Why Homes Actually Tend Not To Be Disappointing Investments

July 28, 2016

One thing I often hear people say (except right after the crash in the real estate market), is that their home was the best investment they ever made. However, a New York Times article titled Why Land and Homes Actually Tend to Be Disappointing Investments points out that real estate has increased by only .6% a year in real terms from 1929 to 2015 compared to a 3.2% average annualized increase in GDP over that same time period. The problem is that comparing just increases in price ignores a lot of the financial benefits of home ownership:

You don’t have to pay rent. If you don’t buy a home, you’ll probably have to pay rent and unlike a mortgage payment, rent tends to go up at least as much as inflation and never goes away. In fact, one of the biggest factors I’ve noticed in whether people are on track for retirement is whether they will have a paid off home by the time they retire. This “imputed rent” (or income from your home in the form of not having to pay rent) is one of the main sources of return. If you’d like to see whether buying or renting makes more financial sense for you, you can see how all the factors come out with this NY Times Rent v Buy calculator.

Real estate allows you to use leverage. Let’s suppose you purchase a $100k home and put down 20% or $20k. If the home appreciates with inflation by 2%, it’s now worth $102k. That doesn’t sound so great until you realize that the $2k increase in your net worth is actually 10% of the $20k you put down.

Being able to borrow from your home can help you in other ways too. Once you have equity, you can generally get a revolving line of credit or a home equity loan against it with relatively low interest rates and deduct the interest from your taxes. This can be useful in an emergency or to pay off higher interest credit card debt. (In that case, be sure you can make the payments because your home will be on the line if you can’t.) When you reach age 62, you can also take a reverse mortgage that allows you to supplement your retirement income by borrowing from your equity without having to make payments as long as you live in the home.

You’re less likely to over-react to market downturns. One of the biggest mistakes people make with stocks is to stop buying or to even sell when an investment goes south, only to miss the recovery. It’s not as easy to stop making your mortgage payments and if anything, people are less likely to sell when their home value is down.

Don’t forget the tax advantages. Not only can you deduct the interest and property taxes, you can also sell it and pay no taxes on up to $250k of gain (or $500k if you own it jointly) as long as it was your primary residence for 2 out of the last 5 years. You can also defer the taxes if you immediately reinvest the sale proceeds in a new real estate property, and if you pass it on to your heirs, they can sell it without paying capital gains taxes on all the gains during your lifetime.

You can rent it out. While you live in it, you can rent out an extra bedroom to a long term tenant or possibly for shorter stays on sites like AirBnB. If you move out, you can also rent out the entire home as an investment property (which also allows you to deduct depreciation and other expenses from your taxes).

There’s an emotional return. Not every benefit can be measured precisely in dollar terms. Homeowners also benefit from knowing that their home is truly their own. They can make renovations as they want and don’t have to be concerned with being kicked out by a landlord.

When looking at real estate as investment, don’t just focus on historical appreciation. Be sure to understand all the pros and cons. Then maybe one day you’ll be saying it was your best investment too.

Don’t Believe Everything You Hear

July 01, 2016

I’m the kind of person who will always try to listen with an open mind to different points of view and find something to learn from the speaker. I hear a lot of theories that way, some which appear to be myths, superstitions or misinterpretations, and some of which offer a refreshing change in perspective. In many cases, what’s true for most people might not be true for everyone. When sifting through financial advice, make sure to ask yourself if that guidance makes sense for your situation. Here are three common examples of financial guidance where you might want to think about things differently:

Question: I’ve been told that I should always have a mortgage so that I can get the mortgage interest deduction. Is that always true?

My view on it: MYTH

For each $1 in interest they pay the mortgage company, the typical family gets ~$.20 in tax relief (using the tax rate as the real payback number). To me, you lose $.80 on the dollar by paying interest. Plus if you have no mortgage, your embedded cost of living is permanently lower, so your accumulated savings and investment dollars can last a whole lot longer. Financial advisors typically say disciplined, long term investors could do better in the stock market rather than using savings to pay off a mortgage, but I’ve observed that most people prefer to have the peace of mind that comes with low or no debt so I’m not a huge fan of carrying a mortgage just to get a tax deduction.

Question: I should never contribute more to my 401(k) than my company’s matching contribution. Once I reach that, I’m told I should open a Roth IRA. Is that the right choice?

My view on it:  MYTH

Most people I see who try to implement this, forget one critical part – funding the Roth IRA. The problem with this guidance is that many people never get around to funding the Roth IRA every time they get paid. Once their paycheck hits their checking account, it gets accounted for in so many other ways.  I’d prefer to see people shoot for the maximum 401(k) contribution ($18,000 this year, plus $6,000 in catch-up contributions for those over 50) and once they max out the 401(k), THEN contribute to an IRA.

Also, maxing out the 401(k) doesn’t have to be an instant thing. You can increase your contribution level by 1-2%/year until you get there. If you have a rate escalator in your plan, sign up for it today!

Question: If I close out some of my credit cards, that should improve my credit score, right?

My view on it:  MYTH

Well, it’s not that simple! There are a lot of factors that go into your credit score. A few great places to see the multiple factors are CreditSesame.com and CreditKarma.com.

If the credit cards you want to close are relatively new, closing them may help you because it could increase your average “age of credit” (how long your open accounts have been open). But it may decrease your score because it reduces your overall credit limits and if you carry balances, it makes your “utilization ratio” higher. That’s the amount of overall credit balances divided by overall credit limit. Keeping that ratio below 25%, ideally at 0%, will be additive for your credit score. If closing accounts increases your utilization percentage, then closing the accounts can harm your score.

The thing to take away from this is that credit scores are fluid things. They change constantly. But if you take the time to review your scores and factors on the sites above, you will be able to make well informed decisions that impact your credit score.

As you go about living your life, learn how to discern the differences between good, solid personal financial management and misapplied financial principles. How? Ask a financial planning professional, pose a question on our Facebook page or ask me a question in the comments section below. Having the facts on your side can help save you from the many conflicting theories of managing your personal financial life.