While a fully paid-off home is half a step toward retirement, it is equally important to have an investment portfolio consisting of various asset classes to provide income when we have stopped working. Perhaps due to a long string of strong gains in housing prices, many people seem to believe that their home is an “investment” that will support them in retirement. A recent column in The Wall Street Journal shows why houses are not very good investments and relying on your primary residence as a savings strategy is not a good idea. The article makes some good points:

  • Homeowners simply subtract the price paid from the selling price to figure how much “profit” they made without accounting for interest expenses, taxes, maintenance and home improvements.
  • Houses are not such great investments over the long-term if you figure in all the extra expenses of being a homeowner. Depending on the area, you could do a lot better, or a lot worse.
  • The best way to rein in home ownership costs are to pay down the mortgage as fast as possible and avoid costly renovations.

I do feel though that the article is over reaching to make its point. In calculating the costs of owning a home valued at $290,000 over 30 years, they estimate the total costs of maintenance and repair and renovations to be $408,000, which I think is far too high. In my own experience, I find that maintenance costs averages about 2% of the value of the home.

This article has 36 comments

  1. I couldn’t agree more.

    I don’t agree that the average investor would consider their mortgage as going short on long bonds as Financial Jungle suggests and I don’t think that house equity is relevant unless you are planning to downsize – in that case the difference between the two houses should be considered in your portfolio.

    Mike

  2. I agree that it is nice to have a property, but it is definitely not a good investment.
    In regards to the calculation, I guess that over 30 years, you will have to do major renovation such as windows, roof, kitchen (imagine a 70’s kitchen without no renovation these days, you will never sell your house!) and others. Regular maintenance is not too bad, but over 30 years, you surely have to do more than a little bit of painting.
    The only way you can make money out of your main residence is if you are able to buy, renovate and sell your house every two years. But that is much like speculation than anything else.
    Cheers,
    FB.

  3. Canadian Capitalist

    FB: The 2% estimate includes major renovations. On an average house, 2% works out to $5,000 per year. That will pay for more than the paint. I guess we can quibble about exactly how much should be spent on repairs/renovations, but I do think their 5% assumption is far too high.

  4. Interesting article. It’s indirectly an argument in favour of the generalized Smith Manoeuvre (CC, I know you are not a fan of leverage…) – for the right sort of homeowner/investor, it’s a way to harness the equity in the home to build an investment nest egg at the same time. It exposes you to some extra risk, but the extra return may be worth it – depends on risk profile and discipline (investment approach, expense management…)

  5. Canadian Capitalist

    Houska: I agree with you that the SM (or even just borrowing money against home equity to invest) might be suitable for the right type of investor. I am only critical of a blanket recommendation of leverage for everyone without explaining that they may be taking on some extra risks.

  6. CC. If you own two properties, does one have to be a rental property in order to be able to deduct maintenance and depreciation? I’m thinking of buying a cottage but am scratching my head over the tax implications.

  7. Canadian Capitalist

    Phil: I really don’t know. Maybe we could ask our readers for input.

  8. Phil- without speaking to your situation personally, under Cdn. law, you can only make a tax deduction if your intention is to have a property being income producing. If you intend to use both for personal use, you are out of luck. If you intend to use one for income producing persons only part of the year, best to speak to your accountant as I am not sure you can claim the full amount of the deduction or pro rata based on the number of days in the year you used it for rental income. Regardless, best to speak to your accountant. Good luck.

  9. Phil, do yourself a favour and read the CRA Rental Income Guide, found at:
    ( http://www.cra-arc.gc.ca/E/pub/tg/t4036/t4036-e.html )

    This guide is not too dry and will spell things out pretty clearly for you. A half hour here and you will be well-versed in the rules.

    The coles notes say, yes – among other things, you can write off interest and depreciation on a property earning income.

    People renting out a portion of their principal residence (say a basement apartment in their home), however, should avoid writing off depreciation as it can risk losing tax-free nature of the principal residence.

    Those showing rental losses on a regular basis will soon hear from CRA asking them to prove their rental plan is viable and has a reasonable expectation of profit. If your losses aren’t reasonable, CRA will quickly deny them all and reassess all the tax years meaning you will suddenly owe them a lot of money plus interest plus penalties. If you can show however a business plan that indicates your losses are reasonable and will be temporary, you should be okay for a while longer.

    Hope that helps.

  10. My two cents –

    A good investment puts money in your pocket – my house takes money out of mine so I disregard it completely as an investment. My house price has probably doubled in the last ten years – but it still is just a house. The change in price doesn’t do me any good at this stage in my life, or any stage where I still need a house to live in.

    Home ownership does, however, hedge you to the rise and fall of housing – and one always needs a place to live – so that’s its value to your financial security in my opinion.

    In my experience – people whose net worth is concentrated too much in their home will never experience financial freedom. You just can’t retire on a granite counter top. I believe most people will need about 4-5 times of what their house is worth to retire the way they envision it.

    Also, any stats that show the average house price increases are completely bogus as a financial planning tool because they don’t reflect the entire contracting industry and the work they do. Why this fact doesn’t get stated just as clearly is mostly due to people wanting to believe what they want to believe and help them justify purchases.

    CC – I think 2% is accurate for you because you are careful with your money and you know what you spend. 5% may seem high to many but it is probably not when you consider outliers such as huge additions, tare down/rebuilds, etc. (My rate is probably about half way in between 2% and 5% at 3.5% if I had to estimate.)

    Regardless of what the rate is for each person, the fact remains that good investments put this amount in your pocket each year, as opposed to taking it out of your pocket. Over 20-30 years, a positive cash flow vs. a negative one is so dramatic there is no point even measuring it. Investments will always be the clear winner.

  11. Hmm… Thank you very much for your feedback.

    If a corporation bought the cottage property and rented it to me, then I expect that everything is tax deductible from the rental income received by the corporation. But I wonder if it must be an arm’s length transaction – can I be the sole owner of that corporation? When I’m not using the cottage, I can probably try to rent it out to others for use as well.

    Actually, now that I think about it, what if I sold my prime residence to a corporation and made the same arrangement? Hmm… The thoughts of this really has my old synapses firing away… Haha…

    I would technically be renting but I would own the corporation that owns my home but my net worth would continue to increase because the corporation could probably show zero or almost zero income every year if I set the rental price close to what the costs are… The corporation could reinvest the surplus money which is offset by the depreciation into other income earning stocks or something… Hmm…

  12. I don’t entirely agree with this guy. He’s selectively data-mining purchase times to bolster his argument, and he’s entirely discounting the non-financial benefits of living in a place that you own. I get a lot of enjoyment from living on a property that I know is not subject to the whims of a landlord (even if, yes, the municipality or other govt’s can do stupid things).

    He also doesn’t get that when you make improvements to your home, you are benefiting from them in non-financial ways. I didn’t get my basement finished in order to get a monetary return. And if I’d been renting, either the improvement would have been reflected in permanently-raised rents, or it simply wouldn’t have been done (leaving me without the commensurate small rise in my standard of living).

    There’s a much better reason not to treat your home as a great investment: in order to sell out of your investment, you either have to borrow against it or move. You can’t just transfer its value into something else. But balanced against that is the fact that part of your investment cost is presumably going towards raising your level of personal happiness, since you are (hopefully) buying a home that you actually want to live in.

    Not as cut ‘n’ dried as the author makes it out to be.

  13. I had been a homeowner for three years, and I can honestly claim that I’m happier as a renter now. There are other headaches that come with owning a home. It’s a personal choice, but the market is diverse enough that we shouldn’t automatically assume everyone craves for the same thing.

    FourPillar – Yes, it’s not fair of me to not back up my stand that a mortgage is similar to shorting a long bond (say 5-year bond). If someone borrows a mortgage, he’s essentially selling a 5-year bond that he doesn’t own to the bank, and agreeing to buy it back sometime in the future.

    If the market value of the bond goes up (yield comes down), he doesn’t benefit from the appreciation. In fact, he loses because he must buy back the initial principal with a (relatively) higher yield that the market yield. On the other hand, if the 5-year bond goes down (yield goes up), he benefits because he’s buying back the principal with a (relatively) lower yield than the market yield.

  14. FJ, I can’t argue with your logic but I don’t personally consider my mortgage as part of my investment portfolio.

    Mike

  15. Wouldn’t that be a form of mental accounting?

    When you monitor your all finances as one giant portfolio, only then will you realize that the bonds in your investment portfolio can earn a higher return if “invested” in your mortgage.

    In fact, I’d go as far as including myself in my portfolio, because I invested thousands of dollars and time into my post-education to earn a decent return. Why not, right? An education has its investment risk. Some people can’t find a job after graduation.

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  17. Canadian Capitalist

    Tom: That’s precisely why a home isn’t strictly an investment. People buy it for various reasons (to improve their standard of living, to impress their friends etc.), not with the main aim of making a profit. One survey showed that many people consider their home as a source of retirement income. While a paid-off home is a big part of reducing shelter costs, it shouldn’t be counted on to pay for other expenses.

    FJ: Maybe it is a form of mental accounting but there are very good reasons for it. Like I mentioned, housing costs are a negative bond for everyone, regardless of whether they own or rent. If most of your investment portfolio is in a RRSP, you can’t use the capital to paydown your mortgage anyway.

    I find mixing purely financial assets with non-financial ones makes things very messy. I could take a lower-paying job if I get more vacations or less stressful work. Or, I might decide to retire at 45. The point is you can’t easily think of human capital as a bond. Not that it isn’t a valid way of seeing things, just makes it more complicated (IMO) than it needs to be.

  18. FJ, isn’t all accounting mental?

    CC is right, things get messy fast the more things you include in the equation.

    Mike

  19. Have you owned a house for 30 years? Can you say for sure it won’t be more than 2%?

    That’s why its’ meaningless for people to include their house as their ‘net worth’. Sorry, you can’t buy food or gasoline with your house (last I checked anyways). And just about everyone is an x interest raise away from being in DEEP do-do about owning. (Remember the 80’s?) Could you handle your house at 13-15% interest?

  20. Sure. I can’t possibly cover all permutations inside this little box of space. Don’t dimiss the entire notion just because a few examples mute the flaws of mental accounting. As a rule of thumb, consider all finances whenever possible. In the event that investors thinking of buying a balanced fund in a non-registered account — I’m sure this happens all the time, they should consider buying the equity portion directly, and funnel the bond portion to the mortgage. There shouldn’t be an abitrary barrier between your investment portfolio and your mortgage. Open the door to let them cross.

    An education is part personal and part financial. By thinking about the financial aspect of your education, it may sparks a few ideas like buying a disability or life insurance to protect this undiversified income stream. Another thought is everyone should assess the aggregate of all income streams. If you work for a high tech company, you might want to tilt your investment portfolio away from techology. Many friends of mine lost both their jobs and big check of their investment portfolios when the dot-com bubble popped.

  21. Canadian Capitalist

    Jim: When a mortgage on a house is paid off, housing expenses are vastly reduced. While a house won’t pay for groceries or gas, it does provide a significant benefit – shelter -, which is a major expense for everyone.

    FJ: Whether you have a mortgage or not is immaterial to where you should put your bonds. They should be in your RRSP, period. Good point about diversification. I’ve made the same point in several posts on holding employer stock.

  22. That’s not necessary true, because it depends on your tax-rates, and the spread between the mortgage rate and bond yield.

    Example:
    Tax Bracket = 30%
    5-Year Fixed = 5.79%
    5-Year Bond = 4.65% (should be lower in practice accounting for spread)
    $100 pre-tax to invest
    Time horizon = 20 years

    Paying down mortgage:
    ($100 – $30) x (1.0579^20) = $215.76 tax-free

    Bonds inside RRSP:
    ($100) x (1.0465^20) = $248.19 pre-tax

    The liquidation tax rate decides the winner.

    Anyway, we’re derailing because my original point was on the subject of mental accounting.

    If people are actively paying down their mortgages, it is equivalent to buying long-bonds on steroids due to the higher yields. People should factor that into their overall asset allocations. If you still want to own additional bonds over and above what you already “bought” in your mortgage, then buying bonds inside RRSP is a possibility subject to various factors. I don’t think I said otherwise. If I did, it was unintentional.

    My point is don’t view your mortgage and investment portfolio in isolations, because you may unknowingly overweight in bonds, and exceed your intended allocation.

    A dollar saved is a dollar earned. If you make a lump-sum payment toward your mortgage, it’s equivalent to earning 5.79% tax-free a year. Obviously, this has to affect your other investment decisions somehow. Do you really want more fixed income securities inside your RRSP? Are you optimizing your overall portfolio for a 20 to 30-year time horizon?

  23. Hi FJ – I see what you mean – paying off the mortgage is equivalent to buying bonds.

    I think this argument lends itself well to investment outside an rrsp however an rrsp is a slightly different animal.

    I’ll have to think about this more. I agree that in the case where you are deciding between paying down the mortgage or contribute to an rrsp or a taxable account, the house becomes part of your financial equation.

    My argument is that from an asset allocation point of view, I don’t count the house or mortgage as part of that allocation.

    I don’t know if this makes sense but that’s the way I look at it.

    Mike

  24. Canadian Capitalist

    FJ: I think our discussion is getting derailed. We are talking about the same thing, with different perspectives. I’m assuming that a decision is made to contribute to the RRSP, rather than pay down the mortgage (could be for any number of good reasons). Now, should a portion of the portfolio be in bonds? My answer is yes, at least a little bit, to provide stability to the investment portfolio, irrespective of the size of the mortgage. That bond portion should be inside a RRSP.

    Of course, my point is immaterial if a decision is made to pay down the mortgage (again for any number of good reasons).

  25. When I used to own a home, I regularly contributed to RRSP and made lump-sum payments to my mortgage. In one extreme year, I even paid down $60,000 on top of maxing our my RRSP. To me, my mortgage payments have a profound effect on whether I should buy bonds in my RRSP.

    >>”Now, should a portion of the portfolio be in bonds? My answer is yes, at least a little bit, to provide stability to the investment portfolio, irrespective of the size of the mortgage. ”

    This statement outlines the difference between our perspectives. In my perspective, if I’m buying $60,000 worth of super bonds in my mortgage, then I ought not to buy more bonds in my RRSP. Since in my view, my porfolio encompasses all aspects of my finances including this $60,000 and my RRSP, I already have the intended stability.

    I think mental accounting, by breaking up your finances into mini pockets, will create ineffficiencies, if each pocket doesn’t know/care what the others are doing. e.g. buying bonds inside RRSP irrespective to how much super bonds you already have outside.

  26. I still don’t see how you can equate a mortgage to a bond. When you finish paying off your $200K home, you don’t have a $200K bond that is yielding 5% or whatever, you have a house. A mortgage is an expense, not an investment. It is on the negative side of the balance sheet.

    And a house is not guaranteed to yield interest at any percentage and can burn down on any given day. I consider it an asset, because without it you’ll either be renting or sleeping on a subway grate. So, there is an implied yield in comparison to renting. But otherwise, it is a tangible asset not much unlike an automobile (without it, you’d have to buy a metropass – assuming you can get to your place of work on the subway or buses).

  27. Canadian Capitalist

    FJ: We’ll have to agree to disagree. While I am in favour of looking at all *investment* accounts as one pot, I think mortgage interest is an expense, just like food, clothing etc. I don’t know what mini pockets you are talking about. There are only two pots: one for purely financial assets and everything else goes in the other pot.

    Paying down the mortgage does nothing for the stability of your investment portfolio; it simply reduces your housing costs over time.

  28. Phil – A house and a mortgage aren’t interchangeable. One never finishes paying off a house; he finishes paying off a mortgage. A house isn’t part of the equation. It can burn down, but you still owe the mortgage. When you buy a stock on margin, you still pay the margin interests irrespective of what the stock does. The performance of the stock or the house doesn’t erase your obligation to repay the debt.

    Do you disagree with “a dollar saved is a dollar earned”? If you paid off a 200k mortgage, you’re saving 5.79% tax-free. In effect, you’re earning 5.79% tax-free.

    Why anchor around $0 bond? Homeowners are born –$200k in bonds. If you set -$200k as the baseline and pay it all off, then you increase your bond position by $200k. While having a paid off mortgage doesn’t add to your revenues, it improves cash-flow. Every 5.79% not squandered in mortgage interests is an extra tax-free 5.79% contribution toward your investment portfolio. Mortgage and investment portfolio do go hand in hand.

    >>” A mortgage is an expense, not an investment. It is on the negative side of the balance sheet.”

    Why would that matter? Do you focus only on the positive side of the balance sheet instead of the net equity? If you owe a $200k mortgage and purchase a $50k bond, you’re still $150k in the hole. If instead, you pay down the mortgage by $50k, you’re again $150k in the hole.

    CC – Why so fixated in stabilizing your investment portfolio? Why not stabilize the bottom line?

    Everything comes out of the same pocket, so one can’t conveniently separate expenses from investments. If I have $60,000 in my pocket, I have several options below but they all similar effects on the net equity:
    – Invest in equities (increase income)
    – Buy bonds (increase income)
    – Pay down my mortgage (decrease expense)

    Increasing income is an offensive thinking. Cutting expenses is a defensive thinking. The bottom line is the difference between how much you earn and how much you spend. The name of the game is to maximize and stabilize the bottom line, rather than the individual accounts. Often you can take one step back in one account (investment portfolio), and two steps forward in another account (mortgage).

    You can stabilize your bottom line either by purchasing more bonds or paying down bond-like expenses such as your mortgage. If you just paid down $60k worth of mortgage, why not diversify into equities in your investment portfolio?

    While paying down the mortgage doesn’t stabilize your investment portfolio directly, but it stabilizes your bottom line. Indirectly, paying down the mortgage does stabilize your investment portfolio, because interests saved from the mortgage can be funnelled to the portfolio.

  29. Canadian Capitalist

    Aghhhh. We’re talking in circles here. My point is everyone has a -200K bond, including renters. I simply disagree with your contention that anyone with a mortgage should not have any allocation to bonds (at least that’s what I am inferring).

  30. We currently pay $1,400.00 of mortgage interest per month to the bank. That equates to $16,800.00 per year.

    Just imagining what I can do with an extra $1,400.00 of extra money per month, on top of the $1,000.00 per month that we currently invest, spurs us on to paying the mortgage off ASAP.

    A paid for house is an awesome springboard into wealth creation. (Ahem. Not to be used for leverage I might add. I like to sleep at night)

  31. CC – Yup, I agree with you that renters are also -$200k in bonds.

    Just for the record, I never said homeowners shouldn’t have bonds. I said making lump sub payments against the mortgage is the same as buying bonds. If your intention is to flip $10k worth of savings into bonds, then paying down your mortgage by $10k accomplishes that. It’s not nessary nor desirable to overweight more bonds inside RRSP.

    I was arguing against the statement, “Whether you have a mortgage or not is immaterial to where you should put your bonds. “

  32. Wow Bob. I’m hoping that you actually meant to say that your total mortgage PAYMENT is $1400 per month, not that your INTEREST portion is $1400 a month! That would be totally crazy!

  33. Canadian Capitalist

    FJ: A mortgage pay down and investing in bonds aren’t exactly the same thing (like you said, one is defensive and the other offensive). The savings you realize from a pay down won’t normally result in extra cash flow for many years (could be longer than 10 years). Mortgage interest savings is funneled toward the principal balance, not to the investment portfolio until the mortgage is paid off. Bonds give you regular cash distributions that can be reinvested, which provides stability to your investment portfolio. That said, we are arguing if cake is better than ice cream. I’d have either, but I am a bit partial to ice cream 🙂

  34. @ Phil S,

    Our mortgage is $280,000 the interest 0n that is currently around $1,400 per month.

    I think that is about average for 2 income families these days given the price of homes across Canada. Especially in the west where we are living.

  35. CC – Mathematically speaking, it’s the same thing. When you buy bonds inside RRSP, you can reinvest future income back to bonds. If you make a lump sum mortgage payment today, a greater percentage of your future mortgage payments goes toward paying down the principal. (i.e. buying super bonds.) The net effect is the same. Your net equity rises in both cases.

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