…to be more specific, you shouldn’t consider your primary residence, the house you live in, as part of your long-term wealth and investments. This article will explain why:
For many of us in our 20s and 30s buying a house is a big goal that’s either staring us in the face or coming up on the horizon. A house is likely to be the biggest purchase we will make in our lives and it’s a likely trigger for beginning to think about saving money and growing pennies.
However, whilst saving for a house deposit is an admirable goal it shouldn’t stop you from begin investing for even longer-term savings goals like retirement. It’s not OK to just be saving for a house. Here’s why saving for a house isn’t enough:
Renting from the bank
You may be tempted to rush into buying a home because ‘it’s an investment’ and you want to avoid ‘throwing money away in rent’ (phrases I’ve heard my friends and people online say all the time). Yet paying for a roof over your head is largely unavoidable: even if you own your own home: in the early years of a mortgage only a fraction of the monthly payment is going towards to the ‘principle’ (the money you owe on the house). Most of your money is going towards the interest your mortgage provider is charging you each month. You are essentially renting so the amount of money you’re contributing to any ‘long term’ investment like a house is very small. You should therefore be making provisions for more meaningful long term investment plans while you are still young.
A lifestyle investment
Most people consider a house to be an investment: certainly it is worth a certain value in the market-place and tends to increase in value over time. However, assuming it’s the house you are living in, then it’s value is limited because you need a place to live: It offers you shelter and depending on the size and quality of its features it also provides you with a certain lifestyle. Rather than an ‘real’ investment it is what I call a ‘lifestyle investment’. As explained when exploring lifestyle inflation, with any lifestyle investment it comes the ‘norm’ for you. Regardless of any appreciation of house prices you are unlikely to want to down-trade in house due to lifestyle inflation so the relative investment return for your house is 0%!
Real investing is about reducing today’s lifestyle to put your money to work for a secure financial future tomorrow. Pouring money into your primary residence may give you a secure place to live in the future but this alone will not help you grow your pennies long-term. You need other investments in place as you commit to your future today and the sooner you start, the better.
Playing with leverage
Leverage in financial terms is taking advantage of movements in value using extra money. For example if you were playing roulette and only had a £1 but had a strong feeling that the ball was about to land on red, you could leverage your prediction by asking me if you borrow £9 to put on Red. If the ball did land on Red you could return my £9 to me and you could keep your winnings: the £1 from your own bet and the £9 winnings from my money! You just made an extra £9 even though you only had £1.
Leverage is what makes property so appealing. You may only have £10k but if you then borrow £90k on a mortgage you can ‘afford’ a £100k house. If that house then goes up 10% in a year and you decide to sell you’ll have a £10k profit –add that to your original £10k and you’ve doubled your money!
However leverage can work the other way. If the ball had landed on Black in the roulette example you would owe me my £9 even though you only had £1 to bet with and you’ve lost that too! With houses if the value goes down even a small amount you can find yourself ‘upside down’ –owning more money that you ever put into the house. You would be trapped in the house until you could sell it and pay off the rest of the mortgage that the house sale couldn’t cover. If you needed to sell and house prices dropped 10% in that year you’d be in trouble: trying to pay off an extra £10k debt can wreak habit with your mission to grow your pennies!
Poor flexibility
For those of us in our 20s who have not settled into our careers or a particular location, a house, (or rather the leveraging mortgage) is not an investment but rather it’s a dangerous liability (debt) that’s not worth the trouble: that is until you have saved a big enough house deposit to not worry about being ‘upside-down’ should you need to move after your house has lost value.
Houses are also one of the most expensive and inflexible ‘investments’ as anyone who has tried to sell a house will be able to tell you! Unlike other investments like shares that can be sold in batches and almost instantaneously on the open market if you need to sell quickly, a house is pretty hard to sell brick by brick!
Buy and Invest!
Ultimately anyone who is actively working towards saving for a home is doing a great job as they must certainly have a great mind-set and vision for what they want in their future. This is great and they get the Magical Penny Thumbs Up!
However, buying a home is not automatically a good move, especially if it comes at the expense of being prepared to save separately for the long-term. Inflating your lifestyle by buying a home can be a great move at improving your quality of life but don’t think that investing in a home is simply enough to secure a comfortable financial life in the future.
Thankfully you don’t have to choose between saving for the long term and for a home (or dutifully paying on a mortgage). You can do both –even if you can only afford a small amount to channel into long term savings, the likely returns will help your pennies grow over the long-term and will prepare you for another one of the biggest purchase you’ll ever likely to make: buying your financial freedom!
What do you think?
This article refers to the problems with considering your primary residence as an investment. The subject of investing in property as a investment asset class (as discussed in some brilliant and recent comments) is a different issue and will be covered here on Magical Penny soon.
{ 9 comments… read them below or add one }
I can see your point of view, I really can.
But I think it is a bit blinkered. You talk about lifestyle inflation and you mention that people wont want to downsize.
Downsizing property is a common occurence amongst older people, very common infact. Your whole blog is about saving money until you’re older, for better use in your later years, property can be and is used in that way for many people.
But that is a minor niggle.
You also ignore the fact that the quick its bought the quickers its paid off the quicker you can have that monthly amount (usually the biggest outgoing for a family) back to yourself.
I’ve sent you a document with my math but basically:
If Joe and John both want to buy each half of a semi detached house and both have the same deposit and both have the same income and amount one can spend on mortgage/savings but John decides to rent out his half for 10 years and put the 10k into savings then buy whereas Joe wants to buy his property outright Joe will end up the better off.
John will be charged higher in rent than mortgage meaning in the early years he is unable to put as much savings away as Joe who has the lower monthly mortgage payment for the same property. Joes ‘pennies’ will grow as he is putting more in earlier, and the money he is spending on property is earning him an appreciable asset.
Your article only really works, like some of the other points of view you have, if someone really delays their life i.e. John rents a worse place than Joe for 10 years. But I don’t think this is applicable to most people i.e. most people either have, or want to, get on with life sooner rather than later.
More agreeing with Mr knight I’m afraid, Adam. I like your explanation of negative equity, and you should only buy after weighing up risks for the next several years. However, this strikes me overall as lifestyle delay; my metal image was the old man with the biscuit tin of money but poor house. Far better to position yourself to play the property market as needed, including up and downsizing. Anyone who can afford to invest in a rented property does even better, imo.
I love these comments guys and knew this post would be controversial -my first draft of this post covered many of your arguments but the post started getting very large and the arguments unwieldy to hold together.
Suffice to say I do have an answer for everything (!) so thanks for opening up the discussion. I will say though that I’m unashamedly in favour of “lifestyle delay” because the benefits after only a few years are so compelling and ripple through the rest of your life. I’ll address some of your other points in these comments after work one day this week.
I find it hard to debate with you Adam because inherently I agree with you, but not to the excessive degree you give.
Lifestyle delay can happen, but not necessarily by not looking for a relationship/ a house/ or roots to settle into. Doesn’t it seem a tad drastic to really be so focussed that you won’t open your mind to living life differently?
I am no belittling your life, or your point of view. It is to a great degree highly respectable, but I think there is another way.
My partner and I bought our house on a collective household income of 21k. It was affordable. We bought at the age of 18/19. We now have a 50k+ family income (when we’re both full-time working), but still living in the same house with very similar outgoings. If anything buying a house and being ‘stuck’ in this cheaper property has meant more pennies to save.
If we’d been renting I can say with certainty we would have inflated our lifestyle to match our new income. Sometimes being stuck and commiting is better than not.
Adam, I am with you on this argument. We wrote a post at http://www.consumerismcommentary.com/2010/04/06/the-best-way-to-invest-in-real-estate/ last week where we make a similar case as you do. When we bought our house in the middle of the housing frenzy – but still far from the top – we did not make an investment in real estate, we made an investment in happiness. My family loves living in our house that we can afford easily. We don’t care whether the price of the house goes up or down 25% or even 50%.
I think Andy’s comments are very pertinent, both in the fact that older people can downsize and that renting is a much quicker route to lifestyle inflation than buying (personal experience with the latter). Also old people benefit from equity release on property later in life which can fund retirement.
But Mr Knight. Math? REALLY?
Mathematics darling. Or Maths for short.
;-p
@sean i’d busily compiled a bigger than expected excel document for pip to explain what I wanted to explain so when I wrote ‘math’ of course I didn’t mean it.
I meant ‘that number thing’ or for me to ‘numberwang’ pips data (maths and mathematics? get wiv da times). Simples.
I think this blog boils down to the weaker elements of your financial commentary.
You’re very strong and very well-read on all subjects and the advice you give is fantastic in many areas.
But I would suggest to you, the best advice you give is advice where if two people in the exact same lifestyle read your advice but one took it and one didn’t the one that took it would be better off. Your information on saving strategies and your upcoming information on stocks & shares investments definately fits into the bracket.
Conversely, your weakest elements are where you challenge lifestyles. The suggestions you make can’t be for everyone then, they can only be for a smaller readership – those that haven’t already started treading down lifes path, and even then only those who would be willing to deprive themselves for future gain which will be a yet smaller group of people.
I argue that you have lifestyle inflated too much. Why couldn’t you stay at your parents and put even more in your savings? If they charged you board why didn’t you move out and secretly live in your office? Why did you take a taxi to work when your bike was punctured instead of walking the 4 miles? Your lifestyle is overinflated Pip.
When you return to solid advice that all can benefit from I will read each word with baited breath, and truly take some of it on board (when I feel like overspending it is great to touch base with some of your articles to stop myself). Until then i’ll challenge the life-delaying point of view.
Keep it all up though!
@Rightly Knightly.
Thanks for your comments. You make some good points and think you have made some phenomenal progress through your increased household income and low housing costs.
I fear, however, that you are very much the exception as when most people buy a house they wish to buy a nicer property than the one they may have previously rented, rationalising that ‘it’s an investment’ and ‘for the long term’.
In reality they give themselves a huge monthly payment, and want to improve the property to make their mark. They’ll probaly want to move soon enough too -cue more fees. It can get very expensive very quickly even with reasonably priced housing.
As for your other points, a very entertaining read but I feel you went slightly off-topic so will debate them with you another time 🙂
@Sean. I shudder at the reference to ‘equity release’ -have you seen the fees on those? Daylight robbery preying on the vulnerable old -it’s a blog post in itself but have you ever done a google search on it?! Try this google search It’s not the magic bullet you would think.
@ctreit Thanks for sharing -I love reading happy endings 🙂
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