This is only the second house my wife and I have purchased in our adult lives. Our first one was back when I was 24 years old.
With our first house for sale on the market at almost the same price we paid for it back 11 years ago, this got me thinking:
What if we hadn’t bought a house when we first got married, and did something else with our money? Would we be better off financially?
Although this is a fun little question to ponder, it’s actually a very real and tough choice for lots of young working professionals today. Many of them are faced with the decision of whether to find a place to rent or settle down with a good starter home.
Well, even though getting your first home can be very exciting, I’m going to show you that perhaps waiting a few years to become a home-owner might make better financial sense.
Let’s first take a closer look at some of the myths that push us to buy a home as soon as possible.
Do Houses Really Appreciate in Value?
There are so many things in our lives telling us that buying our first home is a good idea:
- Our parents tell us it’s a great investment. (Back in their day, it probably was!)
- We know we’re doing a smart thing by no longer throwing away money on rent for a place that we’ll never be able to call our own.
- You’re finally somewhat accepted as a responsible grown adult who is capable enough to manage a mortgage.
- Best of all – it feels great to be the king of your own castle!
From a financial perspective, let’s zero in on that first point. Folks from the baby-boomer generation (and older) love to tell you that “buying a house is an investment”.
Like I mentioned, my wife and I are currently putting that theory to the test. We’re trying to sell our house of 11 years at approximately the same asking price that we paid for it originally. The sad reality is that more than likely, by the time it finally sells, we’re probably going to end up with slightly less than that amount.
Now factor in all the numerous upgrades and investments we’ve put into our house over the years, and we’re surely not going to be make any of our money back.
Dr. Robert Shiller of Yale has pointed out this sort of phenomenon with house prices before. According to his research, thewas only 0.2% between 1900 and 2000.
We say “real rate” because that’s adjusting for inflation. So in reality when your parents bought a house for $100,000 and later on sold it years later for $150,000, it wasn’t really because the house increased in market value. It was more likely due to the economic forces of inflation.
No matter how you slice it, 0.2% is a pretty crumby rate of return. If I told you I had an investment opportunity for you at that rate, you’d tell me to get lost!
So then what else could we do with our money that would be better? Is there something else that would have made me richer if I had waited 10 years later until age 34 to buy a home?
Absolutely there is!
Saving for Retirement vs Buying a House:
- You started saving a certain amount for retirement right away at age 24, stopped saving that amount at age 34 so you’d have more money to buy a house, and then never saved any more money for retirement ever again.
- You bought a house at age 24, did not start saving for retirement until 10 years later starting at age 34, and then continued to save that certain amount for the next 30 years until you reached the age of retirement.
(I say set “certain amount” because I’m not insinuating that you wouldn’t save anything for retirement in either of these situations; only that this amount would be in addition to what you plan to save. Glad to clear that up.)
To keep things consistent, let’s assume we’re working with the same figures in both situations. If you’re not living in a house and paying a mortgage, then you’re likely renting a place to stay. So here are our assumptions:
- Rent per month: $500
- Mortgage per month: $1,000
- Difference per month to save for retirement: $1,000 – $500 = $500
Scenario A – Delaying the House Purchase and Saving Right Away:
In our first situation, you start saving for retirement right away. That means at age 24 you’re stashing $500 per month into a tax-sheltered savings account (like a 401(k)).
By the end of 10 years at a compounded rate of 10% per year, your 401(k) would be worth $95,625.
Then at that point you decide to stop saving this $500 and instead use it to help finance your new mortgage and home purchase. So you stop contributing this amount to your 401(k).
That $95,625 stays in your 401(k) and continues to grow and compound for the next 30 years until it reaches a balance of $1,668,591 by the time you’re ready to retire at 64.
Not bad for only 10 years of making contributions!
Scenario B – Buying a House Right Away and Waiting to Save:
Now let’s play out the other scenario.
At age 24, you buy a house right away and no money to set aside for retirement. However, 10 years in to your career (now at age 34), you decide to start setting aside $500 per month for retirement. And you continue to save for the next 30 years until you’re ready to retire at age 64.
Surely after 30 years of contributions, you’d have a higher 401(k) balance, right?
It Matters A LOT When You Start Saving for Retirement:
So effectively, scenario 1 is the winner with a balance of $681,627 more by the time you’re ready to retire.
How is this possible??
Saving Early is the Key:
This whole phenomenon is due in thanks to the power of compounding returns. And the fuel that feeds compounding returns is “time”.
Because you started saving and building up your retirement account 10 years earlier in scenario A, you had far more money to compound and grow by the time you hit age 34. In fact, you had so much money saved that it was able to outpace any additional savings over the next 30 years. This is very similar to a situation I illustrated in an earlier post where at some point you could literally stop saving your money (if you wanted to) and still end up hitting your retirement goals.
Obviously, I’m NOT ever recommending that you stop saving for retirement; we just did that here to illustrate an interesting point. Can you imagine how much money you’d really have in scenario A if you had continued to save more retirement for the next 30 years? Your nest egg would be incredible!
This is why I always recommend to people to start saving as early and as big as possible.
Stocks Return More Than a House:
The other thing that really helped was the return rate of your investments.
Stocks, the things that make up most of our retirement accounts, have an annualized rate of return at about 10% according to NYU. Even adjusting for inflation, that’s still a decent 7% year over year return.
Combining this fact with the recent phenomenon of low interest rates is also the reason why I choose to invest my money rather than pay off my mortgage early.
Houses Aren’t Really Investments, They Are a Place to Live:
Now I know supporters of the house will claim that the house rose in value over the course of 40 years too.
But did it?
Go back to the beginning of this article. Remember that Dr Shiller found housing to produce an inflation adjusted rate of 0.2%. So even though you may be able to sell your house for more (eventually) than what you paid for it, this is likely only due to inflation; not because it was a great investment.
Compare that to the return of the stock market and its unfortunately no contest for the stocks.
What Can We Learn From This?
Really this whole exercise is NOT to dog on anyone buying a house at an early age (or any age really). Like I said, I bought my first house at age 24 and have lots of great memories. I’m all in favor of home ownership.
Like all things on My Money Design, this article was meant to make you “think”. It’s meant to challenge conventional wisdom and really do a deep-dive into the numbers to see which financial opportunity is really the best.
When you crunch the numbers as did and really examine both scenarios, you quickly realize just how powerful saving earlier rather than later can be. In fact you can almost double the size of your nest egg depending on how much you save and how your investments perform.
But does that mean we should all wait until our 30’s to buy our first home?
Of course not! Ultimately, the choice is yours.
There are plenty of “qualitative” reasons why you may want to buy a house. It’s not always about what makes you the most money.
Just remember that a house is a house; not an investment. You should buy a house because you love it and can see yourself being happy there for the next 10 or 20 years. If you want an investment, there are other places you should look.
Readers – Which would you rather tell a young a person in their 20’s: To buy a house or save for retirement? Looking back, which would you have rather done?