The wider media and investment guru’s preach that a home is your most valuable asset. Perhaps your influence came from your grandparents who bought their house for $15,000 and sold it 30 years later for over $100,000. Perhaps it was all those books you read that said real estate is a great investment (side note: yes it is, but you should never tie your entire net worth to one asset). Perhaps it’s your friend who touts a huge net worth in front of you, mostly tied to his or her million dollar home.
We all need a place to live and preferably it’s a safe place where we know our neighbors. We often envision retiring in the place we raised our children, getting old on the front porch, or maybe it’s moving away to a beach-side community. Though, when we talk about retirement and a home fully paid for, we are overlooking the missed potential earnings of that capital.
Assuming that a home appreciates annually at the price of inflation (3%), we are shortchanging putting our dollars to work. The S&P simply has made annual returns over 11% for nearly 40 years. The difference between those two returns is astounding – 8% compounded annually equates to a huge difference in the funds available for retirement. Because, let’s be honest, you aren’t going to spend the last 10 years of your life alone in your house – you likely will sell it, move in with family, or into a retirement community while using those funds to assist in the process.
Let’s take two separate scenarios to explain the different paths we have. One is the put all our eggs in the residential real estate basket and the other is to invest our eggs in the basket of the stock market. We are going to let this go and not touch it. These charts and examples are simplified to prove a point and below the first chart you will see another chart highlighting if we merely split the difference. The net result is astounding!
| Asset Type | Residential Real Estate | Marketable Securities |
| Annual Return | 3% | 11% |
| Initial Capital | $10,000 | $10,000 |
| Ending value after 30 years | $24,272.62 | $228,922.97 |
| Asset Type | Residential Real Estate | Marketable Securities | Total |
| Annual Return | 3% | 11% | 8.85% |
| Initial Capital | $5,000 | $5,000 | $10,000 |
| Ending Value after 30 years | $12,136.31 | $114,461.48 | $126,597.79 |
This calculation can get even more complex as you look at the taxability of and the carrying cost associated with each option. The simple appreciation of the home does not include the interest expense annually, the repairs, the maintenance and the improvements to ensure the sellability of the home. The marketable securities does not include the potential capital gains tax that occurs at varying times over the investment horizon.
What is often missed about splitting the difference is that the annualized returns far exceeds the 8% return you would have estimated it be. By letting your winners run, you are actually compounding a larger amount on an annual basis resulting in an annual return around 8.85%. So by simply splitting the difference you are ensuring you could have captured any home asset increase over 3%, a solid market return and a beautiful home to raise your family. Essentially allowing for the best of both worlds.
The point of this article is rather the key takeaway from the two contrasting approaches to retirement. What should I do, you are asking? The key is to split the difference and limit the missed earning potential of either. Perhaps you live in a market like New York City that has seen huge appreciation over the last 20 years, well not have buying would have been a mistake. By splitting the difference we ensure that even if one market class is a loser for an extended period our ending net result will be a solid retirement. But do not lose site of the fact that the decades before the run, NYC real estate was a real loser for quite some time and contrary to popular belief people even lost money! Additionally, the market may not always return 11% or more, there will be bearish markets in the future. So, I am condoning the split approach. Buy a home less than you need (avoid keeping up with the Jones’) and take the difference of the monthly mortgage expense and invest in your future (tax deferred or not retirement account, this depends on your decision after this article). Either way, split the difference of your investments with the goal of beating inflation and increasing that nest egg over 30 years!
Photo by Martyn Smith
