We were taught we could count on the equity in our homes to be a major part of our retirement and wealth-building plan. Not long ago, home equity was the biggest chunk of most nest eggs. Many of us even made extra mortgage payments or refinanced into fifteen-year loans so we could have the security of knowing our homes would be paid off in full when we retired. Here’s a snapshot of how well the strategy of plowing money we could have put into our savings into our homes instead has worked out in recent years:
SOURCE: Standard & Poor’s Case-Shiller Home Price Index.
Starting in January 2002 to the peak of the housing market bubble in June 2006, home values skyrocketed by 71 percent. But by March 2012, they had plunged to a level barely 10 percent above where they were a decade earlier.
From January 2002 to January 2013, housing prices increased by less than a measly 2 percent per year. However, we had 30 percent inflation during that period, which more than wiped out any real gains in home values. And that ignores the pain and suffering experienced by millions of people who lost their homes or are underwater on their mortgages.
The bubble that burst in 2006 laid bare the fiction that housing prices only go up. Real estate is subject to the same volatility and unpredictability as any other investment. Even seasoned home buyers who regularly purchase properties to improve them and flip them for profit were caught short in this latest real estate crash.
Real estate investments can be part of a well-diversified financial plan. Real estate enjoys some tax advantages and has the potential for income and appreciation. But you have no way of predicting real estate values, whether residential or commercial. You also can’t predict how much rent you’ll be able to charge for your property, how long it will take to find a tenant, or what maintenance costs you’ll incur.
And the financial crisis and credit lockdown have made it painfully clear how little control you have over the equity in your home and other real estate. Home equity lines of credit were slashed or frozen without warning, and refinancing options dried up even for people with good credit.
Many people were unpleasantly surprised to discover how difficult it can be to sell your real estate to get at your equity. Much like trying to predict the stock market, you can’t guarantee the real estate market will be up when you’re ready (or need) to sell, and you have no way of knowing how long it will take to sell.
How an Experienced Real Estate Investor Got Caught Short
Eric Greene proudly bought his first home forty years ago when he was only twenty-three years old. Since then he’s bought and sold a dozen homes and investment properties, making a profit each time. As the owner of a successful retail business, he accumulated a nice nest egg by saving diligently and investing the money in the stock market. He planned to retire around age sixty-five.
Eric built his last dream house in 2004. As the value increased rapidly over the next few years, he refinanced several times, investing the cash in home improvements. He felt confident that this real estate investment, like all his others, would continue to increase in value. “Heck,” Eric says, “even the government and Congress told us real estate was just going to continue to rise.”
When the bubble burst in 2007, Eric found himself underwater on his mortgage by hundreds of thousands of dollars. And with the slowdown in his business, he could no longer afford to make the payments and make repairs to his home. After Eric negotiated fruitlessly with the bank for more than a year, his dream home was sold on the courthouse steps. His retirement account was totally decimated by the stock market crash. Now at age sixty-three, Eric is facing the unimaginable prospect of having to build a retirement fund from scratch. Fortunately, Eric found Bank On Yourself and says he now has the peace of mind of knowing the Bank On Yourself plan he started four years ago will give him the predictability and guarantees that were missing from his previous financial plan.
Even if a crash of the magnitude of 2007 proves to be a one-time disaster, is owning real estate a reliable wealth-building strategy? According to Robert Shiller, co-creator of the widely used Case-Shiller Home Price Index, periods of rapid increases have consistently been followed by declines. As a result, home values in the U.S. have outpaced inflation by only about 1 percent per year over the long term. That’s not even close to the growth rate you really need for your nest egg, is it? And the days of using a house as a piggy bank or an ATM are gone.
U.S. home values have only outpaced inflation by about 1 percent per year over the long term.
In the April 13, 2013, article, “Why Home Prices Change (or Don’t)” in the New York Times, Shiller wrote, “Booms are typically followed by busts, usually in far less than ten years. In a decade, an entire housing boom, if there is one in inflation-corrected terms, is likely to have been reversed and completely washed away.” As a 2011 opinion piece titled “The Housing Illusion” in the Wall Street Journal noted, “A home’s main economic purpose is—or should be—shelter. During the mania of the last decade, housing too often became an investment out of proportion to any sensible contributions to national wealth and well-being.”
How Precious Are Metals?
Now let’s take a look at the promise of gold and other precious metals. I’ve found most people who are buying gold today have no clue about the volatile history of that metal. And as the saying goes, those who forget or are ignorant of the past are condemned to repeat it.
A picture is worth a thousand words:
INFLATION-ADJUSTED PRICE OF GOLD
An ounce of gold would have had to be worth more than $2,000 in December 2015 to have same purchasing power it had in 1980.
In September 2011, gold hit a record high of $1,920 per ounce. Anyone who bought gold at its low of $608 in 2007 and sold it at or near its high enjoyed a most impressive gain. What I haven’t been able to find are any flesh-and-blood individual investors who timed their gold purchases to actually cash in on these theoretical returns. I’m sure some such lucky souls did make a killing. They are, however, far more rare than the precious metal itself.
By June 2013, gold had plunged by 38 percent. On April 15 alone, gold fell a whopping $115 per ounce—it’s like bungee jumping without the bungee cord!
On an inflation-adjusted basis, the price of gold would have to be about $2,003 per ounce today to have the same purchasing power it did thirty-five years ago. In spite of gold’s recent meteoric rise, that’s around $930 per ounce more than gold’s price in December 2015.
For those of us who don’t have the Midas touch when it comes to investment timing, gold remains a leaden financial vessel.
In Common Sense on Mutual Funds, John Bogle points out that “Gold provides no internal rate of return. It provides none of the intrinsic value that’s created for stocks by earnings growth and dividend yields, and none of the value provided for bonds by interest payments. For the more than two centuries between 1802 and 2008, an initial investment of $10,000 [in gold] grew to barely $26,000 in real returns.”
Gold pays no dividends and generates no income, so your only way to profit from a gold investment is to actually sell it for a higher price than you paid for it. Until you do sell, your paper profits do you little good, since you can’t take that pretty number on paper to the grocery store.
And what about taxes? Most people don’t realize that you will pay one of the highest federal tax rates on any profits you might make with gold whether you’ve got gold coins or bars or an exchange-traded fund that invests in gold bullion. That’s because precious metals are considered a collectible, which is taxed at nearly double the rate of stocks and real estate capital gains.
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