Is Your Home Your Best Investment?

I often hear from people that their home was the best investment they ever made. They bought it when they were starting a family, lived in it for a couple decades, and now it’s appreciated quite a bit.

The typical home price in the United States has roughly doubled in value in the last 20 years. For example, if you bought a home for $250,000 in 2005 and the value grew at the same rate as the national average, it would be worth about $506,000 today. That’s a hefty $256,000 gain just by living in a home.

According to data for the Pittsfield metropolitan statistical area (MSA), home prices have appreciated slightly less but are still up more than 90 percent in the last two decades. The bottom line is that being a homeowner has been a great way to grow wealth. The home is also the single largest asset for most people. This all leads to a perhaps accurate conclusion that buying a house was the best investment for many people.

But it turns out that real estate has not seen returns anywhere near as good as the stock market. The 102 percent total return going back 20 years equates to 3.6 percent annualized. The growth in the value of a typical home over the last 20 years is hardly better than the rate of inflation. This is true going back further in history as well, as the typical rate of return on the value of real estate is generally in the 3 to 4 percent range no matter what data you look at.

The stock market, as represented by the S&P 500, has returned 10.3 percent per year in the past 20 years, also in line with long-term averages. This equates to a total return of more than 600 percent since the beginning of 2005. In other words, the same $250,000 investment 20 years ago would be worth almost $1.8 million – a much better investment than a home (excluding any fees and assuming the reinvestment of dividends).

Why then do we tend to think of a home as such an excellent investment?

The first reason is that buying a home is generally a long-term investment. You don’t look at the market value of your house and think about selling it every day. You put money into your home every month in the form of a mortgage, and although the value grows relatively slowly, buying a home almost forces you to be a long-term investor.

The same cannot be said of investing in the stock market. The value fluctuates wildly from day-to-day and you can choose to sell at the click of a button. One of the biggest obstacles for investors in the stock market is their own behavior. Even though the average annual return for stocks has been about 10 percent over long periods of time, there is a pile of evidence that actual investors have not fared that well. The trouble is that people can buy and sell too easily, and they tend to do so at the wrong times.

A second major reason that houses tend to be good investments is that most people use a mortgage to buy a home. This leverage means that you didn’t need the entire $250,000 to buy a house 20 years ago, maybe you only put down a $50,000 downpayment. This may make a large investment seem more attainable.

But a large investment in the stock market could be equally attainable with the right mindset. If you take the same idea of paying a monthly mortgage and instead put that money toward buying into the stock market systematically, you would have seen impressive growth over the long-term.

This method of investing a set amount at regular intervals is called dollar-cost averaging, and there are reasons to believe that it can have a strongly positive behavioral impact as well. You’re less likely to worry about the fluctuations in daily value when you get an opportunity to keep adding to investments over time.

If homeownership is attainable, it can be an excellent way to build wealth over time. You can’t live in the stock market, and ownership in mutual funds and exchange traded funds is not tangible. Nonetheless, we could learn an important financial lesson from folks who have seen their home values grow.

It’s not necessarily that homes have appreciated at an exorbitant pace. Rather, it is the ability to put the money in at regular intervals and not let daily, monthly, or even annual fluctuations in value deter you from holding it for the long term. We should aspire to do the same with all our investments.

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