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I'm in my mid-20's, and so I am aiming at long-term growth with higher risk in my portfolio. My financial adviser is showing me some investment allocations that put my money in some growth, mid, and value-retention locations. He doesn't seem to be taking into the equation the fact that I am putting a huge percentage of my paycheck into my home.

I know home values fluctuate, but long term, it seems to be a pretty good way to at least retain value, and at best make a small return. If I am already contributing so much to my "home" investment, why would I also invest in stocks or bonds with a low rate of return, even though they are considered a "safe" part of my portfolio?

Update: I think the question really has two parts.

1) How does owning a home fit into my financial portfolio? Most seem to agree that at best it is a hedge against rent or dollar inflation, and at worst it should be viewed as a liability, and has no place alongside other real investments.

2) How should one view payments on a home mortgage? How are they similar or different to investing in low-risk low-reward investments?

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There's a missing point here. It may be splitting hairs, but to me, there's a distinction no answer has made. The house purchase is a fait acompli. The house is bought, occupied and mortgages. Cory is asking how to look at this debt. In a sense, the house has the same value regardless of the mortgage. It's say, $500K in value that goes up or down in value as a percent of that $500K. Money used to pay the debt isn't invested in the house, it's used to retire the mortgage. As discussed in other threads, paying 4% mortgage has more in common with investing in a 4% CD with a term same as mortgage. –  JoeTaxpayer Jul 16 '12 at 20:32
    
Thank you JoeTaxpayer, I think you helped clarify the question a lot. I am trying to figure out how to financially view paying down my mortgage. Paying on the mortgage to me feels kind of like the inverse of slowly putting money into a low-growth investment, in that the faster I pay it down, the less I end up paying in interest. I think the question has been sidetracked a bit (mostly my fault, I think) by only focusing on the "home investment" problem, and ignoring the question of the financial effects of paying a mortgage. –  Cory Klein Jul 16 '12 at 20:46
    
You're in your mid-20s. Why would your financial adviser suggest that some of your investments go into "value-retention" assets? –  Jeremy Stein Jul 18 '12 at 17:40

6 Answers 6

Have you ever tried adding up all your mortgage payments over the years? That sum, plus all the money that you put as a down payment (including various fees paid at closing) plus all the repair and maintenance work etc) is the amount that you have "invested" in your house. (Yes, you can account for mortgage interest deductions if you like to lower the total a bit). Do you still feel that you made a good "investment"?

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Coming from paying a similar amount in rent about a year ago, I feel that my home has been a great investment so far. I have much more equity right now than I would have if I decided not to purchase a home. I feel that buying a home freed up a hefty portion of my income that I am now putting towards a low-risk low-reward asset. Also, I am selling my house soon, and anticipate my hard work in repairing and improving the home to have a return greater than what I spent (which was very little, considering I did the work myself). –  Cory Klein Jul 16 '12 at 20:03
    
Don't forget property taxes in that equation. –  JohnFx Jul 16 '12 at 23:13
    
The mortgage interest deduction does not reduce the money expended towards the home but rather reduces income tax liability. So unless you are going to include the taxes you pay on your income into the amount you invested in your home(and a case could be made for that) reducing the total amount invested in the home by the amount saved is not legitimate. –  user4127 Jul 19 '12 at 14:44
    
@Chad I agree with littleadv and Scott Lawrence that a home is not an investment in the usual sense of the word. With an investment I have a choice of where to invest: Stock A or Stock B or Mutual Fund C etc... If I choose not to buy a home, I cannot invest that money elsewhere, I have to use it towards paying rent on a place to live. –  Dilip Sarwate Jul 19 '12 at 15:27
    
I am not arguing that just that reducing the amount put into your home by the mortgage interest deduction would be improper. I just did not air-quote the word investment in my comment as you did in your answer. –  user4127 Jul 19 '12 at 16:04

Unless you plan to sell your home and live in a box during your retirement I wouldn't consider it an investment that is a viable replacement for a retirement account.

Consider this: Even if housing prices DO go way up, you still need a place to live. When you sell that house and try to buy another one to live in, you will find that the other houses went up in price too, negating your gain.

The only way this might work is if you buy a much bigger house than you will need later and trade down to pull out some equity, or consider a reverse-mortgage for retirement income.

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I think it is very common for people who are retiring to liquidate much of the equity in their home by downsizing. This makes sense, as generally you don't need the same size/location of home when retiring as compared to when you have kids running around. –  Cory Klein Jul 16 '12 at 23:19
    
@JohnFx - I'm curious if there's data to show house size/value before and after retirement. I don't know either way, but I imagine there's often not that much room to downsize, maybe 25-30%. That might not be the windfall some might be looking for. –  JoeTaxpayer Jul 16 '12 at 23:53
    
More likely people ladder their way up to bigger and bigger houses. I think people are more likely to downsize the houses not because they don't need the space, but because it is a chore to maintain. –  JohnFx Jul 17 '12 at 2:16

Your home (the one you live in) is not an investment. Its an expense/liability/asset, but its something you pay for to use, not invest to grow.

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A home can be a hedge against inflation, right? If that is the case, it already beats most money market accounts with regard to "growing", doesn't it? And from what I understand, money markets are investment tools. Could you explain your claims? –  Cory Klein Jul 16 '12 at 18:57
    
It can, but that's not the reason you buy it is it? You purchase your home to live in, not as investment. I have a home I purchased to live in, and a couple for investment - entirely different kinds of properties. I wouldn't live in my investment home, and I don't expect too much return on my residence. You need to differentiate between real estate you bought for your personal usage, and real estate you expect to appreciate and provide income. These are not the same. –  littleadv Jul 16 '12 at 19:09
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You're richer because you saved money by buying vs renting, not because buying a home is a profitable business. There's a difference, even if you refuse to see it. You saved money, not earned it. –  littleadv Jul 16 '12 at 20:09
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I guess your argument makes sense coming from the perspective of somebody owning three properties. For me, I just have this broad decision of, "Should I buy a home? Is it a worthwhile place to put my income?", and there are lots others like me. When it comes down to saving and protecting my income, buying a home has been a great financial decision. I guess I just feel like that fact is lost on this answer, that maybe you would have me just ignore the equity that owning a home provides me. I feel safe knowing that a portion of my salary is going somewhere that it won't just disappear. –  Cory Klein Jul 16 '12 at 20:27
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A home isn't a hedge against inflation. There has been inflation in the last 7 years, but If you bought a home 7 years ago there is a good chance your are upside down on the mortgage. In fact you may be unable to sell, and may be that way for a long time. –  mhoran_psprep Jul 17 '12 at 0:58

Like @littleadv, I don't consider a mortgage on a primary residence to be a low-risk investment. It is an asset, but one that can be rather illiquid, depending on the nature of the real estate market in your area. There are enough additional costs associated with home-ownership (down-payment, insurance, repairs) relative to more traditional investments to argue against a primary residence being an investment.

Your question didn't indicate when and where you bought your home, the type of home (single-family, townhouse, or condo) the nature of your mortgage (fixed-rate or adjustable rate), or your interest rate, but since you're in your mid-20s, I'm guessing you bought after the crash. If that's the case, your odds of making a profit if/when you sell your home are higher than they would be if you bought in the 2006/2007 time-frame. This is no guarantee of course. Given the amount of housing stock still available, housing prices could still fall further. While it is possible to lose money in all sorts of investments, the illiquid nature of real estate makes it a lot more difficult to limit your losses by selling.

If preserving principal is your objective, money market funds and treasury inflation protected securities are better choices than your home.

The diversification your financial advisor is suggesting is a way to manage risk. Not all investments perform the same way in a given economic climate. When stocks increase in value, bonds tend to decrease (and vice versa). Too much money in a single investment means you could be wiped out in a downturn.

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How does paying down the mortgage rate on your scale of good ways to preserve principle? How should I choose between paying extra on the mortgage vs buying money market funds or treasury inflation protected securities? –  Cory Klein Jul 16 '12 at 23:39
    
@CoryKlein The reason I would pay extra on a mortgage would be to reduce the time needed to pay it off fully (which reduces the amount of your spend that goes to interest). If I were trying to preserve the principal value of an amount of money, I'd use money market funds or treasury inflation-protected securities (TIPS) ahead of extra money toward mortgage principal. Because you're under 30 (and presumably have a lot more time before retirement than someone in their 40s or 50s), you can afford to invest more aggressively. Preserving principal shouldn't be your primary investment strategy. –  Scott A. Lawrence Jul 18 '12 at 16:14

A home is an investment, but the value it returns isn't primarily financial ($$) - they are consumption (a place to live). This gives it different characteristics than other investments (e.g. increasing the amount invested by buying a more expensive home doesn't do much to assist your financial well-being and future income, and isn't necessarily the "responsible" thing to do). You may get some capital gains, typically in line with inflation, sometimes less, sometimes more, but those aren't the most reliable, and it's difficult to realize them (it involves selling your house and moving). Its main value as a hedge is a hedge against rising rent. But if you're still working full-time and can expect cost-of-living increases, that hedge may not be as valuable to you as it would to, say, someone living on a fixed income.

But as for treating it as a "low-risk investment"? That's very problematic. Real low-risk investments are things like government bonds, where you can't lose principal. Unless you're going to live into your house until the day you die, the real estate crash should have disabused you of any notion that housing values never go down. Rather, your house is a single, indivisible, undiversified, illiquid investment. Imagine, if you will, going to your brokerage and borrowing a hundred thousand dollars or more on margin to invest in a single real estate investment trust... then take away whatever diversification the trust offered by holding multiple properties. Also, you can't sell any of it until you move away, and the transaction fee will take something like 3%. Still sound "safe"?

Moreover, it's exactly the wrong kind of risk. Your house's value is tied to what people are willing to pay for housing where your house is, which is usually subject to the whims of the local economy. This means that in a recession and housing bust in the local economy, you can lose your job and have your mortgage go underwater at the same time.

It totally makes sense to treat your house as an investment to some extent, and it makes double sense for a financial adviser to consider it as part of your investment recommendations. "Safety" is not the way you should be thinking of it, though.

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1) How does owning a home fit into my financial portfolio? Most seem to agree that at best it is a hedge against rent or dollar inflation, and at worst it should be viewed as a liability, and has no place alongside other real investments.

Periods of high inflation are generally accompanied with high(er) interest rates. Any home is a liability, as has been pointed out in other answers; it costs money to live in, it costs money to keep in good shape, and it offers you no return unless you sell it for more than you have paid for it in total (in fact, as long as you have an outstanding mortgage, it actually costs you money to own, even when not considering things like property taxes, utilities etc.).

The only way to make a home an investment is to rent it out for more than it costs you in total to own, but then you can't live in it instead.

2) How should one view payments on a home mortgage? How are they similar or different to investing in low-risk low-reward investments?

Like JoeTaxpayer said in a comment, paying off your mortgage should be considered the same as putting money into a certificate of deposit with a term and return equivalent to your mortgage interest cost (adjusting for tax effects). What is important to remember about paying off a mortgage, besides the simple and not so unimportant fact that it lowers your financial risk over time, is that over time it improves your cash flow.

If interest rates don't change (unlikely), then as long as you keep paying the interest vigilantly but don't pay down the principal (assuming that the bank is happy with such an arrangement), your monthly cost remains the same and will do so in perpetuity. You currently have a cash flow that enables you to pay down the principal on the loan, and are putting some fairly significant amount of money towards that end. Now, suppose that you were to lose your job, which means a significant cut in the household income. If this cut means that you can't afford paying down the mortgage at the same rate as before, you can always call the bank and tell them to stop the extra payments until you get your ducks back in the proverbial row. It's also possible, with a long history of paying on time and a loan significantly smaller than what the house would bring in in a sale, that you could renegotiate the loan with an extended term, which depending on the exact terms may lower your monthly cost further. If the size of the loan is largely the same as or perhaps even exceeds the market value of the house, the bank would be a lot more unlikely to cooperate in such a scenario.

It's also a good idea to at the very least aim to be free of debt by the time you retire. Even if one assumes that the pension systems will be the same by then as they are now (some don't, but that's a completely different question), you are likely to see a significant cut in cash flow on retirement day. Any fixed expenses which cannot easily be cut if needed are going to become a lot more of a liability when you are actually at least in part living off your savings rather than contributing to them.

The earlier you get the mortgage paid off, the earlier you will have the freedom to put into other forms of savings the money which is now going not just to principal but to interest as well. What is important to consider is that paying off a mortgage is a very illiquid form of savings; on the other hand, money in stocks, bonds, various mutual funds, and savings accounts, tends to be highly liquid. It is always a good idea to have some savings in easily accessible form, some of it in very low-risk investments such as a simple interest-bearing savings account or government bonds (despite their low rate of return) before you start to aggressively pay down loans, because (particularly when you own a home) you never know when something might come up that ends up costing a fair chunk of money.

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