Hedging real estate

[6 Iron]

I am fortunate to own a lake cabin as well as my home. I am in complete agreement that your home should not be counted as part of your portfolo, and that real estate in general has no place in the permanent portfolio. I wonder though, if, because of my extra exposure in real estate, and the fact that I will probably sell it when I retire and head southwest, if I should have some asset in a variable portfolio that would act as a hedge. At present, I do not count my cabin as part of my variable portfolio, it has been just something my family has enjoyed.

[LifestyleFreedom]

I don't know how to hedge real estate with another asset class (i.e., I'm not sure which asset classes are negatively correlated with real estate), other than perhaps owning several asset classes to achieve broad diversification.

My investing focus is on income-producing assets.  Stocks pay dividends.  Bonds pay interest.  Cash pays interest (although not much in today's world, but I earned 7% on my checking account balance back in the 1980s).  Real estate (other than raw land or property owned for personal use) pays rents.  I can convert this cash income into the necessities for life (e.g., buy food at the grocery store).

Other asset classes don't pay income.  Gold, art, jewelry, and baseball cards, for example, have their valuations derived from the greater fool theory -- no matter how foolish you are when you buy them, you are hoping a greater fool will come along someday and pay a higher price for them than you did.  Unless we find ourselves in a post-Armageddon world, stores will likely not accept payment in the form of gold or jewelry.  People will have to sell them instead for whatever price they can get at the time if they need to raise cash for any reason.

I've been watching investing shows since the 1980s (Wall Street Week then, Wealthtrack now) and these alternative asset classes have been discussed from time to time.  The secret to investment success in these areas is to know what you are doing.  With art, for example, the suggestion is always to buy what you like to look at because you may have to look at it for a long time before you can sell it at a profit.

Harry Browne picked cash, bonds, stocks, and gold as the four asset classes for the Permanent Portfolio (his reasons for selecting these particular asset classes make a great deal of sense).  But selecting other asset classes for the Variable Portfolio can be whatever the individual investor feels comfortable doing.

Unless a piece of real estate ends up on a toxic waste dump or is in an area that has gone downhill economically, it will probably have some fair market value.  Whether that sale price will be more or less than what you paid for it is a question no one can really answer (unless they are a real estate specialist who possesses a lot more expertise on the subject than I have).

[6 Iron]

I don't know how to hedge real estate with another asset class (i.e., I'm not sure which asset classes are negatively correlated with real estate), other than perhaps owning several asset classes to achieve broad diversification.

This is essentially what I have been doing, plowing money into my permanent portfolio, and eliminating debt. After the discussion of using EDV and GDXJ as a possibility for a variable portfolio, I realized that while my variable portfolio is small, it is basically a full on bet on prosperity. If I were to consider the cabin as part of the variable portfolio, it becomes a substantially greater bet on prosperity, without any warranty protection as I have in my permanent portfolio. Thank you for your thoughtful reply. I had come to the same conclusion-- I did not know what would reflect an effective hedge, and I would obviously have no potential for a rebalancing benefit.

Still, it has provided my wife, and family much happiness and a lot of great memories. Perhaps that should suffice.

[LifestyleFreedom]

If I were to consider the cabin as part of the variable portfolio, it becomes a substantially greater bet on prosperity, without any warranty protection as I have in my permanent portfolio.

Another way to look the situation is to see the cabin as a robustness to exploit a possible positive black swan event (i.e., unbridled prosperity in this age of gloom and doom) or to hedge against a possible negative black swan event (i.e., a backup location in case the economy completely collapses).

http://en.wikipedia.org/wiki/Black_swan ... wan_events

I take it that the cabin is a sunk cost (i.e., you've already bought it) and you're still earning psychic income from it (i.e., you're spending your vacations there).  So the only decision to make is whether to sell it now, sell it later, or not sell it at all (i.e., there is no buy/don't-buy decision to make).

The Permanent Portfolio can be used as a defensive strategy for money you can't afford to lose (which is what Harry Browne said if was for), while the Variable Portfolio can be used as an offensive strategy for money you can afford to lose (but you may end up not losing it if the investments turn out well).

P.S., Eliminating debt gives you more flexibility in the long run because you end up with fewer obligations to meet each month.  If your income remains high, the additional difference (between income and expenses) means more money to invest.  If your income declines substantially, the fewer obligations give you a margin of safety to absorb some or all of the financial shock.