Reversion To The Mean

We can have a “reversion to the mean” discussion on real estate, stocks, or just about anything. What is Reversion to the Mean? This is a theory suggesting that prices and returns eventually move back to the mean or average.

If you want to be a successful investor of common stocks conventional wisdom says you should spend lots of time analyzing companies or mutual fund managers and then try to pick the best ones. That is fine, but is a mistake if you are solely relying on that. If you want to be a successful investor of common stocks forget about using solely conventional wisdom, and also focus on reversion to the mean. You can be lucky and pick stocks and mutual funds without doing a lot of analysis. Or you can build a diversified portfolio with a clear understanding of the role that reversion to the mean plays in the stock market. And this also holds true in the real estate market and with many other things. Don’t rely solely on professionals, do your own research on the house or assets you may want to buy.

Some of the same Realtors that were pushing real estate in the bull markets who were making grandiose claims that real estate never goes down in value, are the same ones now hawking short sales! Some of the same stock broker’s who told you that stocks were on firm ground before the big correction, are now telling you its safe to get back in! How many 1000 point levels did we have to fall through before we realized that stock brokers are simply salespeople, and do not really have the tools nor the interest to do real analytical research? Apparently quite a few. This holds true for most assets we buy, so use your own analysis instead of relying on the salespeople selling you the asset.

Things can improve in a society due to invention, economies of scale, and general progress, but if we see centuries of data that says real estate only goes up 1-2% over inflation, how can we justify 20-30% over inflation for too long? During the real estate boom we had no major invention, advances in housing, we had no baby boom, yet we had 20%-30% annual real estate appreciation in most major markets!

The moral of this story is whether looking at a purchase of real estate, stocks, or most any investment to use a healthy dose of analysis, do your own research, consider reversion to the mean, and be careful.