Common wisdom says that buying a house is a great investment. Real estate only goes up over time and you are not throwing money away on rent each month.
There are many articles, blogs, YouTube videos and even TV shows about whether buying a house is a better investment than renting.
There are many variables that go into a decision like this. I have owned my own house twice and I have also rented many places. I have rented short term and long term, I have subletted, I have used Airbnb for long term rentals. I have even been a landlord and rented out my own house. Let’s just say I have experience in this area.
This article will not really compare renting vs owning. I’ll do that another time. Rather it will examine the financial results from buying a house or investing the money in the stock market.
There are many variables and decisions to make when it comes to the best financial plan for you, especially when it involves where you will sleep each night! Consider this article food for thought rather than my opinion telling you what is best.
So let’s say you have $100,000 saved up and you are thinking about using it as a downpayment on a house, condo or duplex that you will live in.
As I mentioned above there are many factors that will influence your decision about whether buying a house is a good idea or if another option is better for you. But let’s look at the numbers from an investment standpoint.
In 2008 I bought a house. The downpayment was $100,000. I lived in the house for 10 years, paying mortgage payments each month, often trying to pay extra so that I could pay off more of the principle. Of course I also paid property taxes, repairs, utilities, insurance and all that good stuff.
In 2018 I sold the house. The profit after the remaining mortgage was paid off was $200,000. To clarify, the profit was $200,000 minus my original $100,000 investment. So the gains were $100,000. I guess you could say I made $10,000/year.*
That sounds pretty damn good right? I made $10,000 each year for living in my own house.
Well, not exactly.
Don’t forget I also paid principal and interest on the mortgage for 10 years. But hey, let’s ignore that for now even though it is significant. Why? Because if I didn’t pay that mortgage I would have paid rent. I did have to live somewhere. And again, I will discuss renting vs owning in another post.
Let’s look at the $100,000 gain on my $100,000 investment from a purely numbers perspective.
Let’s imagine that instead of putting that $100,000 down on a house, I stuck it in the stock market in an index fund. For fun, let’s imagine a few scenarios of different index funds just to see what might have happened.
I’m a huge fan of Vanguard. I have been a customer for many years but I don’t have any other reason to tout their services. However, because I like them, let’s use a few of their funds in this example. I may or may not own some of these funds. 🙂
I made this chart on the Nasdaq.com website just because it was the first thing that came up in Google. I entered five Vanguard funds. (the Admiral funds are versions of the funds that have higher deposit levels and lowers fees, usually the minimum deposit is $10K)
VBTLX: Total Bond Market Index Admiral
VFORX: Target Retirement 2040
VFIAX: 500 Index Admiral
VTSAX: Total Stock Market Index Admiral
VSMAX: Small Cap Index Admiral
You can see from the chart that VSMAX outperformed the others, and that VBTLX didn’t do much. That’s not a surprise.
Note that this chart starts in July 2008 with an investment of $100,000. The max growth ends in July 2018 at $280,000. Remember my house example? I started in 2008 with $100,000 and got $200,000 in 2018. Looks like VSMAX outperformed my home investment. Don’t forget that I also paid a portion of the mortgage principle each month, a form of drip investing you could say. Over 10 years I added nearly $60,000 to my $100,000 downpayment.
Take another look at the chart. VTSAX and VFIAX are quite close in performance, ending in July 2018 around $220,000. These also outperformed my home.
VFORX is a retirement account comprised of a mix of stocks and bonds. It is meant to be a bit more stable than the stock market and indeed it was less volatile. It also has a lower return, but still not bad at around $170,000 after 10 years.
Bonds are considered a relatively safe and stable investment. In this case indeed the bond fund did not dip as much when the market crashed in 2008-9, but they also didn’t grow very much in the following years.
Looking back I can tell you what I think about buying a house versus investing in the stock market. I wish I had not bought a house. Or at least I wish I had invested that $100,000 in the stock market instead of in the house. Of course hindsight is 20/20.
Let me give you a few additional details.
Look at the chart above, you’ll see that the stock market took a big dive in 2008-2009. Guess what also took a dive? The value of my home. I couldn’t sell it for a profit in 2010, I had to wait. What if I didn’t want to live there anymore? What if I got a new job in a different state or wanted to move in with my boyfriend? I had to wait. Or rent out my house and try to pay the bills that way.
Of course, if I also wanted to take my money out of the stock market in 2010 I wouldn’t have made any profit either. So I guess that’s a wash. But keep in mind that I do not live in the stock market, nor do I have to keep paying the stock market’s mortgage each month.
Let’s look at the mortgage. I borrowed $300,000 at 5%. Let’s say that I paid around $1600/month including principal and interest. In 2018 the loan balance would still be $243,000. I would have paid off $57,000 in 10 years. You could also subtract that from my $100,000 profit if you wanted to. This would mean my actual “gains” were only $43,000 and my total investment was $157,000.
I paid $150,000 in interest. Yes, you read that right. But that’s only about $1200 per month which is cheaper than rent would have been in the area for a house of the same size. In fact, the mortgage payment of $1600 was lower than rent would have been for a house of the same size in that area.
In this case, if you look only at the monthly costs of the mortgage, owning the house was probably cheaper than renting. But the house was much bigger than I needed. I could have lived in a smaller apartment and in a different neighborhood closer to my job which might have been about the same costs per month, especially once you add in the property taxes, maintenance and homeowners association dues.
I also spent a lot of time and money fixing up my house. Putting in a new floor, painting the interior and exterior, remodeling the bathroom and kitchen, planting a garden. There was a lot of sweat equity in the home, but also a lot of actual money spent on the upgrades. My theoretical money in the stock market required no effort on my part. Vanguard charges low fees mostly less than 0.1%.
A stock market investment is risky. The stock market might take a dive. A bear market might last a long time. The housing market is risky too.
Ok so now it’s 2018 and I want my money!
I sell my house and receive $200,000 or sell my theoretical VTSAX index fund and get $220,000.
What about taxes?
My house is in the USA. There are no capital gains taxes on the first $250,000 of gains on my primary home if I am single. Aha! No taxes! That’s great!
My stock sale is not so lucky. I will be paying long term capital gains tax on at least some of those gains, depending on my tax bracket and other income that year. It’s most likely that I’ll be paying 15% on at least a portion of $120,000. Damn.
In this way, the sale of my primary home is more favorable as far as tax planning is concerned. However, while I want to sell my house so that I can move somewhere else, I don’t need to sell my stocks. Or at least I don’t need to sell all my stocks. Even if I wanted some of the money for other purposes I could plan to sell only some of the stocks on an annual basis in order to keep my taxes lower. That’s a complicated subject for another time. Suffice to say, if I had that imaginary stock investment from 2008 I would not be selling it in 2018.
What do you think? Would you rather invest your savings in the stock market or use it as a down payment on a home? I hope you enjoyed this article.
*obviously the numbers are rounded for simplicity but the actual figures are very close
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