A persistent financial fallacy of our time is that you financially maim yourself by renting rather than owning a home. In fact, a renter who invests diligently can do very well financially, too.
Here's a Q&A guide to make it happen:
What am I trying to achieve?
Homeowners build wealth by paying their mortgage down and increasing their equity in a house that they will presumably be able to sell for more than they paid. Renters build wealth by taking the money they save through not owning – let's call this the renter's dividend – and investing it in a diversified portfolio. The value of these investments is like an owner's equity in his or her home.
Can't I just spend my savings as a renter?
Sure, but recognize that you put yourself at a financial disadvantage. A homeowner with a paid off house has the luxury of choosing to:
- continue living mortgage-free in the home (and rent-free, for that matter);
- downsizing to a condo or smaller house and possibly having money left over for investing or personal spending;
- selling and moving to a rental, thereby freeing up hundreds of thousands of dollars in capital;
- selling and using the proceeds from the sale to cover the cost of moving into a retirement home.
Spend your renter's dividend instead of investing it and you face a poorer retirement with fewer options.
What if I'm just renting for a few years before buying a house?
Then your renter's dividend becomes your down payment. Be sure to park your savings in a high-interest savings account to protect your principal.
How much should I invest? (Part 1)Monthly rents and mortgage payments aren't far apart in some cases, but that's a false comparison because owners must cover the additional costs of property taxes, maintenance, improvements, furnishings and house-sized utility bills. It's these expenditures that renters should look at in deciding how much to invest.
How much should I invest? (Part 2)
Okay, so you're going to invest the money you save by not owning a house. A rough guideline is that home maintenance and upkeep would have cost you an average 1 per cent of the value of your home over the years. Add in property taxes and the cost of discretionary home improvements and you're up to 1.5 or even 2 per cent of a home's value, on average, each year.
We'll go with 1.5 per cent in this exercise. Next question – what house price do we apply this savings/investing rate to? You could use local housing prices, which would have Toronto, Calgary and Vancouver renters saving vastly more than those in smaller towns. The risk here is that residents of smaller communities end up undersaving.
Another approach is to use the national average housing price, which in April was $409,708. Investing 1.5 per cent of that amount would mean monthly amounts of $512; at the more aggressive 2 per cent savings rate, the monthly investment amount rises to $683.
What if I can't invest that much?
With many people, the rationale for renting is that they can't afford a house in the community where they want to live. In that case, investing the full renter's dividend won't be realistic. Try tapering back to 1 per cent of home prices, or less if necessary.
Where should I invest?
To avoid paying taxes on your investment income as much as possible, make maximum use of tax-free savings accounts. To defer taxes until retirement, invest in a registered retirement savings plan. If you invest in a non-registered account, be mindful that bond interest is taxed as regular income, while dividends and capital gains are taxed more lightly. Homeowners have an advantage here in that they can sell a principal residence tax-free.
Should taxes play a role in my investing?
Yes. Think about squeezing your bond allocation below where you might otherwise be, especially if you have 10-plus years to go until you plan to dip into your investments. A 30-year-old renter might have as little as 10 or 20 per cent in bonds (I'll discuss mixing stocks and bonds for young investors in a future column).
If you hold stocks for the long term, keep in mind that 50 per cent of your capital gains are taxable. Many mutual funds and exchange-traded funds pay distributions that include a return of capital, which is basically a sliver of the upfront amount you invested. A return of capital is not taxed when received, but it does lower the adjusted cost base for an investment and thus increase the potential capital gain on sale.
How do I stay committed?
Whether you're a renter or an everyday investor, there's only one way to set up a disciplined investing program. You need to have money transferred electronically into your investment account from your chequeing account every time you get paid, or once per month.
Do I have to invest separately for retirement?
Just as a homeowner needs to have dedicated savings for retirement, so does the renter. Ideally, you devote 10 per cent of your gross pay to retirement and other savings goals, and then invest your renter's dividend as well.
What kind of return should I expect?
Six per cent after fees is a reasonable expectation from a diversified portfolio with a heavy stocks weighting, but a little more may be attainable. The low-cost Mawer Tax Effective Balanced Fund has averaged 8 per cent annually over the past 20 years. This fund, designed for people investing outside registered accounts, is one of several funds I mentioned in a previous column because their returns have exceeded the long-term national average price gain for houses in Canada.
Globe app users click here for tables showing renters' investment options.
A homeowner with a paid off house is sitting on a valuable asset, but not a very liquid one. The long-term renter who invests money saved by not owning ends up with a pile of money that can be used for anything, and at any time.
Here's an example of how a renter can generate significant wealth. Note: These are after-fee, pre-tax returns. Taxes would reduce these numbers in non-registered accounts.
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How much should renters invest, exactly?
Beyond mortgage payments, the cost of owning a house is roughly equal to 1.5 per cent of the home's value per year. That's the amount you should aim to save and invest if you're a renter. Here's how this rule plays out in various cities across the country using average April resale prices.
|City||Average price||Monthly amount needed|
to meet goal of investing
1.5 per cent of
house value per year*