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April 10, 2017

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Don’t think your house is a ticket to your fortune

THE same week the legendary American investor Warren Buffett put his California vacation house on the market, a friend told me her widowed mother had sold the family home in Cleveland.

Buffett bought his Laguna Beach place in 1971 for US$150,000 and is asking US$11 million. My friend’s parents bought their home for US$24,500 in 1965 and have just sold it for US$104,000. Put another way: If Buffett gets his asking price, his house will have appreciated at an annual rate of 9.79 percent compared with the Cleveland house’s 2.82 percent.

Neither buyer could have predicted nearly five decades ago what their homes would be worth now. But while Buffett scored a healthy return, my friend’s mother didn’t even keep up with inflation. (If she had, her home would have been worth about US$190,000.)

Homes are a big part of most Americans’ net worth. But whether a home purchase pays off big, or pays off at all, has much to do with geography. It’s a kind of wealth inequality that doesn’t garner much attention but can have big consequences for individual finances.

Some will hit the real estate lottery, blessed with pieces of equity they can tap for spending or bailing themselves out in retirement even if they haven’t saved enough. Others can do everything right — buying homes they can afford and diligently paying down their mortgages — but have far less to show for their efforts.

The solution isn’t necessarily to buy into hot markets, since predicting which markets will outperform in the long run is pretty much impossible, says David Blitzer, managing director at S&P Dow Jones Indices.

A better course is to invest in stocks, which historically deliver better returns than other investments and which help you build wealth regardless of where you live.

People often believe homes are a better investment than they actually are. On average, home prices across the United States have barely kept up with inflation since 1900, Blitzer says. Most of the nation’s housing wealth is concentrated in just a few states, notably California, New York, Florida and Texas, according to an analysis by the Urban Institute.

Homes can offer tax breaks for mortgage interest, property taxes and capital gains, since the first US$250,000 of home sale profit per owner typically is exempt from taxes. But homes also come with considerable costs that can’t be deducted, including insurance, maintenance, repairs and upgrades (though improvements can reduce the possible tax bill if you sell at a big profit).

Stocks, by contrast, never need a new roof and outpace inflation over time by a fat margin. Theoretically, my friend’s mother would be more than half a million dollars richer today if she and her husband had invested their US$5,000 down payment in the Standard & Poor’s 500 stocks instead.

Or consider what Buffett could have earned. A US$150,000 investment in the S&P 500 in 1971 could have turned into almost US$14.5 million — even more than the asking price on his six-bedroom, ocean-view house.

Of course, a US$150,000 investment in Buffett’s Berkshire Hathaway Inc would have done even better. That purchase would be worth more than US$800 million today. But no one could know in 1971 how wildly the company would grow in coming decades.

Without a crystal ball, people need to hedge their bets. Buying a home and paying down a mortgage can be a kind of forced savings that results in at least some equity, regardless of market conditions. But most people should be wary of advice that encourages them to “stretch” to buy a house or view their home as an investment.

“Buy your house for what you need for your family,” says certified financial planner Tim Obendorf of Chicago. “Don’t count on your home appreciating 5 percent a year and being your retirement savings.”


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