Homes aren’t a foolproof financial plan

Would the people who believe a house is the best possible investment please stop for a moment to look at what stocks have done lately.

One of the forces sustaining the real estate market is a belief that houses are a sure-thing investment. There are a couple of problems with this reasoning – people rarely factor the cost of home ownership into their calculations, and they act as if housing is immune from the cyclical downturns facing all financial assets.

But never mind all that. Houses have done very well in many cities in recent years, and people have made money. Meanwhile, the stock market has been its usual erratic self. Up 10.6 per cent on a total-return basis in 2014 (dividends plus share price gains), down 8.3 per cent last year and up 21 per cent for the year to Dec. 12. Who wants a saw-tooth investment like stocks when you can have the steady gains produced by the housing market in many cities?

Read more: BoC worries still focused on household debt, housing market

Read more: Rise of non-bank lenders poses risk: BoC

Read more: B.C. offers interest-free down-payment loans for first-time buyers

You do, and the reason is that tying your personal wealth to housing alone is as risky as relying on a single stock. An ideal net-worth statement for individuals includes real estate plus a diversified portfolio of investments in stocks and bonds.

People ignore this rule in two ways, the first being through the purchase of homes that cost so much to own and operate that there's no room for saving and investing for the future. The second is obsessing over paying down the mortgage and ignoring investing. Either way, you end up with a wealth imbalance in favour of housing.

In our recent Mortgage Overload series looking at the impact of high house prices on household finances, we included a chart of the top-performing real estate markets from 2008 through 2015. Toronto, Thunder Bay, Ont., and Yorkton, Sask., all averaged gains of 7 per cent or a bit more on an annualized basis, and another six cities clocked in gains in the 6-per-cent range. Given the weak inflation rate of 1.5 per cent over that same period, housing was awesome.

Stocks have been similar. For the three-, five- and 20-year periods to Nov. 30, total returns averaged in the low to mid 7-per-cent range. The 10-year gain was 4.7 per cent, a reflection of the crash of 2008-09. The 30-year annualized gain was 8.2 per cent, a reflection of a sustained bull market that seems unlikely to be repeated in this slower-growth era.

The time frames for these housing and stock-market numbers differ a bit, but the broad point is that both stocks and real estate have shown the ability to generate similar returns on a gross basis that ignores the cost of investing or owing. Stocks have been the rougher ride for sure, but there's an argument to be made that they produce a more practical form of wealth than houses.

It's all about liquidity. With stocks or funds that invest in them, you can sell and take profits any time you want. You can also collect dividends and use them to buy more stocks or another type of investment. In short, you can manage stocks to protect your wealth.

Your house can't be finessed the same way. People typically sell when they're ready from a lifestyle point of view – they want to downsize and move somewhere more urban, they can't manage the upkeep any more or they need a bigger house because they're having kids. Planning to sell at a market peak is tough to do. People tend to hold on too long out of fear they will miss out on future gains.

A mix of real estate and stocks is ideal. The stocks help build your savings and give you a pot of money you can use to generate retirement income, help your kids pay for college, travel and more. The house is a complementary asset that you will probably be able to sell for more than you paid. The fortunate home owner retires with a portfolio of investments and a house that can be downsized with money left over.

Don't own a house without some exposure to the stock market as well. What about owning investments in the stock market, but no house? If you have to choose, stock market wealth is more practical. Words of comfort if expensive housing has you considering a lifetime of renting.