Which is Better?

This is a test—Is buying a house a better investment than the stock market?

 

Before answering, let’s examine some data:

 

  • Since 1928, the U.S. stock market has compounded at an average annual rate of 10.2%. More recent results have also been pretty good. Despite the dot-com crash of 2000 and the financial crisis of 2008, the stock market has produced a cumulative gain of over 700% since January 1990.
  • Measuring appreciation rates for single-family homes over long periods of time is more difficult. Average home size has increased significantly since 1928, making an apples-to-apples comparison impossible. There is no doubt in our mind, however, that the average stock has outperformed the average house over the long run. For comparison, the average U.S. homeowner has only experienced a cumulative gain of 160% since January 1990 (source: Federal Housing Finance Agency).

 

According to Gallup, somewhere between 50% – 55% of Americans have ownership in a public company (mostly through 401k plans), but only half of these households own more than $50,000 worth of stock. New York University economist, Edward Wolff, says that the wealthiest 10% of households now own more than 80% of all U.S. stocks.  So, if stocks have a higher expected return, why do so many prefer real estate?

 

  • For starters, the 10.2% average annual stock market return was not achieved without risk. Since 1928, the standard deviation of annual stock market returns has been 18.7. This means that roughly 70% of the time, the actual calendar year return fell somewhere between negative 8.5% and positive 28.9%. It also means that about 15% of the time, the actual annual return fell more than 8.5%. In addition, if you got nervous and sold stocks during any of those years, your actual long-term return might have been much less than 10.2%. Volatility exists in the housing market as well, but people tend to be more committed to their home than they are to an individual stock or mutual fund. You also get to enjoy living in a home. It’s hard to host a party in your mutual fund.
  • Due, in part, to the high volatility associated with stocks, most people do not borrow money to purchase stocks. On the other hand, most people do borrow money to purchase a home. The use of leverage increases your return on investment (ROI) when home values are appreciating. Of course, debt can have the opposite effect on wealth when home prices fall.
  • Mortgage payments are a form of forced savings. A portion of the mortgage payment is paid to the bank in the form of interest, but the remainder goes to pay down the principal value of your loan. Eventually, you will own the house free and clear.

 

We’re not trying to turn people into renters. Owning a home has many benefits and it is the right choice for almost anyone who is planning to put down roots in a certain area. However, we would encourage people to think of a house as a financial commitment, not a financial investment. We all need to live somewhere, but if most of your wealth is tied up in a house, what will you do at retirement?  Will you have to sell your home to fund future living expenses? This is not an ideal strategy.

 

Buying a house should be a lifestyle decision first, and one that fits into your overall financial plan. The investment attributes of a house should not be ignored, but they should also not be the primary deciding factor when deciding where to live. Depending on selling your house at some point down the road to help fund retirement is not a good idea. Unless you are committed to moving to a less expensive region in retirement, it is unlikely that you will experience a significant financial benefit from downsizing.

 

Establishing automatic regular savings in a 401k plan and regular brokerage account is still the surest way to build wealth over time. It’s simple and hassle-free, but simple doesn’t mean easy. It takes discipline, but the reward is great.

 

The nice thing about a brokerage account is you never have to paint it, mow the grass, pay property tax, HOA or insurance, and the furniture/furnishings never need updating.  Enjoy!