In Laguna Beach, California, there are homes that sold for $172,000 in 1956. By 2018, many of them traded in the $2.5 million to $4 million range ($2.84 million as the median). And yet, the worst recession that affected these home values occurred in 1973-1974, when then the 1972 peak of $232,000 crumbled such that the average home price in Laguna Beach became $145,000. If the equity in your Laguna Beach home was a meaningful percentage of your net worth, it was the most noticeable hardship to hit the California real estate market in American history, excluding the Great Depression.
We are talking about two decades of negative compounding, and a peak-to-trough percentage change of 37.5%. That $87,000 swing was the worst destruction in fair market value wealth in the Laguna Beach real estate market in three quarters of a century.
And the past year, there was a point when the average price of the homes went from $2.84 million to $2.68 million. That’s a 5% swing barely worth mentioning—ordinary volatility that is destined to exist. And yet, some media outlets described the $160,000 as the greatest dollar drop in the history of Laguna Beach investing.
It is a claim that was technically true, but preposterous to draw any meaningful conclusions from. When an asset expands in value, so does the absolute amount of dollar values that are necessary to bring about a given percentage change. It should be grade-school level mathematical literacy to know that a 10% swing on a $1 million asset involves a swing of $100,000 whereas a 10% swing on a $100,000 asset involves a swing of $10,000.
But yet, in the past year or so particularly, the American financial media has begun speaking in terms of absolute changes in the price of the Dow Jones and S&P 500, describing 5% swings as the greatest point decline in American history when that statement can serve no purpose other than to induce panic, fear, or some other emotion to catch your attention. Percentage changes, not absolute changes, should rule the day’s analysis.
The sad part is that I know there are a lot of people who watched stock prices increase every year coming out of the Great Recession and chose to make investments in stocks not because they understood what they were doing (turning surplus capital available into an ownership interest in a business) but rather participating in the trading of blips on a screen that had developed a habit of going up and up.
The internet has done an incredible job of democratizing information for the masses, giving you and me the ability to access in seconds data points that for all of human history we might not even know existed, let alone how to find it in a timely and cost-effective manner. The downside is that the data points that are shoved in the faces of our smartphones from the website headlines does not facilitate a rational allocation of assets. In most circumstances, it is pure balderdash to discuss absolute rather than percentage changes in trying to prove a point about the history of an asset.
Originally posted 2018-08-29 01:20:00.