This past weekend my family has made the move into a new home, which needless to say, has been a chaotic process. It really got me thinking, though, about real estate/home ownership and how it fits into client portfolios and their financial plans.
Buying residential real estate certainly poses some undeniable advantages. For many people, there is a certain pride in homeownership. After all, it is the epitome of the American Dream. Additionally, the interest and property tax portion of your mortgage is tax-deductible, and not unimportantly, homes tend to increase in value, build equity and provide a nest egg for the future.
But what is very often overlooked by the average American is the opportunity cost of their money and how their mortgages play a role in that. A recent Wall Street Journal article highlights the important decision individuals face when they have excess cash. It recommends taking a close look at what interest rates you pay on a mortgage and how those compare to the savings amount on your bank account as well as the rate of return on investments in equity and bonds.
When homeowners do this, they often are struck with a revelation: they are likely not getting as high of a return on their investment as they would have if they were invested more heavily in equity. Ultimately, the opportunity cost of having your money tied up in your mortgage could actually hurt your long-term wealth. Even worse, the tax breaks you are receiving do not cover the amount of loss incurred from your interest rate! A recent Bloomberg article went so far to say that this simple understanding is one of the distinctions that separates the world’s wealthiest individuals from the middle class and one of the major contributing factors to income inequality. Basically, it argues that a major difference between the middle class and the top 1% is that the middle class have too much of their portfolios tied in up residential real estate that is not providing adequate returns.
There is a theory out there that wealthy individuals are simply more skilled investors. A recent study explains that this is not true. (In fact, they might be worse!) Wealthy people just tend to own most of the equity in the economy, meaning that when business does well, they reap disproportionately large benefits. Generally speaking, rich individuals own the upside of the economy in the form of stock, while the middle class’s gains are limited by the slow growth of housing wealth. It is no surprise that the collapse of the housing bubble has exacerbated wealth inequality because stocks recovered more strongly than real estate did. Maybe the difference between you and the 1% is just your perception of the options available to you.
Surely, shelter is one of the basic necessities of life. Everyone has to live somewhere – but taking the time to consider all of your options before making any large financial decisions is something that every person should do. At the very least, you should consider the opportunity costs of your cash and look into advantages of a less expensive housing option, renting, or investing more in equity to ensure that you are getting the most out of your money in the long run.
These are the kinds of decisions we want to help you make, so don’t hesitate to contact us today to get started.