In Robert Kiyosaki’s highly popular book titled Rich Dad Poor Dad he shows the difference between assets and liabilities, and further discusses the topic of your home. He says a home is a liability, and not an asset. He’s right. Even though your home is an emotional piece of what you own in your life, a home only costs you until the day you sell it. It doesn’t generate one dollar of income. Now everyone needs a place to live or a home to raise a family, but the bigger the home the bigger the liability. For many a home is their only way to save for their future.
In California it is often perceived that homes are a great asset. Recently, a friend sold their home for which they had owned for over forty years in a neighborhood with good schools. Knowing the starting cost, the time of ownership, and the selling price I ran a simple return on the investment, and over the holding period time the home’s pre-inflation return was 5.8% per year. Using an average inflation rate of 3% historically the inflation adjusted return is around 2.7%. No kidding, and this rate doesn’t include any improvement costs, monthly payments, or other monies spent on home ownership.
To further investigate this I then went to the California Association of Realtors website where they list the average home costs in California over the years. The website shows the average home price in California of $194,952 as of January 1, 1990. For December of 2019 they show the average home price as being $614,880. Impressive right, a $419,928 gain or 215% increase. The annualized return paints a different story. Annualized this equates to a 4.04% return.
As a comparison, I googled a simple online S&P 500 calculator available to anyone, to determine what the S&P 500 index return was from 1990 until 2019 using the same months. Without reinvestment of dividends the S&P 500 provided an approximate 7.75% per year return. Remember this S&P 500 average return includes the dot.com boom and bust, and the recession of 2008. As a comparison if you invested the 1990 average home price of $194,952 in an investment averaging an annualized return of 7% (less than the average annual S&P 500 return found online) as of December 2019 the investment would be worth approximately $1.386 million dollars before inflation. A gain of $1.191 million dollars or over a 600% gain.
The point I am making here is with all of the out of pocket costs of a home keep your home in perspective within your whole financial picture. We all need a place to live, yet if possible try and build your income generating investments first, so they can help you pay for and determine the price of what size home you can afford. If you are starting maybe a duplex or triplex might be a good starting asset where you could live in one of the units, and collect rent on the other unit(s). Think assets that generate income first, and let their passive income along with your working income guide your path. Also, when money is cheap that is when borrowing is best for a mortgage. Remember, no matter what you do, and if you get laid off or something does go wrong you need to be in a defensive position to ride it out without having to sell off assets, so set yourself up so you can sleep at night no matter what.