Does home ownership still mark a significant milestone in realizing the American Dream? In my financial practice, I am beginning to notice a trend that more people are electing to rent instead of buy a home. The most common reasons I hear include housing prices are too high, payments are too expensive, or life is to be lived today because you only live once. There is some truth in those reasons but I hope to make a case for owning your own home that goes beyond common knowledge.
1. The economics of inflation is on your side. Inflation refers to the graduate increase in prices and deteriorating buying power of money. There are variety of social, economical and political reasons that cause inflation. The Bureau of Labor Statistics publishes CPI, or Consumer Price Index, to keep track of inflation. This chart(1) below indicates that inflation has been observed consistently in recent history. I am sure you have all learned about the story that a loaf of bread cost some 25 cents back in the day and that the first Ford Mustang only cost $2,368 in 1964 and a 2016 model will set you back $25,000.
Bringing the focus back to real estate. Consider that the real cost of borrowing is the mortgage rate you pay minus the rate of inflation. The higher rate of inflation the lower the cost of borrowing. Suppose your mortgage payment is $3000 each month. The buying power and the economic impact of that money will be less and less each month through out the entire 30 year term of that mortgage. In today’s prolonged low interest rate environment borrowing on a fixed term for a long period of time means it’s very advantageous to own real estate.
2. Owning real estate diversities your overall portfolio. Educated investors recognize the value in diversification among different asset classes to reduce investment risks. Having the appropriate mix of asset classes improves the chance of reaching your investment objectives while minimizing volatility. Today we are observing a lot of uncertainties around the world. Russian’s involvement in the Syrian war, sanctions and negotiations on its oil export, Greece’s continued requests for bailout, UK’s election to exit the EU, the migrant crisis in Europe, the daily drama in the Chinese equities market, the souring economy, Zika virus outbreak, and the looming environmental challenges in Brazil leading up to the 2016 Olympic games…the list goes on. As investors react to these worries plus the created volatilities in the equities market, it sure feels pretty great that at least one asset you own, the home you live in or your rental portfolio is seeing some consistent appreciation.
3. Diversification is also critically important when it comes to retirement income.As a professional financial advisor I can’t emphasize enough that saving in your 401(k)s alone isn’t enough and that you must create alternative sources of income for retirement.
You might have heard about the “4% rule” used by many financial professionals to calculate retirement income based on an asset value. The idea is that if your assets can be invested in a safe place that produces a 4% rate of return, you can spend that money without compromising the principle and next year there will be another 4% earned and thus the model is perpetual. For example, if you have accumulated $1,000,000 by the time of retirement, at 4% it will earn $40,000 each year for you in retirement as depicted in the chart below.
Can you always get 4%?
I didn’t get 4% in 2008. Or 2011, or 2000, 2001, 2002…
You see your retirement expenses do not reduce accordingly just because the market has a down year. For all those retirees whose portfolios suffer a setback during a market correction, it is often not possible for them to maintain the integrity of the principle. When that happens, there is less to capture the rebound in the market and the portfolio inevitably begins to shrink.
Real estate properties can produce income and it is rather uncorrelated from the equities market. Rent is a diversified source of income even if the market is down it can still bring the owner a lot of reassurance during uncertain times.
Lets not forget the emotional reasons to own real estate, pride and joy of home ownership, realizing the American dream, never have to pay rent again…and yes, there is the interest payment tax deductions. Whatever reason it might be for you, I hope this article makes the case that it is worth the effort to own a home. I know that it is not easy and many other things demand our cash flow. Child care costs a ton, new iPhones we all want, private schools and lets not even mention college. However, I hope you find the courage and the discipline to save for your down payment and take actions toward becoming a home owner. Start your journey by consulting with a real estate professional and your financial advisor.
This article was written by Peter Mu
1. Produced with The Living Balance Sheet, data source Bureau of Labor Statistics. http://www.pacificadvisors.com/peter_mu/financial_balanceImage is public domain, free for commercial use. http://thestocks.im
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