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The cover of Your Money Milestones: A Guide to Making the 9 Most Important Financial Decisions of Your Life, written by Moshe Milevsky
The cover of Your Money Milestones: A Guide to Making the 9 Most Important Financial Decisions of Your Life, written by Moshe Milevsky

Book Excerpt No. 2

Many homeowners should have rented Add to ...

Investing in Social Capital This relationship between social capital and financial well-being then manifests itself in a number of interesting ways. For example, the authors in the previously-noted study obtained detailed records of more than 170,000 individual credit card histories over a two-year period to observe individual payment behavior and bankruptcy filing status for each of these 170,000 individuals. The dataset contained enough information so that the individual's age, address, marital status, and homeownership status could be linked to their credit card behavior and in particular could determine whether they filed for bankruptcy protection during the two-year period.

Now, as you might expect, borrowers living in counties and regions with high unemployment and poor economic conditions and those individuals who have lower income and wealth status experienced higher default rates. No surprise there.

However, what is interesting is the following conclusion. I quote from their study: "An individual who continues to live in his state of birth is 9 per cent less likely to default on his credit card and 13 per cent less likely to file for bankruptcy, while an individual who moves 190 miles from his state of birth is 17 per cent more likely to default and 15 per cent more likely to declare bankruptcy." This, of course, is consistent with a social capital story under which the closer you live to your place of birth, the more likely you are to have vested social capital to protect. Along the same lines, it seems that married individuals are 24 per cent less likely to default on credit cards and 32 per cent less likely to file for bankruptcy. Finally, homeowners-and keep in mind that home ownership provides another proxy for social capital-are 17 per cent less likely to default and 25 per cent less likely to declare bankruptcy.

In sum, I suspect that people grossly underestimate their home ownership expenditures. They overestimate the amount by which the house will appreciate over time. They tend to live where they work (obviously), which means that their housing capital (which is a subset of financial capital) is exposed to the same economic risks as their human capital. And yet, the one thing an investment in housing might achieve is that it creates its own investment in social capital. Perhaps this one factor outweighs the many other negatives and makes this particular money milestone worth pursuing.

Summary: The Four Principles in Action •Americans (as well as Canadians) have ADDED significantly to their personal balance sheet allocation to housing over the last few decades. Housing can ADD to your net worth over time. However, even a small decrease in the value of housing can also SUBTRACT value from your personal balance sheet, and the effects of this subtraction can be MULTIPLIED if your household is over-allocated to housing.

•A more rational way to approach your need for shelter is to DIVIDE your spending on a primary residence, if you are a homeowner, into an allocation for shelter (meeting your consumption needs for shelter) and an allocation for investment. Another rational approach that has been advocated by a number of financial economists is to hold off on purchasing a house until you have converted a significant amount of your human capital into financial capital.

•If the cost of the house, today, exceeds the value of your human capital, in all likelihood you shouldn't be a homeowner, period, regardless of how low the (current) monthly payments are or how low the interest rate is. This is likely another one of the most important concepts within strategic financial planning for individuals.

•The role of housing is also connected to another form of capital: social capital. The effects of investing in social capital can MULTIPLY your investment in your home, increasing your financial well-being-and that of your community-in surprising and unexpected ways. So, it's not only about the money after all.

Reprinted with permission by FT Press, by an imprint of Pearson.

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