The other day I posted this story citing a Gallup poll about how Americans think housing is the best possible investment out of most major asset classes. This is extremely strange considering how widespread the data is on real estate and its poor real, real returns. But it doesn’t explain why so many people believe this myth.
In a piece yesterday at the Washington Post Robert Shiller offered up his opinion:
“People remember home prices from long ago better than they remember other prices,” he says. “Ask anybody, ‘What did you pay for your home?,’ and they’ll remember even if it was 50 years ago. It will be some ridiculous number like $30,000. They then compare it to today’s prices, and it makes a big impression, and they forget there has been so much inflation since then.”
I think this is an excellent explanation. It points to a common bias related to asset prices – past price fixation. Past price fixation is our tendency to focus on past prices as justification for future buy/sell decisions. The purchase price of a home is obviously an important figure because homes are such an important part of the household balance sheet. So that price stands out in our minds. But we only remember the nominal figure. We don’t calculate anything close to the real, real return (the return adjusted for taxes, fees and inflation). So we tend to overstate the returns in real estate and consider it to be far superior than it really is. In essence, our behavioral biases fail us.
I think this not only explains the myth behind why people overstate the returns of real estate, but it also strikes another stake in the idea that consumers are in any way efficient or rational thinkers. In fact, we tend to think in such narrow financial terms that we often make highly irrational decisions. Our biases play a much more important component in our financial decisions than anything resembling order or rationality….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.