This is a loaded question, obviously, because I just revisited the subject of buying your first home (of which I am now an avid fan) a week or so ago; Rick suggested:
Since equities also have a good long term investment record, why not scale back on the primary residence somewhat and invest in both real estate and equities?
At the time, I responded by saying: “The effect of the 20% Equity Rule and 25% Income Rule is to ensure that you are always investing AT LEAST 75% of your networth elsewhere (could be business, RE, equities, etc., etc.).”
Of course, that doesn’t address the question, as I have also said that these rules are up for grabs – meaning, you can just ignore them – when considering buying your first home.
Now, I am clearly a fan of buying your first home – you just need to go back to one of my very first posts to see that – but, it wasn’t always that way …
… I started by believing that there were other investments out there that performed better than your first home.
And, that still holds true; after all, as my Grandfather once told my Grannie when they had the same decision to make soon after immigrating to Australia:
You can’t always buy a business from your home … but, you can always buy a home from [the profits produced by] your business.
This still holds true … as does the 20% Equity Rule. In other words, if you are absolutely committed to using the funds to start a business, or are ABSOLUTELY committed to ALWAYS investing at least 75% of your Net Worth, then by all means keep renting.
It’s just that 99% of people will – sooner or later – fall off the investing wagon. It’s human nature.
Then they’ll end up with no investments, little net worth, and no home. Buying your first home, and using that as a springboard into other investments, is a great way to go; just remember what I said, way back in the beginning of 2008:
If you are ready, willing and able to buy your first house, or you are thinking of trading up (or, down) …. here’s my advice:
Put aside the emotional decisions and just consider the financial impact, and that is: your house is the ONLY way that most people will ever get off the launching pad to financial success …
Why? Because, you are building up equity over time (even a flat or falling real estate market eventually climbs back up again) …
… but – and here is the key – ONLY if you are prepared to put the equity in your house to work for you … that means, borrowing against the equity in your house to INVEST.
The overwhelming consensus of opinion on internet forums and blogs is that your home is not an investment. (There are even people who think it is a liability rather than an asset!!!)
I disagree very strongly with that view. The equity in your home will usually represent a significant amount of your net worth (in particular if it is the typical first home). If you are putting that much money into something (and taking on a significant amount of debt to finance it), not treating your home as an investment strikes me as stupid. (Whether it is a good investment or not is a different subject.)
For poor savers (which probably does not apply to most people reading this), a home/mortgage payments represents forced savings – which is a good thing.
Lastly, statistically home owners are much better off financially than renters. Whether they are wealthy because they buy a home or buy a home because they are wealthy enough to afford it is clearly debatable but the fact remains that home owners are wealthier.
@ TraineeInvestor – Interesting, isn’t it?
On the one hand, we have “the overwhelming consensus” (who, I wager, doesn’t have $7m7y), who says a home is NOT an asset.
On the other hand, we have wealthly people who ‘statistically’ do think their home is an asset – at least, enough of an asset to warrant owning rather than renting.
If I had to decide which group’s advice to follow, I wonder which I might choose? Hmmmm …. 😉
Once you start getting in the black a little bit, do you do home improvements, or put the extra cash in equities??
@ Iliquidity – check out this post:
http://7million7years.com/2008/04/11/applying-the-20-rule-part-i-your-house/
@ adrian – probably a lot of recency bias in the commonly held views
@ illiquidity – equities every time for me (maybe some selected work if it will add value ahead of a proposed sale – most home improvements do not add more than their cost to the value of a property) or a downpayment on another property
The way I look at it, a home is an asset, but not really an investment vehicle. And homes do tend to appreciate (unlike 99% of cars), but I don’t count on that. When we move, I’ll probably replace my current house asset with another of similar value.
Now, getting the house in the first place is the challenge as any money you put in for the downpayment isn’t going to be working for you, and it gets worse when you overstretch to acquire a house beyond your means. Fortunately, the monthly costs are similar to renting, so home ownership isn’t completely unobtainable.
We are starting a “small” house remodel project, knowing all too well that the money we put into it will not be returned when we sell the place. But the value of my overworked wife being happy and a better-designed office for me? Priceless.
Oh, and I did include the costs for the remodel in the 20/25 rules.
Neil
@ Neil – I’m glad somebody’s following my rules … anybody else wanna come clean?! 🙂
Adrian,
I agree the home is an asset- the mortgage, taxes, and repairs are the liabilities. Of course if you paid too much for the home it may well be a net liability for many years. The other factor is transaction costs- selling a home is expensive so I wouldn’t buy in an area I wasn’t sure I would be staying in for several years.
-Rick
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