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rob carrick

Home-buying or investing – which will make you richer?

Gen Y, this could be the defining question of your financial life. Don't make the mistake of passively accepting the line that housing is a great investment.

Houses are a lovely place to live and raise a family, and they've solidly appreciated in price over the past several years. But stocks, even after the mega-crash of five years ago, have been the better long-term investment.

National price data from the Canadian Real Estate Association shows an average annual gain of 5.4 per cent nationally from 2004 through 2013 for resale homes. The comparable average return from stocks was just under 8 per cent. If we go back 20 years, we get an 8.3 per cent gain from Canadian stocks and an increase of 4.5 per cent in the average national house price. Over 30 years, stocks made 8.5 per cent and houses 5.5 per cent.

Stocks, or at least the benchmark for the Canadian market, win. Case closed. So why do houses enjoy such a great reputation as an investment? Some answers to this question were recently presented in a blog post by Adrian Spitters, a certified financial planner (CFP) with Assante Capital Management Ltd. in Abbotsford, B.C. For one thing, he thinks people take a much longer-term view of housing prices than they do with stocks. With stocks, they focus a lot on short-term price fluctuations and lose sight of long-term results.

The perception of stocks has also been hurt by two market crashes since 2000, even though long-term investors have still done fine. "Years ago, when people didn't have access to information online, I don't think they panicked as much about stocks," Mr. Spitters said in an interview. "People tend to be more aware of the volatility."

He also says people ignore the true cost of owning a home and thus come away with an overly optimistic view of how much money they've made. Property taxes, furnishings, maintenance, improvements, insurance and mortgage interest all have to be factored into calculations of how much money is being made on housing.

There's also a cost to investing, of course. But it's much more contained and predictable than a house, where costly repairs could be needed at any time. A do-it-yourself investor might pay 0.5 per cent of the value of her account assets in fees and commissions per year, while an investor with an adviser might pay 1 to 1.5 per cent. Even if you lower stock market returns by this amount, you still get a better result than housing.

It's worth noting at this point that while investing only in the stock market is doable for young investors, most will be happier with some bonds as well. This will result in lower overall returns, but less of that scary stock market volatility. Can you still beat houses with a diversified portfolio? A number of mutual funds offering a balanced mix of stocks and bonds have done this over the past 10-plus years. (Let me know if you'd like me to round them up for a future column.)

Meanwhile, the 20- and 30-somethings of Generation Y are told endlessly by parents, family and friends that extending yourself financially to buy a house is okay because it's a great investment.

"It's a cultural thing," Mr. Spitters said. "People have made money in real estate, and therefore they think their kids will make money in real estate. It's called recency bias – people look at where they've made money recently and think it will continue to be a good investment."

Mr. Spitters believes housing prices can't maintain their momentum, which means stocks could add to their advantage in the years ahead. But even if this doesn't happen, he worries that young adults will buy houses today based on the idea that they're a good investment and then be so cash-poor that they can't afford to save for retirement.

A house, by the way, is not a retirement fund. When you sell a house later in life, you'll use most of the proceeds to buy a condo, bungalow or whatever you downsize into.

But what if you're set on buying a house? In that case, consider a five-year plan suggested by Mr. Spitters. Essentially, you'll rent for five years and invest the money you save because you don't have the higher costs of a homeowner. By his estimate, you'll come out financially ahead with this strategy, regardless of whether housing prices rise, stagnate or fall.

There's an argument against delaying your foray into the housing market by five years – the threat of rising mortgage rates. Given how expensive houses are in many cities, even a modest move up in rates would have a noticeable impact on affordability. Mr. Spitters' response is that rising rates will cool the housing market and cause prices to fall. In any case, the five-year investing plan will help you build a bigger down payment and reduce the amount you need to borrow when you buy.

Mr. Spitters based his plan on a couple with household income of $120,000 and $22,500 saved for the minimum 5-per-cent down payment on a $450,000 house. If they buy, they'd spend about $2,764 on mortgage payments, taxes, utilities and maintenance. If they rent, he figures they would pay $1,850 per month. That happens to be the rent he's paying on a townhouse in Abbotsford.

The investing plan works as follows: The couple take their $22,500 down payment (plus the $9,000 they would have spent in closing costs) and invest it in a diversified portfolio that makes an average 6 per cent annually over five years. On a regular basis, they also contribute the $914 savings they realize from renting instead of owning.

Renters generate more wealth in each of Mr. Spitters' examples, but what if the stock market fouls things up with a big crash? His suggestion: Be prepared to stay invested for one or two extra years to let the market come back to its long-term average performance level.

In a Personal Finance column last year, a McMaster University finance instructor and ex-banker explained how it's possible to generate more wealth as a renter over a lifetime as well as the short term (read it online here). But doing so requires diligent saving and, anyway, most people want to own a house for lifestyle and family reasons.

Suit yourself on deciding between buying and renting, but do it with a full understanding of how housing has performed as an investment.

The record for houses is good, but investing did better. The investing advantage will only increase if house prices go sideways or decline.

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