.

Think about that. If your stock investments had grown at just 5.6% annually over the past 25 years, you'd be kicking yourself. And with good reason -- during that time, the S&P 500 earned 10.3% annually -- almost double the average gains in housing. Alcoa (NYSE: AA  ) (12%) would have more than doubled the average house's return, while Abbott Laboratories (NYSE: ABT  ) (14%) would have nearly tripled it, and Colgate-Palmolive (NYSE: CL  ) (23%) would have quadrupled it. Even Goodyear Tire & Rubber (NYSE: GT  ) , a long-run market underperformer, churned out a 7%-plus annualized gain from 1980 to 2005.

Treat investing like you treat homeownership
During the past eight years, home prices have grown at a much faster clip, so some of you are probably accusing us of cheating. We aren't.

Instead, we're taking a long-term view -- because that's the only view that can make you super-rich.

What's a mere million?
Consider that cocktail party story about Sal from Asbury Park who made a million a few years ago flipping condos in Miami. It's a great story, and we'll go ahead and bet that bits and pieces of it are true. In fact, it might all be true.

But for every Sal from Asbury Park, there was a Jimmy from Hackensack who got in over his head and lost everything. Yeah, that happened, too. That's why the collapse of the subprime lending market has hurt companies from Toll Brothers (NYSE: TOL  ) to Fremont General (NYSE: FMT  ) .

And even if Sal did make a million in 2003, is he set for life? Certainly not. In order to make that nest egg last, Sal can only withdraw about $40,000 per year. Our guess is that Sal wants to live better than that. So he probably kept flipping houses. Flipping and flipping until the Miami condo market came down around him. Or, if he's still holding properties, the real estate boom cycle has ended, and Sal will be lucky to eke out 5% returns over the next decade or more -- all the while servicing the debt he needed to buy those condos in the first place.

A cautionary tale
Of course, Sal's a figment of our imagination, but we invented him to make a point. One great year will not set you up for life. Even a short-lived real estate boom -- now ended -- won't make that happen. To set yourself up for life, you need decades of good years. And the stock market is the wealth-building enterprise that has demonstrated the ability to return 10% per year for decades. In other words, buy a house for the comfort, but buy stocks for the profits.

Don't get us wrong. That absolutely does not mean there won't be down years in the stock market. But history shows that the good outweighs the bad, and you can do better investing in stocks than in any other asset class.

Make your fortune in the market
Pick up any newspaper, and you'll be faced with pundits who think now is an uncertain time to start trying to make your fortune in the market. But they're taking the short-term view. You can do better by taking the long-term view.

That's what we do at Motley Fool Stock Advisor, where Fool co-founders David and Tom Gardner have posted greater-than-22% annual returns by investing in companies that are:

  1. Built to last for 100 years or more.
  2. Little-known, yet dominating their growing industries.
  3. Steered by committed management teams.
  4. Governed by the highest corporate values.

These types of investments will help you feel comfortable taking the long view. Even better, they'll help you earn great returns for decades.

If you need a few stock ideas, you can see the stocks David and Tom are recommending for your money today by clicking here to join Stock Advisor free for 30 days. There is no obligation to subscribe.

This article was originally published on March 9, 2007. It has been updated.

Tim Hanson and Brian Richards hear that New Jersey is nice this time of year. Neither Tim nor Brian owns shares of any companies mentioned. Colgate-Palmolive is a Motley Fool Inside Value recommendation. Contrary to what you may have read, the Fool's disclosure policy does not get hopped up on Mountain Dew or come at you like a spider monkey.


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