itakitez: Firstly, I’m not a financial expert, I’m just sharing some of what I’ve read. People should do a lot more research, rather than simply taking my word for it.
I’m not talking about renting vs buying. If you’re able to lock in a low rate on a mortgage, over the long haul, aside from building equity in a home, you will indeed save money compared to rent because of inflation (because your mortgage payment will stay the same, but your rent will probably increase at inflation).
What I am talking about is the relative percentages of net worth. Your house may indeed increase in value (one would hope so!), but it won’t bring in passive income in the way that other things will. As such, money in your house isn’t a bad thing, but it isn’t a great thing either because that money doesn’t work as hard as investments.
When looking at types of investments, over the long term, stocks and property will outpace inflation. Over several decades, if you’ve bought with value in mind (instead of jumping on a bandwagon), you’ll be fine. Not so with cash. Bonds I don’t know a lot about, but they’re somewhere in the middle over the long term.
On a side note, running your own business really trumps most of what people will do for jobs and making money, and it also gives you a certain freedom to do things your way – even if you’re working really hard, it’s still your thing, so probably a lot more satisfying. I know success rates are low, but you can do it on the side, or maybe even take that risk. I personally think most people who have gone to university from my generation have been suckered into being mediocre by the mantra of getting an education. Even if they do get a decent job, their lifestyles rise accordingly (how many professionals would turn up to work in an old bomb?), and they become tied to their job because they’re too unwilling to live a few hard years now for many good years in the future. Frankly, I wouldn’t advise my children to go to university unless they were genuinely really interested in what they wanted to study or were quite content to be mediocre for the rest of their lives. Likewise with most white collar jobs. I’ll be teaching my kids about money from a young age and heavily encouraging their entrepreneurial spirits so that by the time they’re of university age, they’ll be doing their own thing (and failing several times if need be along the way), not following all the other lemmings over the corporate employment cliff.
Property can indeed decline in value, so the old notion of bricks and mortar is not true. All things being equal (e.g. your level of expertise in seeking out good investments at good prices, luck in the movement of the market, especially when you want to start drawing down on your assets), over the long term, stocks out-perform real estate.
Also, more importantly, as I have been pointing out, is that you can be house rich and cash poor.
Here’s an example. Let’s say you want to retire on $50,000/year. Living off a 5% return on your investment would mean you’d need $1,000,000 to do so, but that doesn’t include the effects of inflation in eroding the value of that money. By the Rule of 72 (basically, divide 72 by the percentage change and it’s the time it will take something to double or halve in value, depending upon which way you’re going), at 4% inflation, it will take 18 years for your money to halve. In 36 years, it will be worth a quarter of what it is today. In 54 years, it will be worth one eighth. That’s why any investment that doesn’t outpace inflation (for instance, cash) is really bad in the long term.
Anyway, back to our example. If you want to retire on $50,000/year (in today’s money), you need $1,000,000 (in today’s money). Even assuming you outpace inflation, here’s the potential problem. You need that in income producing assets. Your house does not produce income for you (unless you’re renting out part of it or you’re using it as a business). So, you could be sitting on a $1,000,000 house, but where’s that $50,000/year going to come from? You could use a reverse mortgage, but at most, that’s going to give you twenty years’ worth of equity (actually a lot less once you take out fees and inflation). You could sell your house and scale down. Even if you scale down to a $200,000 house (probably a major lifestyle change someone used to a $1,000,000 house would not be happy with), and even assuming no fees for doing so, you’d still only have $800,000 in income producing assets, so you’d be retiring on $40,000/year, not $50,000/year.
Hence, house rich, cash poor. So, you would need to have at least $1,000,000 outside your house in incoming producing assets. I’m not entirely sure why the 75-20-5 rule (which isn’t hard and fast, and really depends upon a lot of other factors) other than the more you have in the first category (assets), the more you earn, which means you can live better in retirement or get there quicker. The more you have in the other two categories (house; stuff, including cars), the less you have to invest to build up the first category, so the less you retire on, or the later you retire. It may simply be that you’re diverting too much money away from the first category if you move away from 75-20-5. Putting all your money into your house is a case of that because each dollar of house above and beyond what you need (and here it’s important to really take a very honest look at needs and wants) does not work as hard for you as it could in other things.
That’s why I said the middle class dream (finish school, go to university, get a steady job, pay off a house) keeps people middle class and mediocre. Far from being free in retirement, plenty of people are really hamstrung by their finances. They’re no less free than they were when they were commuting 3 hours every day to and from a job they didn’t like.
This is largely the case with my parents. My father started his own business, but he didn’t really invest well. He and my mother have always had this morbid obsession with getting the biggest mortgage they could afford and paying it off as quickly as possible, and they also let their lifestyles increase in cost accordingly along the way. To be fair, they’re still way ahead of most people their age, but they’re not where they want to be or should be. They’re now extremely house rich and asset poor. At the end of this year, they’re moving to yet a more expensive house (WHY?! :aiyo: ) and they’re really worried about being able to afford it now (because they signed a contract for it to be built pretty well right at the height of the bubble, and they’re pretty well going to sell their current house at the bottom of the market – my sister is trying to advise them to rent out their current place until the market picks up again, and then sell, but they’re not keen on the idea of not owning a large part of their house at all ). All of my life, my father was really against investing in the stock market (because he considered – and probably does again after the past couple of years – it too risky compared to real estate, despite having over-capitalised and/or taken losses on two of the three houses I’ve lived in, and being about to really screw themselves over the next switch ), yet got into it through a financial advisor a few years ago. Now though, he’s had to watch his investments tank because he hasn’t allowed himself a long enough time frame for them to recover, and because for the majority of their lives, my parents have had their money sitting in ever bigger houses (which they have also had to maintain and clean – my mother is forever bemoaning the amount of housework she has to do, not realising that she’s brought that on by wanting an enormous house), and so he’s having to put off official retirement (he’s been in a state of semi-retirement for several years). Likewise, my mother doesn’t particularly like her job and she’s sick of work generally. My father will be 61 this year, and my mother 58, and they’re both feeling their age and ill-health. If things pick up again, I’m sure they’ll be quite fine (much better, actually, and my sister and I will probably inherit a small fortune, at least in today’s money), but by then, they may be too unwell to really enjoy their retirements. That’s them. Now imagine my relatives, and most other people, who are quite average financially. Retirement is not going to be pretty.