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“A house is made of walls and beams; a home is built with love and dreams.” – Unknown
Over the past year, we have witnessed heartbreaking examples of homes being destroyed. Last fall, Hurricane Helene swept through the Asheville and North Carolina mountains, leaving devastation in its wake. This year, fires in Los Angeles have displaced countless families. These events are sobering reminders of the fragility of physical structures and the emotional toll of such losses.
While it is crucial to empathize with those affected, these tragedies also serve as an opportunity to reflect on how we view our homes in the context of our financial lives. Many Americans mistakenly consider their primary residence an investment, but this perspective warrants reconsideration.
The Definition of an Investment
The CFA Institute defines an investment as “putting money into a project or undertaking with the expectation of earning a profit or income.” Real estate investments, according to the CFA Institute, typically fall into four categories:
- Private Equity: Direct ownership of property.
- Publicly Traded Equity: Indirect ownership claims, such as real estate investment trusts (REITs).
- Private Debt: Direct mortgage lending.
- Publicly Traded Debt: Securitized mortgages.
A property is considered an investment if it is not your primary residence and is purchased to generate income or profit. This includes residential rental properties, commercial spaces, industrial properties, or even vacant lots.
Your primary residence, however, is not typically purchased with the intent to generate income. While it may appreciate in value over time, this appreciation can be misleading due to the time value of money and other hidden costs.
The Reality of Home Appreciation
Homeownership often feels like a sound financial decision because many people see their homes increase in value from the time of purchase to the time of sale. However, this appreciation is often less impressive when viewed through the lens of financial principles. For example:
- Time Value of Money: If a home’s value doubles over 18 years, the annual growth rate is approximately 4%, as calculated using the Rule of 72.
- The Rule of 72: This rule states that dividing 72 by the annual rate of return gives an estimate of how long it will take for an investment to double. For example, at a 4% annual growth rate, it takes 18 years for a home’s value to double.
This 4% growth is modest compared to historical returns of diversified equity investments, which have averaged around 7-10% annually over the long term.
Hidden Costs of Homeownership
Beyond modest appreciation, homeownership comes with significant costs that can erode any perceived gains:
- Maintenance: Roof repairs, HVAC replacements, and landscaping are just a few examples of ongoing expenses.
- Property Taxes: These are often a significant annual expense.
- Insurance: Necessary but costly, especially in regions prone to natural disasters.
- Opportunity Costs: Funds tied up in home equity could potentially earn higher returns in other investments.
The Importance of True Diversification
The key to building a resilient financial portfolio is diversification. While owning a home is an essential part of life, relying on it as your primary investment can leave you vulnerable. Natural disasters like those in North Carolina and California are stark reminders of this vulnerability.
Instead, consider spreading your investments across different asset classes and geographic regions:
- Stocks and Bonds: These provide opportunities for growth and income that outpace inflation over time.
- International Investments: Diversifying beyond local and national markets can reduce risk.
- Insurance: Proper insurance coverage is essential to protect against catastrophic losses.
Final Thoughts
While your home may feel like a cornerstone of your financial security, it is important to view it through a realistic lens. Homes often appreciate at a rate that merely keeps pace with inflation, and the associated costs can significantly diminish returns.
At Intelligent Investing, we’re here to serve as your accountability partner in building a diversified and resilient financial future. Let us help you create a strategy that goes beyond your home to achieve true financial peace.
Our prayers go out to those affected by the recent disasters. At Intelligent Investing, we believe strongly in risk mitigation, and this aligns with our passion for minimizing financial stress and maximizing lives. As the new year begins, this is an excellent time to organize your financial “junk drawer” and create a plan for a secure future.
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