Some Americans believe that buying their own house is the best and smartest investment they'll ever make.
There are several valid reasons buying a home is better then renting. There is no landlord telling you what pets you can have or how many guests you can have at any given time, and buying a home gives you the freedom to improve or add to the property as you see fit. In other words, buying a home is the best way to make your living situation truly yours.
But buying as an investment or as the cornerstone of your long-range financial plan should not be one of your primary motivators. If your home doubles in value over the next few years, then great! Consider it a bonus. There are several reasons you shouldn't look at your home as an investment, especially in today's economy.
An inefficient investment
The main reason not to buy a bigger or fancier home simply because "it's an investment" is that there are much better ways to put your extra dollars to work. Real estate has generally appreciated around 4% to 5% per year on average, and this can be higher or lower depending on your specific location. Depending on what statistic you look at, home prices have historically appreciated at 3.4% to 5.4% annually over the past 20 years.
Compare this with an average annual return of 9.1% for an S&P index fund, 7.2% for the average mutual fund, and 7.16% for the ultra-safe 30-year Treasury, although it pays less these days, around 3.65%.
As you'll see, if you're hoping your home will generate these types of returns, you may be mistaken. Simply put, the risks are not worth the rewards.
Don't forget about mortgages
Your mortgage will cause you to pay much more for your home than the agreed-upon price, which also will eat away at your returns. Let's say you buy a $300,000 home and put 20% down, so you finance the remaining $240,000 at 4.5% (about today's rate for a 30-year mortgage). If your home appreciates at 5% annually, by the time your mortgage is paid off, it should be worth around $1,296,583.
However, because you are paying interest on your mortgage, when you add up all of the payments, you're really "paying" a total of $497,794 for the house. This implies a total return of $798,809 after 30 years, or just 3.2% per year on an annualized basis. Better than paying rent for 30 years, but not quite what I expect my "investments" to return.
Poor risk/reward ratio
When you consider the risks involved with owning a home, it doesn't really look like a prudent long-term investment. In fact, the risks associated with owning a home are quite comparable to the level of risk associated with investing in an index fund, but without the upside benefit. From top to bottom, the S&P lost 58% of its value before bottoming out in March 2009. It has since recovered to a level that is 13% above its pre-crisis peak.
In contrast, the U.S. real estate market fell about 35% from its peak and is currently well below its pre-crisis peak. Some U.S. states, such as Florida, lost more than 50% from the peak and have not yet recovered.
There are good investments in real estate, but your home isn't one of them
If you really want to "invest" in real estate, the only worthwhile way to do it is to buy an actual investment/rental property. These can be very lucrative if done correctly. In theory, an investment property should be a house (or apartment building, commercial space, etc.) that you buy and someone else pays for over time.
In contrast to our example above, let's say you buy a $300,000 duplex and put $60,000 down. In a conservative case, we'll assume you collect just enough rent to cover the mortgage, and your other expenses associated with owning the property. Assuming even just 4% appreciation, after 30 years, the property would be worth about $973,000. You only put up $60,000 out of your own pocket, making your total return over 30 years $913,000, or 9.8% on an annualized basis. Much better than the return from owning your own home!
To sum it up, there are several ways of putting your investment dollars to work that simply make more sense than buying your own home. I'm not saying you shouldn't buy a house to live in, it just doesn't make sense for "investment" to be the reason to spend more on a house in the hopes of producing long-term gains.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
More from The Motley Fool
How to Stick to Your New Year’s Career Resolutions
Don't let 2018 be yet another year of giving up on resolutions.
Don't Laugh, but After Horrible Holiday, Sears Says Profitability Is Still on the Table for 2018
The retailer has few options open to it to get into the black.
4 Things That Can Get Your Resume Thrown Away
Getting hired is a competition. Don't get disqualified before the game really begins.