You’ve probably heard this before: “a home is your biggest investment.” Unfortunately, I don’t think it’s true.
A home is actually your biggest expense. Let me explain why.
Is Your Home an Investment?
Personal finance 101: you should invest in assets. Robert Kiyosaki made this idea famous in Rich Dad Poor Dad, but it’s an elementary principle that’s been around for centuries.
So, what is an asset? An asset is something with a value that increases over time. In other words, you get paid to own it. This is why a home isn’t a good investment. Families actually pour money into their homes.
- Property taxes
- Mortgage interest payments
- Lawn care
- Heating & AC
- Septic inspections & pump-outs (Fun fact: I worked for a septic company in high school. Lesson #1 = smile with your mouth closed…)
- No one would ever have to call the plumber about leaking pipes… right?
- Periodic repairs
- Renovating your bathroom or kitchen
- Replacing the floors
This isn’t even an exhaustive list, but still, I rest my case. When you live in a home, you have to pay for it. But, that doesn’t matter because property values increase over time, right? Let’s take a look.
I used my computer analysis ninja skills to make the following chart, which displays the change in real (inflation adjusted) value of the US House Price Index (HPI) and the US stock market (not including dividend reinvestment) from 1918 to 2015.
As you can see, the stock market achieved huge gains during the 97 year period. On the contrary, the real value of home prices merely doubled. Keep in mind that the stock market values in the graph don’t even include the impact of dividends. Here are the annual rates of return for the stock market and home prices from 1918 to 2015:
- Stock Market: 5.99%
- Stock Market With Reinvested Dividends: 10.38%
- Home Price Index: 3.69%
Real Values (inflation adjusted)
- Stock Market: 2.96%
- Stock Market With Reinvested Dividends: 7.22%
- Home Price Index: 0.72%
Based on these numbers, property values barely beat the rate of inflation over the long run, while investing in publicly traded companies has created significant wealth.
What does this mean?
It means that you are going to pour money into your house for maintenance and repairs, but its value isn’t going to increase enough to offset those expenses.
You also have to consider your opportunity cost, a.k.a., what you’re giving up in order to buy an expensive home. If you put $400,000 into your house instead of $200,000, then you’re losing the chance to invest that additional $200k in the stock market or elsewhere and build additional wealth.
How Should You Invest in Real Estate?
If your home isn’t an investment, then the natural response is: “how do I invest in real estate?”
As we already discussed, home prices increase at a rate slightly above inflation. This means that for a house to be an asset, then it must provide some source of cash flow in addition to an increase in resale value.
To achieve this additional income, you can purchase rental properties. Over the long run, your initial investment should grow in order to cover inflation. On top of that, you are collecting monthly payments from tenants, which can boost your long term rate of return to a level similar to the stock market.
If you don’t have enough capital to buy several homes, duplexes, or apartment complexes, then you can invest in a Real Estate Investment Trust (REIT) instead. In that case, you would basically purchase shares of a company that invests in a wide variety of rental properties for you. These can include homes, apartments, malls, hotels, health care facilities, etc.
Hopefully, I have convinced you to treat your home as an expense, not an asset. I’m definitely not saying that home ownership is a bad thing; just don’t consider it an investment.
Historically, real estate is still a great wealth-building tool. But, consider investing in rental properties or REIT’s.
What do you think about homes? Are they investments? I’d love to get your feedback, so please leave a comment below and get a conversation started. Also, if you want to keep up to be the first to know about new posts, click on the icon at the bottom of the screen to visit my Facebook page and give it a like.