Investing

Investing for Retirement: Housing Wealth

Introduction

Your home is, of course, an asset. Over time, housing appreciates at approximately the rate of inflation. Equities will have higher long term returns than housing. Therefore, your home should not be the primary vehicle for funding your retirement.

Housing risks are generally reasonable. However, all house pricing is local. And there have been speculative bubbles that burst–spectacularly in some cities–most recently in the late 2000’s.

[INSERT CHART: HOUSING APPRECIATION OVER TIME. TREND V ACTUAL]

[INSERT CASE SHILLER HOME PRICE INDEX]

Advantages and Disadvantages

Unlike other investments, housing has unique advantages and disadvantages:

  • There are purchasing costs to housing including your downpayment, closing costs,
  • There are carrying costs to housing including mortgage interest, property taxes, homeowners insurance, homeowners association fees, and maintenance.
  • There are investment opportunity costs with housing versus a diversified portfolio.
  • If you need immediate cash, you cannot sell a portion of your house.
  • But, your home has greater utility because it provides shelter to your family.
  • Your mortgage payments force you to save, growing your equity over time.
  • If you itemize your tax deductions, your mortgage payment may be tax deductible.

Buying Versus Renting

How do you know when there is a housing bubble? Historically, the ratio of house price to annual rent has been about 16. Therefore, if the ratio is higher than 16, it may make more sense to rent, especially if you expect to move within five years.

Don’t Be House Poor

Housing is likely your largest yearly expense. Ideally, you should spend no more than 20-25% of your household income on housing. Unfortunately, many homeowners spend as much as 35% of their income on housing, which signficantly reduces their retirement savings.

The type of mortgage matters. You should prefer a fixed rate mortgage. Shorter term mortgages are better because you pay less interest. This is particulary true if you are approaching retirement age. Avoid adjustable rate mortgages, low or no downpayment mortgages, mortgages with graduated payments, and interest-only mortgages.

Summary

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Updated on December 26th, 2018