Home ownership is a lousy investment.
While I don’t dispute the numbers, they are based on averages, and don’t take into account location. Also, there is no accounting for the intangibles of owning your own house, with the ability to make it the way you want it.
I’ll file this under “No shit, Sherlock.” It still amazes me how many idiots bought into the idea.
But, it can be a good investment under very special conditions. A friend of mine has easily beaten the S&P by a healthy margin over the last some years by investing in real estate in Bangalore and Mumbai. That will continue to be a good play for a while too, as India has not had the same type of property bubble that China, the US and the UK/EU are experiencing, and their economy will continue to grow for decades yet.
As several comments point out at the link, the analysis doesn’t discount cost of fair market rent. It approaches the problem as if shelter is free unless you buy a house. Dumb, and given the example probably a big deal.
Can someone explain why Question #3 matters at all?
There are lots of reasons houses shouldn’t be looked at as an investment, but this article doesn’t do it for me.
And re-reading it (trying to figure out if I should care about #3) I notice something else: the “cost” used doesn’t include interest on the mortgage. At least I can’t see how it was, if it was. WTF? The true “cost” has an additional $250,000 in interest. Right?
If my house were meant to be a bank it would have a coin slot in the roof.
Of course it’s a lousy investment in general (in the sense of “mechanism for turning money into more money”).
However, unlike bonds and stocks, it lets you have a place to live, as jrman said. And that’s got value outside of “investment”.
If you don’t care about mobility very much, you’re beating renting by owning a house. (If you do care about mobility, you wouldn’t be buying in the first place…)
jrman: Further, their #3 also doesn’t include interest deductions from taxes, which would make the analysis even more complex.
Renters don’t get to deduct rent, but owners get to deduct interest on a mortgage. Which is a distortion caused by the tax code, of course, but still a real economic factor.
I’m with jrman and Sigivald. I also ask this question of the original author: How much money did the renters get when they moved out? And don’t tell me renters could have saved money by getting more house for less dollar value by renting. I bet less than 1 in 10 families would really take such savings and invest that money in something out performing inflation (since the author factors it). Most will simply opt for more house for equal money.
The main thing about buying a house is some money is being transfered to the future where otherwise it probably would not. Any return, positive or even negative (ie. 74k becomes 50k) is better than just throwing the money away for no return.
There is no ideal best investment. Risk and return change in unpredictable ways over time. However, the article gives a good starting point for thought.
There’s also the unexamined assumption that some other easily-defined investment would be better. But that is not the case. Take the stock market, for example: 401k managers routinely wildly overestimate the probable returns on the stock market by choosing carefully their window of comparison and substantially discounting the risk (particularly for large windows of comparison) by ignoring any firm that failed sometime during the period of comparison. (What rate of return did people who bought Pan Am stock in the 70s reap?)
Common sense tells you that any readily definable investment in a tradeable asset will have a real long-term rate of return near zero. How could it be otherwise? When you buy such an asset, you’re essentially making a bet with those who sell them that your predictions of the future value of the asset are more accurate than theirs. You can only have a real rate of return above inflation if on average you win such bets. Obviously it’s impossible for everyone to win on average.
Hence to earn a good rate of return you must by definition invest in things that the conventional wisdom says are bad deals. Buy stocks when the market is apparently tanking, buy real estate in swamps everyone knows will never be developed, invest in technology that everyone says is crazy unrealistic. You’re panning for gold. (Which is why so many people choose instead to emulate the real beneficiaries of the Gold Rush, and sell advice on investments rather than investments per se.)
I think the best possible “investment” advice you can follow is pretty simple: if you have special knowledge, not available to everyone, then by all means invest as that knowledge directs. (And this implies you can and should invest in yourself, since you have very special knowledge there.) But otherwise? Stop thinking of “investment” and return to thinking of plain ol’ “savings.” And a house, provided you think of it that way, is not a particularly bad way of stashing your savings away for the long term.
Common sense tells you that any readily definable investment in a tradeable asset will have a real long-term rate of return near
zerothe same rate of return as all other assets with the same risk.Wealth used as capital makes it easier to generate more wealth, with a non-negative, non-zero return. That’s a fact of nature, true ever since hunter-gatherers learned to sharpen sticks.
And capital used for more risky endeavors generates a higher rate of return (on average, even accounting for the people who lost their shirts) than capital used for less risky endeavors. That’s a fact of economics, a simple consequence of supply and demand combined with the decreasing marginal utility of money.
So if you want a long-term rate of return which beats saving money in your mattress you can get that easily, even in investments like FDIC-insured CDs which are just as safe as that fiat money was to begin with.
And if you want to beat the market indices, you can do so, in expected monetary rate of return, by putting your money in riskier investments. That’s not a good idea for most people, though. For example, investments which have a 50% chance of quadrupling in value and a 50% chance of becoming worthless have a fantastic expected return rate but are a lousy place for savings you depend on.
In theory you can beat the market in expected utility rate of return, e.g. by buying riskier investments when you’re young and can afford to gamble (those two examples above weren’t hypothetical, they were where I put my first IRA contribution) and safer investments when you’re old and can’t afford to lose much. In practice I’m not sure if young investors can do better than an index fund; by picking individual risky investments small investors can’t diversity enough to reduce their risk well, and by picking risky mutual funds their investment is likely to be nibbled to death by management overhead.
Common sense tells you that any readily definable investment in a tradeable asset will have a real long-term rate of return near zero.
“Definable” isn’t the right term. I can define an investment that basically crushes the other kids over any time period you like. That would be the pool of the Senator’s investments.
The problem is knowing what they’ve invested in ahead of time. Or at least in sync.
Sure, buying a house is a lousy investment if you’re stupid about it. Buy a housing-boom era box of ticky-tacky with a whole three feet of yard all the way around in some five-cent subdivision next to a low-income housing project, and watch how quickly its value drops… especially as the repair bills come flooding in, as all that cheap particle board gives out.
Buy quality, in a neighborhood that’s not likely to go downhill- solid construction, maybe a little land around it- and the absolute worst you’ll do is break even. Good houses in good neighborhoods will always be in demand, and there’ll always be fewer of them than there is of the aforementioned crackerjack boxes.
Common sense tells you that any readily definable investment in a tradeable asset will have a real long-term rate of return near zero.
I guess common sense isn’t very useful then since we have obvious counterexamples that have gone up exponentially over a century or more even with inflation and default.
To elaborate, since the snark to information ratio was a wee bit high, sure if you had invested in a single thing, especially in the stock market, then the value of the asset would likely be zero by now. But there’s two factors to consider here. First, you can diversify your portfolio so that default risk doesn’t take out your investment completely. Second, you need to consider dividend payouts. Even if the asset expires totally worthless, it can still be worth your while to purchase, if the income is good enough. Loans tend to operate this way.
Like any other investment you need to follow the advice of the Gambler…
Know when to hold them
Know when to fold them
Know when to walk away
Know when to run
You knew it was time to run from Real Estate when it satisfied the Joseph Kennedy test
“When the shoe shine boys started giving me stock tips I knew it was time to bail out of the market”
DaveP.
Wow, dead on. Even better is farming community land when the economy is bad and the farmers start selling off little chunks (10-40 acres) of their outlying pastures, complete with rocks, trees, and swale.
As long as you’re within long commute of the closest city center and build a decent house, it really is “money in the bank”. Chances are the city expands out to you, and you’re sitting on a tidy investment.
Imagine having bought 25-100 acres of divisible Bay Area foothills property in 1960.
Oy.
Roy, you are being just as bogus as the 401k managers in asserting that “high risk” investments have a “high rate of return.” You are calculating that rate of return assuming the risk does not materialize, i.e. you do not lose everything. That’s like a Vegas sharpie saying I’ll give you 1 in 100 odds of winning (99 of 100 odds of losing your bet) but I’ll pay you 10x what you bet, so your “rate of return” is 1000%! Wow!
What’s important in making bets — and an investment is a bet — is your expected return, taking into account the probability that you lose everything. That object for most well-known investments is, as I said, near zero for obvious statistical reasons, because it’s not possible for everyone to win the bet on average. On average, neither buyers nor sellers of commonly traded assets profit thereby more than the other. How could it be otherwise? Where would you find a continual supply of suckers for the losing side of the bet? Only in a bubble, when yesterday’s “sucker” becomes today’s “winner,” and a bubble by definition is not a long-term phenomenon.
Al, I think you know what I mean. Choose your own term. It’s like the late-night pitchman saying buy my book for only $20 and I’ll show you how you can become a millionaire! Anyone can do it! An ounce of intelligence reveals that if it were really the case that $20 and average wit could make you a millionaire, then everyone would be a millionaire, and of course then being a millionaire wouldn’t be worth beans. Same idea here: by defiinition, if everyone thinks X is a good investment, and it’s available to everyone, then it isn’t, with certain reasonable exceptions.
Karl, when you “diversify” your portfolio, you reduce the rate of return. If you diversify enough to ensure you don’t lose money, you’ll ensure you don’t make any, either. And you’re ignoring opportunity cost. Money not investmented in this can be invested in that, instead. No one’s arguing that an investment is worthless, just that its real reate of return, if its avaialbe to everybody and everybody thinks its a good idea, is near zero.
That isn’t necessarily a bad thing, either. A real rate of return near zero is a hell of a lot better than losing your money. It’s just that it’s better called “savings” instead of “investment.” An investment is what you make if you have special inside knowledge — you’re Bill Gates in your garage in 1980 or you’re Jeff Bezos with this crazy idea about selling books — books?? — over the Internet in 1995. Or, better, you’re said Bill Gate’s or Jeff Bezos’s wealthy friend, and you know about the brilliant plan long before anyone else. Those things do indeed pay way better than inflation, on average, because they allow an individual (or a few individuals) to bet against the conventional wisdom when the conventional wisdom happens to be wrong, or just take advantage of what’s not commonly known. That large pool of the ignorant or wrong provides the big pile of cash for the losing side of the bet.
Carl, you make a great argument and I agree with everything except one small point…
…you’re essentially making a bet with those who sell them that your predictions of the future value of the asset are more accurate than theirs. You can only have a real rate of return above inflation if on average you win such bets. Obviously it’s impossible for everyone to win on average.
It appears you are assuming a zero sum game here (adjusted for inflation.)
All wealth comes from exactly one source: a trade. It goes back to the fact that there is no such thing as intrinsic value. Wealth is produced at the moment of a trade because the traders have each added a tiny amount of wealth in their valuations that cause the trade to occur. It really doesn’t matter how the valuation changes from that point forward even if both traders subsequently go broke.
Not being a zero sum game, the slope of the value of the stock could grow faster or slower than inflation. If faster, did the person trading for dollars lose? No, because they have money to invest from the point of the trade onward and may make an even better investment. If slower, did the person with the stock lose? Sure, but not that initial wealth created in the trade. The combined wealth of both is still greater and the ‘loser’ going forward can adjust their mix of assets.
In summary, all wealth is personal valuation. An increase in the rate of trade is what increases the rate of growth of wealth. The government is currently undermining our wealth by creating the uncertainty that makes people resist trading (like hiring a new employee.)
Karl, when you “diversify” your portfolio, you reduce the rate of return. If you diversify enough to ensure you don’t lose money, you’ll ensure you don’t make any, either. And you’re ignoring opportunity cost. Money not investmented in this can be invested in that, instead. No one’s arguing that an investment is worthless, just that its real reate of return, if its avaialbe to everybody and everybody thinks its a good idea, is near zero.
It’s actually closer to 2% per year after default risk and inflation. Remember you’re giving the money to someone else who creates value with it. And because there’s a finite amount of capital to go around, that business has to offer a positive return (after your costs and risks are taken into account) on your investment or they wouldn’t get your money. It’s not a zero sum transaction.