There is a kernel of truth in the widely held belief that the home is the ‘best investment’ that most people make (of course, assuming that all housing-related expenses fit comfortably within a household budget). We know that it is not due to the usual claims (“this house is worth twice what we paid”) because it conveniently omits to take mortgage interest, maintenance, closing costs and other expenses that come with owning a home into account. But home ownership mostly works out okay due to the following reasons:
Disciplined Investing: Homeowners usually put into practice the discipline that equity investors should be following in owning stocks: they invest periodically by slowly building equity with each mortgage payment; they own for the long-term by buying a home and living in it for years; they save more even though, at least initially, owning will cost more than renting because they find a way to spend less on other things. In short, owning a home is probably the ‘best investment’ for most people, even though superior returns can be had from stocks, simply due to better investing behaviour.
Tax-Free ‘Dividends’: The biggest return from owning a home is in the form of a ‘dividend’ – the rent that would have to be paid if the home is not owned. As I noted in an earlier post, such ‘dividends’ can be significant and even better it is tax-free. In the example cited in the post, the ‘dividend’ yield from owning a home is 4.7%, which doesn’t sound all that much until you realize that it is after tax.
Low Returns from Stocks: There is a key difference between how much equities have returned in the past and how much an average investor actually earned by owning stocks. Studies such as those by DALBAR has consistently shown that investor returns have been much less than market returns because of performance chasing, expenses, turnover and taxes. In most cases, the shortfall is quite stunning and shows that the average equity investor would have been better off investing in bonds (thanks to Larry MacDonald for pointing this out). When actual returns obtained from owning a superior asset class is so poor, it isn’t surprising that for most people, their home turns out to be the ‘best investment’.
