The Freedom Factory

Yesterday’s prose was very simplistic and did not take into account many of the variables involved in the home buying process.  Some of them play a big part in the equation and account for large swings in dollar amounts. 

Below is the math which should include all of the variables involved.  My thinking may not be perfect so please comment and let me know what thoughts you have.

I think in the end it is very clear which investment is the better one financially.  But many people like to own their own home.  Can’t do that if you rent your whole life.  And many people would not save the difference between rent and buying so in a way it is a forced savings plan.  And if buying a home can force people to save nearly $1M dollars, then they are likely much better off than if they rented (b/c they wouldn’t have saved that $1M).  If you are disciplined and can save, I think you can do better with your money than the forced saving plan of buying a home. Continue Reading

In Jeremy Siegel’s book, “Stocks For the Long Run”, he finds that real returns of stocks have averaged 7% since 1870.  Real returns are returns after inflation is taken into account.  For example, if inflation is 3% and a stock returns 10% in a given yr, then the real return would be 7% (10% – 3%).  And real returns are the only returns that matter, because they measure an increase in spending power.  If inflation is 3% and a stock returns 3%, then you haven’t improved your position at all.  You can purchase exactly what you could purchase the yr prior.  In conclusion, stocks increase in value 7% per yr because that is how fast companies tend to grow their profits. 

Houses have their own version of profits: rents.  These rents are profits, either realized if someone is paying you to rent the house or implied if you are not paying rent to live there.  House prices and rents have been closely correlated throughout history, both increasing at the rate of inflation or about 3% a yr.  This number is low because it is hard for a house to think up ways to increase its profits.  Robert Shiller, the Yale economist who successfully predicted the stock market crash of 2000 in his book “Irrational Exuberance”, has found that home returns since 1900 would have been zero if not for 2 brief periods in history.  Even if the two periods, one immediately following WWII and the other from 2000 to 2005, are included they would only boost real returns to 1% per annum.  If you’d like to see his data sets, they can be found here: http://www.econ.yale.edu/~shiller/data.htm.  Continue Reading