I have been an on again off again student of economics since college. The most important things to know, in my opinion, are:
1) The historical inflation rate is 2-3% per year in the US.
2) In most times and places in the US real estate appreciates slightly more than the rate of inflation at 3-4% nominally. So real estate grows much more slowly than most expect. A primary residence should be seen as the cost of shelter, not an investment, because...
3) US stocks have appreciated at an inflation-adjusted rate of 6-7% per year (8-10% nominal) even accounting for booms and busts. Speaking of...
4) No one can reliably predict the business cycle let alone individual stock performance absent inside information. Stock picking is a losing game.
5) The best way to invest in stocks for the vast majority of people is to buy the market in an index fund and minimize fees.
So to distill this down to three life lessons:
1) Don't plan on renting your whole life because inflation will catch up with you.
2) Buy the most inexpensive house you can tolerate.
3) Put everything else in index funds every paycheck, and only check your balance every now and then. Let time be on your side.
One interesting real estate related fact is that a primary residence is there easiest and cheapest leverage a normal person can get. So that 3% can actually be 5x - 20x that depending on the individual circumstances. Not that I'm advocating for everyone to buy homes as short term investments. Just something interesting that may help some of the more financially sophisticated home buyers out there.
This is true - you get easy leverage, and your gains apply to this larger principal, however, if your gains average out to be less than your cost of capital then leverage doesn't matter. Additionally, over the infinite timeline these computations and averages can look good, but your ability to make payments puts some risk premium on having large leverage. Over the short term, leverage can be much more dangerous, especially if you are forced by circumstance to realize gains or losses.
In most times and places in the US real estate appreciates slightly more than the rate of inflation at 3-4% nominally. So real estate grows much more slowly than most expect. A primary residence should be seen as the cost of shelter, not an investment, because...
Your real estate appreciation figure doesn't factor in things like: rent (either payed to you if its nor your primary residence or rent you don't have to pay if living in your primary residence) and all the tax breaks associated with home ownership. With those additional sources of income, it's possible for real estate to be competitive with stocks.
It also doesn't factor in home maintenance or transactional costs. It doesn't factor in time required to maintain a home. It doesn't factor in lost opportunities due to the increase in expense and hassle of relocation.
> It doesn't factor in lost opportunities due to the increase in expense and hassle of relocation.
Selling my residence is so far down my personal list of "frictions to relocation" as to be irrelevant. I hate moving, period. So does my wife.
I also personally do not see having to dispose of a property when moving as that big a deal. Again, that's me.
> Renters are happier. That is worth something.
First off, the article doesn't say that. It says that owners are generally not any happier.
Second, it's one citation. You shouldn't be making absolute statements off one citation.
Third, the overall thrust of the research is the more general "experience > stuff". I find that to be a highly personal decision and not something where population studies can inform the individual.
1) The monetary expansion rate of the US is between 7-9% per year. Historically production has been increasing faster than that, stocks aren't included in the index, and so measured inflation is lower.
1a) Because the money supply is continuously expanding, rents are also continuously increasing, and so over time owning a house is indeed an investment, and one that saves you substantial amounts of money. Calculations that its better to put that money into stocks or similar, typically ignore what happens to rent.
2..3) The US stock indexes have done that, if you measure from low to high. However, companies that fail are removed from the indexes, so this statistic is survivor biased.
4) stock picking is a winning game if you understand finance, and have the time and inclination to read company annual reports until your eyes bleed.
And yes stock indexes are the best bet for share investing, but putting everything into them is ill advised. Bear in mind that the time you are most likely to need that money, is just after one of the periodic great crashes of the stock market has thrown the economy into complete disequilibrium. Which is when it won't be there for you.
I agree with everything up until life lesson #1. How does that follow from the preceding? Nowhere did you say you had learned that inflation in renting prices is greater than inflation in wages which is what would be necessary for "inflation to catch up to you". Maybe I misunderstood?
It's important to start saving first and buy property only after you have a sustainable nest egg. The extra liquidity from saving helps in all scenarios: if you need to find a new rental, if you need a down payment, if tragedy strikes and you need to support a loved one.
If I had to list financial lessons for most Americans they would be:
1. Pay down high-interest debt. Nowadays that's 5%+. Anything above 10% is an emergency.
2. Save an emergency fund: 2-3 months living expenses. Put most of this in a high-yield savings account earning ~2% interest.
3. Look at retirement savings plans that are advantageous for your taxes. Tradtional IRAs, Roth IRAs and employer-match 401ks are a few places to start. Try to save at least 15-20% of your income this way.
4. Great job! Continue to build your emergency fund (to 4-6 months), pay down moderate-interest debt (3-5%), and contribute to retirement accounts.
5. Put extra cash in stock and bond index funds in a taxable account. You can use this money anytime but its value will fluctuate (hopefully growing long-term).
6. Saving for a house? Sock more money in that high-yield savings account to hit a 20% down payment for a home mortgage.
7. Now you're ready for OP's life lesson #1. Buy a house you can afford and keep saving.
This advice is only applicable to those who aren't in mountains of debt, which is pretty hard to do when you're younger than 40: $30,000 in student loans plus whatever other debt was acquired getting situated after college such as credit card and auto loans...
If you're fresh out of college and have student debt, you probably shouldn't be taking on an auto loan of any notable value... and you shouldn't be racking up too much in credit card debt beyond maybe a security deposit on an apartment as a last resort.
Even if you have a six-figure job, everything you need should be acquired like you're broke, because you literally have negative money until that $30k debt is wiped out. In fact, if you live that way for a few years on a six-figure salary, you should be able to knock that $30k out in one year and save up the downpayment for a property in the following years. I understand this isn't fun and most people wouldn't do it, but it is the solution.
The banks have made us very comfortable living with debt, and we have to do everything we can to resist it. Credit cards are great for cash back but you shouldn't carry a balance -- set the limit to an amount that you can pay in full every month.
For someone making median wage after graduating (>= $55k) that $30k student debt should take no more than 5 years to kill - $10k taxes, $30k living expenses (and I'm being very generous with this), $5k savings, $10k loan payment (numbers are approximate). Someone who graduates college in their early 20s and has income comparable to their loan amount should not be entering their 30s with any student debt.
Auto loans - never buy a depreciating asset with debt. When starting out, save up for a few months and get a cheap used car for cash, then level up every few years as your circumstances improve, until you're satisfied with your car. Always pay cash - if you can't pay cash for a car, you can't afford it.
Credit card debt should not exist, period (one exception: life-threatening medical emergency for oneself or a loved one, and no savings). Credit cards are not meant for borrowing money; they are for getting rewards points and building a good credit score.
sounds pretty applicable. As someone who found himself in precisely the described situation ($40K in student loans, a car loan, and some credit card debt resulting from living in the Bay Area on an entry level salary and not being disciplined enough to live within my means then, I can tell you that this advice is painful to execute, but actually the only thing that works.
You miss something important: If you finance a house on a fixed rate mortgage you lock in your monthly cost. Market rents will continue to rise, the value of your property will continue rise, but your cost will not change (modulo increases in maintenance cost, insurance and property tax).
I still don't follow. As market rent goes up you will be renting to yourself below market rate. Suppose market rent is $2000/month and my mortgage is $2000/month. In 10 years market rate rent has gone up, but my mortgage is still $2000/month.
2) Buy the most inexpensive house you can tolerate.
That doesn't follow. Depending on how much utility you derive from quality of house, the opposite could be an optimal move - buy the best house that you can afford.
Can you elaborate more on the utility of a mansion ? There was some research that people spend most of their time in only 3 rooms: bedroom, kitchen and bathroom.
Most people are either inactive or extroverts who prefer to go out for their activities. As an active introvert, I’d rather bring a lot of my activities in-house / on-premises.
Personally I wouldn’t find utility in an actual mansion but I’d certainly prefer something more than a 1 bedroom.
With kids that means at least one extra bedroom if not multiple. The activities I do would mean I’d derive value from a garage (for projects), a home gym (for indoor activities), and a yard (for outdoor activities). Game room / home theater would be nice too. That isnt a particularly large house but it will be rather pricey in an expensive metro like the Bay Area.
> Put everything else in index funds every paycheck, and only check your balance every now and then. Let time be on your side.
I think this is not the obvious conclusion, but a sensible conclusion. You could also, for example, buy bonds from companies that you are sure enough would not easily default. If you know nothing about shares an index fund is not a bad idea.
But, in South Africa at least, some companies have pension funds where even the broker doesn't know (or care maybe?) which shares the fund invests in. The guy at the top (that knows exactly which shares are held) are not always the cleverest or most honest. To be fair, I think these are rather mostly investment funds run by investment companies, rather than an index fund like the S&P 500.
I think once you start earning enough to invest more than just for pension, the picture changes somewhat and you could even invest in alternative things. Agriculture, for example, is a promising prospect for a richer investor, but you need to count your chickens only when they are already old and fat.
> 1) Don't plan on renting your whole life because inflation will catch up with you.
It seems like in your framework (point (2-3) of the first grouping) this is not true as long as your annual rent is less than 3-4% of required capital for comparable shelter (ignoring implicit leverage in a mortgage). You will do better in the long-run in stocks. Risk-adjusted, well that's another matter.
There is some risk with home ownership too though, and with climate change that is likely to increase. The ability to just walk from a property as a renter does have value.
> No one can reliably predict the business cycle let alone individual stock performance absent inside information. Stock picking is a losing game.
This is incorrect. Slow guys like Warren Buffet, and fast guys like Renaissance. Also a bunch of traders I either know or had some info about consistently beating the market.
Sometimes it is not inside information but public information that is hard to pick on. Or analysis that the average person can't do. Or access to other markets that can give you an extra handle that someone else doesn't. It is a big world out there.
> 2) Buy the most inexpensive house you can tolerate.
How about renting? You are young -> Studio. Got family and kids -> House. Back to being a couple after kids leave -> 2-bedrooms.
Expansions have been lasting longer and recessions are staying short.. that implies you should invest after one and take your money out before the length of the last one and will tend to outperform leaving money in.
Of course past performance doesn't guarantee future behavior, but all the points here are susceptible to that.
> Buy the most inexpensive house you can tolerate.
Where I live there are lots of people trying to get a start on the property ladder, so the cheaper places are also the worst value. The best bet here is to get a larger mortgage if possible to escape the lower-end ripoff.
> Put everything else in index funds every paycheck, and only check your balance every now and then. Let time be on your side.
In what index funds? I am primarily an index fund investor myself, but there are dozens of indexes to potentially invest in, so just saying "buy index funds" is inadequate advice.
I think the advice is general: choose a very broad "total market" stock fund to minimize risk, that spans market sectors, large v small cap, nations, and seasons -- like the Wilshire 5000.
Unless you have saved a lot of money, you will be living on a fixed income in retirement, while rents will continue to increase. I'm not saying buy a house today, just be very careful as you get older that you have hedged against inflation for the basic need of shelter.
I have been saying this since forever but so many people think they can beat the market. Cue some gurus with some arcane maths on some youtube channel.
1) The historical inflation rate is 2-3% per year in the US.
2) In most times and places in the US real estate appreciates slightly more than the rate of inflation at 3-4% nominally. So real estate grows much more slowly than most expect. A primary residence should be seen as the cost of shelter, not an investment, because...
3) US stocks have appreciated at an inflation-adjusted rate of 6-7% per year (8-10% nominal) even accounting for booms and busts. Speaking of...
4) No one can reliably predict the business cycle let alone individual stock performance absent inside information. Stock picking is a losing game.
5) The best way to invest in stocks for the vast majority of people is to buy the market in an index fund and minimize fees.
So to distill this down to three life lessons:
1) Don't plan on renting your whole life because inflation will catch up with you.
2) Buy the most inexpensive house you can tolerate.
3) Put everything else in index funds every paycheck, and only check your balance every now and then. Let time be on your side.