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Photo: nancyarora2020 / Flickr ShareThis Share Currently, we find ourselves in an economic quagmire with many investors ferreting opportunities to grow individual wealth. Unlike Baby Boomers, the need to search for personal wealth opportunities are particularly important for young investors, as we need to ensure that enough money is put into retirement "piggy bank." If you consider the general economic trend, young adults have to work longer into retirement years than previous generations in order to sustain a standard of living they were accustomed to in their working years. Consequently, young investors need strong investment returns that exceed the rate of inflation in order to avoid working in later years.
In lieu of our insatiable appetite for moderate to high rates of return, young investors know that traditional bonds won't meet our needs, as they normally return 5% per year. Consider that inflation is normally 3%, which leaves us with a real rate of return of only 2%. To be exact, it's slightly less than 2% based on the Fisher hypothesis, a theory where interest rate is independent of monetary measures, particularly the nominal interest rate. Hence, a real rate of return of a paltry 2% won't afford a 20-something the desired monetary growth for their long-term personal investment portfolio.
If bonds don't give young investors a high rate of return, many economists would suggest investing in stocks. The basic theory of stocks is that the greater the financial risk, the greater the reward. Most young investors know about those who have made a great sum of money in the stock market. We often overhear our friends and colleagues discuss how they made thousands of dollars in the market over a short amount of time.
But let's check the facts…
Consider that 10 years ago, the S&P 500 hovered at approximately 1,400. Today, it's at approximately 1,100. That's a decrease of 21% — an unpalatable figure for those who want to eat in retirement. Not only has the S&P declined, but the Dow is down by 3%. Again, it's not a return needed to prepare a young person for a decent retirement. Net takeaway: stocks.
After examining the investment opportunity in bonds and stocks, the next stop on our journey is real estate. I have often heard that real estate — particularly buying a home — is an investor's best asset. Let's see if this is a valid claim.
ARTICLE CONTINUES BELOW ADVERTISEMENTDepending on your sources, the average home price in the U.S. at the beginning of the millennium was approximately $160,000. Today, that same home will sell for approximately $200,000. Before we attempt to determine whether real estate is a good investment for a 20-something, consider that home prices rose considerably during the first half of the decade. If we explore the change in home prices, the average home increased by $40,000, or 25% over the decade. If you do the math — considering present value, future value, and time — this equates to a 2.2% compound increase year over year. Congratulations, we're now in the positive rates of return.
Just one moment. We haven't considered the rate of inflation, which we know historically is greater than 2.2%. Not only that, we haven't taken into account that it cost us approximately 5% to 6% a year to borrow the money to purchase the home.
Granted, we all have to have a roof over our head, and I'm not suggesting that real estate is a bad investment, but it is my personal opinion that if your home is your best and biggest investment, then you may be in trouble. Young investors need to undergo a paradigm shift in which they view real estate as a place to live and not as a money generating asset. It is vital to our long-term financial success that we understand that homes are not a money machine that will make us all rich, but a place to live that affords us the ability to raise children and keep us warm during the winter months. A home may be your biggest investment — but it may not be your best investment. In my opinion, diversifying your personal portfolio and including a healthy blend of stocks, bonds, and real estate is the best way to go.
This is a guest post by Antar Salim, MBA. Antar serves as a coordinator for Rasmussen College School of Business, at the Eagan, MN college campus, where he teaches business degree-seeking students.
Read More Why young investors should "Stay the Course" and continue to invest Why invest in the stock market? The false goal of maximizing investment returns6 Myths About Real EstateTreasury bills for ordinary folks 5 Average: 5 (1 vote) Select ratingGive it 1/5Give it 2/5Give it 3/5Give it 4/5Give it 5/5 Your rating: None Share (10) add comment ShareThis ADVERTISEMENT Related Topics on Wise Breadadjustable rate mortgage buying a home debt Debt Management housing Investment mortgage Personal Finance real estate Real Estate and Housing
Guest Contributor Antar Salim Antar Salim, MBA serves as a coordinator for Rasmussen College School of Business at the Eagan, MN college campus, where he teaches...
Antar Salim's profile comments 10 discussionsAdd New Comment Comment: * CAPTCHAThis tests helps prevent automated spam submissions. Your name: * E-mail: Website:
16 Sep. 2010 | 6:52 AM Stephanie Christensen #1 Completely agree, Antar. I too, totally bought into the "truism" that real estate is a wise investment. I'm sure it was a sound and sure investment strategy in the "old days" when homebuying was something you did just once or twice (and saved up for for years), because you planned to stay in the home your entire life. IF that is your strategy, it probably still makes sense in the long haul. The trouble is, very few people buy homes for the long term anymore; they intend to continue "trading up" every few years.
Now that I am a homeowner and have experienced first hand how many other expenses it introduces, like tax, maintenance, and insurance, I'm inclined to believe renting might be the better way.
REPLY
16 Sep. 2010 | 12:42 PM Guest #2 Hi Stephanie,
thanks for your input and support of the paradigm. I'm curious to know what constitutes a wise investment for you?
Antar
16 Sep. 2010 | 7:55 AM Veritroth #3 The only real estate that should be considered an investment is from a rental that is cash flow positive. A person's primary residence should in no way be considered an investment. Common sense dictates that housing values can only rise sustainably with rising wages, making real estate an inflation hedge at best and outright liability at worst (interest on mortgage, insurance, taxes, maintenance, etc.)
Too bad for most people, their house is, by far, their largest "investment."
REPLY 16 Sep. 2010 | 12:45 PM Guest #4 Hi Veritroth,
I agree - assuming it is cash flow positive after you take into account risk. For example, if I can only generating 5% return in real estate - I would agree it is a poor investment compared to stocks that generate 4-5% dividend yields.
Antar
16 Sep. 2010 | 10:22 AM Joe Enos #5 I think you're missing the key point of considering real estate to be an investment. You're investing a ton of money that you're borrowing, rather than money you already have. If you have $200,000 cash in your hand, then it may or may not be a good investment to buy a house. However, if you borrow $200,000 from the bank, paying a low interest rate, getting 2% back through appreciation, a significant amount of money back through income tax deduction, and differencing out the amount you would have paid through rent by renting, you might just be making quite a bit of a profit.
If you're renting at $1,000/month, then you are giving away $12,000 per year with no hope of recovery of any of it. You started with no cash, so you're making no money on other investments.
If you buy, and your mortgage interest is $1,000/month (ignoring principal since that's not truly an expense), then you may get back $200/month ($2,400/year) through income tax deduction, and your home value increases by $4,000/year (2%), for a total of $6,400/year increase, which even that number increases every year. A $6,400 "profit" for "zero" initial investment is pretty darn good.
Of course, in real life, there's a down payment (not truly an expense but a big out-of-pocket event), property tax, closing costs, commission, home repair, and a ton of other expenses, which eats away at that $6,400 pretty fast. So the true question about whether home ownership is a good investment is whether or not your ownership expenses outweigh the return, and how long you live there may be the biggest factor in that question.
REPLY
16 Sep. 2010 | 10:51 AM andyg8180 #6 An investment is something that has value and returns capital either in the form of interest income or appreciation. So, no, a single home is definitely NOT an investment unless youre flipping it or renting it out to someone else.
So people have to look at Rent vs Buy scenarios.
REPLY
16 Sep. 2010 | 4:12 PM Libertyville CPA #7 Real estate can obviously be a good investment. But like any investment, timing is everything. Don't just think that because you invest in something it should always go up in value.
REPLY
16 Sep. 2010 | 4:33 PM Guest #8 With all due respect to this learned college "coordinator", this is a very poorly written, poorly contemplated article. On one hand, you seek to demonstrate in your article that stocks, bonds and real estate are poor, insufficient or losing investments, yet on the other hand you conclude that "diversifying your personal portfolio and including a healthy blend of stocks, bonds, and real estate is the best way to go." Your premises do not lead to your conclusion. And frankly, your conclusion that people need to diversify is not very original.
Moreover, the article fails to give "real estate" investment a fair shake. Generally speaking when "investors" invest in real estate, they are either flipping that property or renting out that property. Most people would not consider their residence as an "investment" per se, but rather it is a strategic decision between renting vs buying.
It is worth noting that if an investor did indeed purchase the house at the beginning of the millennium for $160,000, sells that same house now for 200,000 and only breaks even on the value of the house (considering inflation, etc), the investor would still walk away with 10 years of rental income (minus various costs, vacancies, etc)! Or alternatively, as the article suggests, if the investor financed the house, then he will have only contributed $32,000 as a down payment on the house (20% of purchase price), would likely have had a renter covering most if not all of the mortgage costs on the house for 10 years, and then sell it for $200,000. After paying off the remaining mortgage balance, the investor still walks away with a nice return on his initial $32,000 investment.
And the beautiful thing about real estate is that if you can afford to purchase the property in the first place (either outright or financed) you generally have the freedom to sell that property at whatever time it makes sense to do so. So, if the investor was so inclined, he could have pocketed even more profit if he elected to sell at the high points in the housing market between 2004-2006. Otherwise, he could simply wait a few more years until a more opportune time, all the while he is collecting rent and having someone else pay the mortgage for him.
REPLY
16 Sep. 2010 | 5:57 PM ajc @ 7million7years #9 Aaaah .... have you considered that you put in only 20% of the home price? So the return on YOUR investment (i.e. in cash) is considerably MORE than 2.2%?
Also, I would argue that most people are better at picking which real-estate will grow above average (i.e. merely investing in most metro areas and avoiding most rural areas will take you above the 2.2% average that you quote) than in picking which stocks will grow.
REPLY
17 Sep. 2010 | 12:09 PM Greg McFarlane #10 "Is Real Estate A Good Investment?" That's like asking, "Is clear liquid OK to drink?"
Assuming that you're talking about single-family homes, you're not looking at opportunity cost. Rent still comes with a -100% rate of return, regardless of market conditions.
If there was a practicable, actionable piece of advice or information in this post, I'm too dumb to glean it.
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