Updated: Nov 28
Updated post: 9/5/23; Original post: 5/23/23
Many folks are thrilled when they sell their house for a higher price than what they initially paid. They think they made a big profit, but did they?
Buying or selling a home at the right time is crucial because real estate markets are cyclical. Frankly, much of this depends on luck.
The housing market often experiences periods of rapid appreciation followed by stagnation or depreciation, which significantly impacts how much you'll eventually profit when selling your home if anything at all.
Factors that drive home values include interest rates, economic development, and population changes.
Purchasing a home in May of 2023 is expensive. The US Census Bureau reports that the median home purchase price in the United States is $412,400. Additionally, Bankrate reports an average interest rate of 7.04% on 30-year fixed-rate mortgages.
Related reading: Should I Buy or Rent a House?
Often, homeownership is perceived as an investment, and for sound reasons. Purchasing a home provides a place to live and secures a tangible asset with potential appreciation over time. Like stocks or bonds, homes can increase in value, presenting a return on your investment.
Homeownership: The benefits
Investing in a home extends beyond financial returns. Unlike most investments, a home offers immediate utility as a residence, a place to raise a family, or even a potential rental income source. Homeownership grants stability and control over living expenses, shielding you from escalating rental costs.
Homeownership: Building equity
A mortgage allows you to control a large asset with a relatively small amount of your money. As your home appreciates, you build equity - the difference between the home's value and the remaining mortgage balance. This equity can serve as a valuable resource for future financial needs.
Homeownership: Tax benefits
Homeownership can also provide tax benefits, such as the potential to deduct mortgage interest and property taxes under certain conditions. In conjunction with the potential for capital appreciation and rental income, these advantages make owning a home an attractive and valuable investment strategy for many.
Homeownership: The pitfalls
Homeownership is not always the optimal investment strategy for everyone, nor necessarily the most effective investment strategy. These are some reasons why:
Lack of Diversification: A significant portion of your wealth is concentrated in a single asset when you buy a home. This lack of diversification could pose a risk, especially if the local real estate market declines.
Illiquidity: Real estate is an illiquid asset. This means it can't be quickly converted into cash without compromising its value. In a financial emergency, selling your home quickly at a fair price could be challenging.
Ongoing Costs: Homeownership incurs ongoing expenses, including property taxes, insurance, and maintenance costs. These are unavoidable, regardless of whether your home appreciates significantly.
Interest and Fees: Although a mortgage enables home purchase, it's a loan that accrues interest. Also, buying and selling a home involves associated fees, like closing costs.
Market Risk: Home prices fluctuate. In housing market crashes, homeowners can find themselves in negative equity, owing more on their mortgage than their home's worth.
Opportunity Cost: The funds allocated to a down payment, mortgage payments, and maintenance could have been invested elsewhere. If stock market returns exceed real estate returns, potential earnings could be missed.
Lifestyle limitations: Homeownership could restrict your flexibility. If you need to relocate for job or personal reasons, selling your home or finding a renter could prove difficult.
Considering these potential drawbacks is crucial before investing in a home. Your individual circumstances, financial goals, and risk tolerance should inform your investment decisions.
Related reading: Is this the wrong time to buy a house?
Investing in the Stock Market
There are countless ways in which you can invest in the stock market. We will keep this article simple and consider the average return of the overall stock market.
Over the long term, the stock market has typically provided substantial returns to investors.
Looking at the performance of the S&P 500 index, which is widely regarded as a benchmark for U.S. stocks, it has delivered an average annual return of approximately 10% before inflation since its inception in 1926, a figure that includes the reinvestment of dividends.
The real return is closer to 7% per year when factoring in inflation. These figures also don't account for taxes and transaction costs, which can reduce net returns.
Investing in the Stock Market: The benefits
By investing in an index fund, you're essentially investing in the performance of an entire index rather than picking individual stocks. This approach diversifies your investment and reduces risk.
Investing in a low-cost index fund over a long period brings several benefits, including the potential for solid returns, broad diversification, and reduced costs.
Due to their design to mimic market returns, index funds often outperform actively managed funds in the long run, mainly because of their lower expense ratios. Index funds also provide a high level of diversification, which can reduce the risk of losing money if a particular company or sector underperforms.
The power of compounding is also advantageous for index fund investors as they earn returns not only on their initial investment but also on reinvested dividends and capital gains, leading to significant investment growth over time.
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The Better Investment: A Home or the Stock Market? Looking backward
You bought a home
Imagine purchasing a home in 1983 for the median price of that year, $70,300.
$14,060 down payment (20% to avoid PMI)
Financed the remaining $56,240 with a 30-year mortgage at an interest rate of 13.24%.
$913 monthly payment (including the average cost of homeowners insurance and property taxes)
Over 30 years, considering principal, interest, property taxes, and maintenance costs, your total cost would be approximately $328,680.
By 2013, with an average annual appreciation rate of 3.4%, your home would be worth about $170,500.
The result? A net loss of -$154,590. This loss doesn't consider the real loss after adjusting for inflation, realtor fees, or maintenance costs over time. But it gets worse.
After adjusting for inflation: A net loss of $499,380.
Visualizing the impact of inflation on home values
The Case-Shiller Home Price Indices, also known as the Standard & Poor's (S&P)/Case-Shiller Home Price Indices, are a group of indices that measure the average change in home prices in various regions across the United States. They are calculated and published by Standard & Poor's and are one of the leading measures for tracking and analyzing the housing market.
The indices were developed by economists Robert Shiller and Karl Case. Their methodology involves comparing repeat sales of single-family homes over time. This repeat-sales method helps to control the issue of comparing the prices of dissimilar homes by instead focusing on the price differential of the same home over various periods.
There are several Case-Shiller indices available, but the most commonly referenced are:
The U.S. National Home Price Index: This index tracks the value of single-family housing within the United States.
The 20-City Composite Index: This index captures 20 major U.S. cities' housing markets.
The 10-City Composite Index: This index is a subset of the 20-City Composite Index, featuring ten major U.S. cities.
Using Case-Schiller, compare the nominal median cost of homes from 2000-2023 vs. the real (adjusted for inflation) median cost of homes from 2000-2023.
You invested in the stock market
On the other hand, suppose you invested that same amount of money into the stock market.
$14,060 initial investment
$913 monthly investment from 1983-2013
Earned the average rate of return
So, the total amount at the end of the 30-years, considering both the initial lump sum and the monthly investments, would be about $1,763,360 before taxes and inflation.
After adjusting for inflation: a net gain of $1,217,340.
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The Better Investment: A Home or the stock market? Looking forward
Suppose you had to choose between putting down $50,000 in the stock market or putting down $50,000 on a home. Then, for the 30 years that follow, you either contribute $1,565 toward the monthly payment or $1,565 in an index fund (stock market).
Below are the outcomes.
Purchasing the home
Investing in the stock market
There are a lot of numbers here, so I will make it simple.
The home: After 30 years, you will own your home, paid $481,022 for the $250,000 home.
The stock market: After 30 years, you will have just over $5 million in your retirement portfolio.
Remember that this example fails to consider that you'll pay property taxes, home insurance, maintenance costs, and realtor fees when purchasing a home.
The investment is even better if you can invest in a 401k and receive a match to your contributions. Also, investments in a tax shelter such as a 401k grow tax-free.
The Bottom Line
An argument can be made that a home is an investment. With that said, a home is typically a mediocre investment -- at best. Some would even say that a home is a lousy investment if it's an investment at all.
Home values appreciate relatively slowly, generally matching inflation and lagging behind the average returns from the stock market.
Homes come with continuous expenses such as property taxes, insurance, and maintenance costs, which can reduce potential returns.
They are also illiquid assets, meaning they cannot be quickly converted into cash without potentially losing value.
Moreover, homeownership represents a concentration of wealth in a single asset, increasing risk compared to a diversified portfolio. We saw how this destroyed the wealth of middle-class America following the financial collapse in 2008.
Lastly, the returns from homeownership are highly dependent on location and timing, adding another layer of uncertainty.
The bottom line: The effectiveness of home ownership as an investment strategy over long periods of time is not as effective as other investment options. So when deciding how much to spend on your next home, think carefully about how much you want to spend and how else that money could be used.
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Bankrate. (2023). Current Mortgage Interest Rates. Retrieved from Bankrate
Bogle, J. C. (1994). Bogle on Mutual Funds: New Perspectives for the Intelligent Investor. McGraw-Hill.
Federal Reserve Economic Data. (2023). S&P 500 Historical Data. Retrieved from the St. Louis Federal Reserve
Federal Reserve Economic Data. (2023). Mortgage Rates Historical Data. Retrieved from the St. Louis Federal Reserve
Investment Company Institute. (2023). Average Mutual Fund Fees. Retrieved from the Investment Company Institute
U.S. Census Bureau. (2023). Median Home Prices, 1983-2022. Retrieved from the U.S. Census Bureau
U.S. Census Bureau. (2023). Median and Average Sales Prices of New Homes Sold in United States. Retrieved from the U.S. Census Bureau
U.S. Securities and Exchange Commission. (2021, February 10). Index Funds. Investor.gov.