Most people think of the definition of volatility as sudden, unpredictable, or explosive change. Being a science major in college I’m reminded of the chemistry definition which is evaporating rapidly or the tendency of a substance to vaporize. This definition not only works in chemistry, but also works in the financial world.
Investopedia defines volatility as: A statistical measure of the dispersion of returns for a given security or market index..Commonly, the higher the volatility, the riskier the security. Just like in chemistry, the higher the volatility of an investment, the more likely you are to see your money evaporate.
Volatility is the reason that I left the stock market years ago. Volatility is that roller-coaster or yo-yo effect that you get with the market. The ups and downs I experienced made me nauseous and helped motivate me to find better investments.
Sure, some say ignore the volatility and invest for the long-term. How many doctors are still working today who planned to retire in 2008 or 2009? I personally know several. Last week I was reminded of why I hate volatility so much. I turned on the computer to read this headline from Forbes:
“WWE CEO Vince McMahon Loses $350 Million,A Third Of His Fortune, In A Day”
It must be a humbling experience free falling from billionaire status to millionaire status in 24 hours. Nevertheless, make no mistake, this guy will still be able to live his life as he sees fit.
However, what would happen to you or me if we lost a third of our portfolio overnight? That is the problem with high volatility investments. They are always just a sex scandal, or a bad quarter, or computer algorithm triggered sell-off away from a 40% overnight decline.
Most physicians are heavily invested in the stock market and paper assets. Putting your entire nest egg into highly volatile paper assets makes little sense. Diversification into commercial multifamily real estate without having to become a landlord can bring some well needed safety to such a risky portfolio.
Here is why:
- Commercial multifamily investing offers significant economic cycle protection
- Has the best risk-adjusted returns (Sharpe’s Ratio) of any other real estate class
- Has historically low volatility
Let’s take a deeper dive.
Commercial multifamily real estate follows population cycles and not economic cycles. As such, an investment in apartments offers significant economic cycle protection to your portfolio. To underscore this point, the National Council of Real Estate Investment Fiduciaries (NCREIF) looked at the 20 worst quarters for paper assets from 1978 to 2012. Despite the sharp downturn for paper assets, real estate was up 17 out of those 20 quarters. Given this lack of correlation with the stock market, it should come as no suprise that when the market tumbled in 2008, we apartment investors were making money.
Additionally, commercial multifamily real estate happens to be a low volatility investment. Simply put, low volatility means that you mostly have up years with very few down years.
The two graphs show essentially the same thing. The first one shows the low volatility of direct real estate ownership versus high volatility paper assets like stocks and publicly traded REIT’s.
The second graph shows the number of up years versus the number of down years over a 75 year period for real estate, stocks, and bonds.
Given this information, it is easy to see why commercial multifamily real estate is a low volatility investment.
In summary, volatility is risky business. As physicians, we have already lost a decade of our prime earning years to medical education. What would you do if a third of your portfolio was wiped out overnight? Never has it been more important to demand better investment results. Part of that strategy should involve having assets that offer economic cycle downturn protection as well as low volatility. Investing in commercial multifamily real estate can calm the turbulent tides of a stock market rich, high volatility laden portfolio.
P.S. Discovering how to get consistent double-digit returns and significant economic cycle downturn protection from commercial multifamily real estate has secured my retirement. Being body slammed by the volatility of the stock market and watching a third of your net worth evaporate into thin air must be horrifying. I can’t help but wonder if Mr. McMahon would still be a billionaire today had he diversified some of his portfolio into the world of commercial multifamily real estate.
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