Common wisdom may have you following the wrong lead and could disrupt your ability to achieve financial independence. Let’s go on the hunt as our next assignment in the Conserving Money series.
In the previous article, The Best Financial Decision I Ever Made, I discussed the concept of understanding the difference between investing your money and purchasing
This time, I want to discuss a timid investment found in many people’s portfolios. We’ll refer to this investment type as a sheep. This investment appreciates over time, but at a considerably slower rate than many other types of investments. Unfortunately, many people don’t question this and they feel compelled to make this investment. This leads to considerable outlays of time, money, and effort investing in this asset class and missing out on rewards from higher returning instruments. What is it, you ask? Read on and we will find out together.
What’s Considered an Investment?
Investments, at the most basic level, are instruments that are expected to appreciate in value as they age. The level of risk contributes to the return you might expect to see from an investment, i.e. the riskier the investment, the higher potential return you should expect.
In order to benefit you, investments must rise faster than the rate of inflation. The more they beat inflation, the more wealth they will build for your portfolio.
Investments come in many different packages. To keep things simple (and we really don’t need to complicate them for me to make my point), investments may be thought of as money markets, certificates of deposit, bonds, stocks, real estate, and commodities, like precious metals. Here is an article from Investopedia with a quick rundown of different investment types for additional background.
Investing your money in these types of investments will yield a somewhat consistent return over time, especially the longer the time horizon is stretched. Here is an interactive basket of investment types and their annualized returns of various types of investments over the past 15 years as compiled by the web site Novel Investor. Please take a moment to look at the chart and the types of investments considered.
What don’t you see? First off, you don’t see commodities. Considering most of my readers will not be investing in oil, pork bellies, or gold for investment income, I will leave this on the sidelines. The other missing investment return is real estate. Since many readers either own a home or may acquire one in the future, this needs to be highlighted.
Houses as an Investment
Let’s click on the link to the following chart, US Home Appreciation chart. As you look through the returns for housing over the past 100+ years, you may be surprised to see housing and inflation run nearly the same trend line. In fact, according to the data (underline is mine):
“For homeowners who plan to be in their house for 30 years or more, what they’ll most likely find is an appreciation rate that doesn’t deviate that much from the rate of inflation. In the best 30 years for the housing market (1976-2005), real price appreciation averaged 2.2% per year. In the worst 30 years for housing (1895-1924), real price appreciation averaged -2.1% per year.”
Houses are an investment in that they appreciate in value, however, they struggle to keep pace with inflation
Housing Return Rates are a Bit Sheepish
According to Zillow, the median price of a house in the U.S.in 2017 was $225,000. If I look back 50 years to 1970, I find the median value of a home was $25,600. A typical house in 1969 increased its value by $200,000 in the past 50 years. This sounds like a good investment. It certainly appreciated, right?
The house appreciated at an annual rate of 4.5%. But remember, we also need to beat inflation to be accumulating wealth. The inflation rate averaged 4.04% during this same span. If you enter $25,600 into this inflation calculator, you will see your house would be worth $178,671 in today’s dollars. Your investment still ends up appreciating, however, your gain decreased significantly once inflation has been factored in.
Meanwhile, if you invested the same $25,600 into the S&P 500 in July 1969, your investment would have grown 10.3% (including dividends) to appreciate to $3,443,622.90 in July 2019. That amount of money should certainly be worth considering other options than buying a house and waiting for it to appreciate.
A Forward-Looking Example
Let’s say two people are each in the market to buy a house right now. The first buyer goes over the median by $25,000 with a mortgage for $250,000. The second person buys $25,000 under and invests the difference in a mixed basket of investments. They each take a 30-year loan @ 4% interest. Their mortgage payments look like this:
| Person | Loan | Payment |
| Buyer #1 | $250,000 | $1,195 |
| Buyer #2 | $200,000 | $955 |
Buyer #2 invests the extra $240 monthly into an Asset Allocation Portfolio** (from the Novel Investor site linked earlier). Using an investment calculator and plugging in the historic return on that portfolio of 7.3%, we discover our buyer accumulates $308,146 with this nominal monthly deposit.
In 30 years, both people will own their houses. Using the 50-year average housing appreciation rate of 4.5% and an interest calculator, we determine the $250,000 house appreciates in value to $936,329. Meanwhile, our second house’s expected appreciation value is calculated to be $749,063.
After 30 years, here is the full picture including borrowing costs:
| Scenario | Home Value | Investment Value | Total | Cost | Interest | Net Gain |
| Buyer #1 | $936,329 | $0 | $936,329 | $501,673 | $179,673 | $254,983 |
| Buyer #2 | $749,063 | $308,146 | $1,057,218 | $343,739 | $143,739 | $569,740 |
| Difference | $314,757 |
Reducing acquisition costs and investing the difference benefits Buyer #2’s financial picture by $314,757 over the first buyer.
What Does All of This Mean?
We all require shelter and it will cost you something, whether you rent or buy. The shelter you purchase uses limited resources, either income or savings. I want you to consider how much of your income you use for housing and how much you can save for investment purposes. An investment portfolio with securities, on average, will make significantly higher returns than a portfolio dominated by a
Buying a house is not a terrible decision or investment. The purchasing process requires evaluating the opportunities you are forgoing, depending on how much house investment you make. The more house you buy, the more assets you will be investing at 4-5% returns instead of 8-12% returns that have been realized in the stock markets.
Some people will encourage speculation in real-estate with strategies like flipping, purchasing in gentrifying neighborhoods, or buying in foreclosure, for example. These strategies do raise the rate of return but they also raise the risk level of your investment. Tread into these waters carefully with expert assistance. Get rich schemes will seldom actually make you wealthy.
Leave Room for Wolves in Your Portfolio
Having sheep (real estate) in your portfolio provides diversification and inflation-fighting persistence. These are beneficial qualities but do not let them take over all of your investable money. Save room for wolves to sink your teeth into better returns which compensate for the higher risks of the investments. For your financial future, learn about investments and seek hard-working professionals to guide you. There are great resources out there just waiting for you.
Weighing the pros and cons and considering all of the costs involved before buying a house is critical to your financial future. As you analyze housing, factor in options around how lower-priced or more modest house affects your future. Investing part of your hard-earned money in higher-yielding assets instead of sinking it all into a house could dramatically improve your financial outlook.
It’s your money. Save some of it for the wolves. Seek better returns to crush inflation and give you the freedom to do what matters most!
** the Asset Allocation Portfolio is made up of 15% large-cap stocks, 15% international stocks, 10% small-cap stocks, 10% emerging market stocks, 10% REITs, 40% high-grade bonds, and annual rebalancing.