Discover more from Making of a Millionaire
The Surprising Way Homeowners Use Their House to Build Wealth
The subtle ways your home influences your financial decisions
This is not your typical rent vs. buy post.
In this post, I discussed how renters and homeowners can both be financially successful, but renters need to be more thoughtful about their investment decisions.
Beyond the tired debates about whether renting is throwing your money away or your house is an asset, or a liability lies a much more interesting question.
How does homeownership impact how you invest your money?
In today’s post, I review research that answers that question and discuss the indirect ways owning a home can help build personal wealth.
If you don’t own risky assets, you won’t build wealth
No risk, no reward.
Unless you have an inheritance, a defined benefit pension, or plan on working forever, you are going to have to invest some of your money in risky assets like stocks.
Stocks have a higher expected return than less risky assets like bonds or risk-free assets like cash. Invest $100 today and turn it into $200 or $300, which you can use to fund your lifestyle. Save today, invest in a diversified portfolio of risky assets for the long run, and slowly—then quickly—build wealth. That’s the basic premise of personal finance.
A critical question economists have struggled with for decades is what factors impact whether someone invests in risky assets or not?
There are obvious factors like income and financial literacy—richer people and those who understand financial markets are more likely to invest their money.
But what if you don’t have so much money that investment advisors are beating down your door, or you don’t spend all your time reading about the stock market? How does the middle class decide whether or not to invest a portion of their paycheck each month?
A 2008 study titled “The Determinants of Household Risky Asset Holdings: Background Risk and Other Factors” examined how a number of factors impact a working family’s investment in the stock market. Here are the three that were most interesting.
Housing costs (for renters and owners)
More credit = more investment
Households with easier access to credit invest more in the stock market. Remember that homeowners have the easiest access to credit through mortgages and home equity loans with the lowest interest rates of any form of debt.
This does not necessarily mean that everyone with access to credit directly borrows money to invest in stocks (although many foolishly do.) What’s interesting is that having access to credit can make someone feel more secure when investing in a risky asset like stocks.
Imagine a renter and a homeowner who each have $5,000 in cash and are considering whether to start investing in the stock market.
Let’s say the renter has no credit, not even a credit card. While the homeowner has a $50,000 home equity line of credit. All else equal, the homeowner knows they have access to credit in case of an emergency, so they will feel more secure in investing in risky assets like stocks.
This is an issue I discuss at length in my book The Rational Investor.
The less certain you are about when you’ll get paid and how much you’ll make, the less likely you’ll be to invest in risky assets like stocks.
Again, this comes back to security. If you don’t know how much money you’ll make this month, you would want a larger portion of your assets held in cash if you need to tap your reserves to pay the bills. Stocks are simply too volatile to rely on funding short-term needs like paying the electricity bill.
The researchers examined how the size of mortgage and rent payments (relative to income) impacted investment in stocks.
They found that homeowners with larger mortgage payments held a larger share of their money in stocks, but the same was not true for renters.
The paper does not explain why this might be the case, so allow me to put my economist hat on and explain my theory.
A mortgage is a bond. The bank lends you money, and you pay interest on that loan every year and repay the entire principal over a specified time period. That’s what a bond is.
You can think of every dollar paid in principal against a mortgage as an “investment” in a bond.
Fully paying off a mortgage is like having a risk-free and tax-free income from a bond. If you’ve spent the last 30 years paying off a $2,000 monthly mortgage, once it’s paid off, you are free to spend $2,000 in tax-free money on whatever you like.
So, those with a large mortgage are allocating money to a bond (their mortgage) every month. Once you realize that, it makes sense that these homeowners would allocate more of their investment portfolio to stocks.
In rent vs. buy debates, the owners tend to point to their home equity as the only factor that matters. But both homeowners and renters need to focus on building wealth independent of the roof over their heads.
This research hits on the most under-discussed financial benefit of homeownership: having a mortgage and access to cheap credit makes it easier for homeowners to invest in the stock market and build wealth independent of their home equity.
Paying down a mortgage provides future bond-like income. This, in turn, makes homeowners more likely to invest in stocks and build wealth independent of their homes.
I’ve been agnostic about rent vs. buy in the past. While I still believe it depends largely on personal preferences, this long-term benefit of mortgage repayment combined with a higher allocation to stocks does increase the appeal of homeownership from a wealth-building perspective.
What do you think?
Does owning a home make you more or less likely to invest in the stock market?
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.