The Pros and Cons of the Five Basic Investments | Part 3

In the previous segment of our five part series we got to learn about - Collectibles and how to collect valuable stuff, old or new and then sell them at a higher price in the future. In case you haven’t read that you are most welcome to check out our previous blog post.

As we have mentioned earlier in our previous segments, we will post an excerpt from the book ‘Learn to Earn’ by Mr. Peter Lynch where we understood there are five basic ways to invest money; by putting it in a savings account or something similar, buying collectibles, buying an apartment or a house or land, buying bonds and buying stocks.

This segment will cover the third investment strategy - ‘Houses or Apartments’ which will give us an insight to what happens when you buy a house or an apartment and what happens when you don’t.

Have a good read.

 

Houses or Apartments

 

Buying a house or an apartment is the most profitable purchase most people ever make. A house has two big advantages over other types of investments. You can live in it while you wait for the price to go up, and you buy it on borrowed money. Let’s review the math.

Houses have a habit of increasing in value at the same rate as inflation. On that score, you’re breaking even. But you don’t pay for the house all at once. Typically, you pay 20 percent up front (the down payment), and a bank lends you the other 80 percent (the mortgage). You pay interest on this mortgage for as long as it takes you to pay back the loan. That could be as long as fifteen or thirty years, depending on the deal you make with the bank.

Meanwhile, you’re living in the house, and you won’t get scared out of it by a bad housing market, the way you might get scared out of stocks when the stock market has a crash or a correction. As long as you stay there, the house increases in value, but you aren’t paying any taxes on the gains. And once in your lifetime, the government gives you a tax break when you do sell the house.

If you buy a $100,000 house that increases in value by 3 percent a year, after the first year it will be worth $3,000 more than what you paid for it. At first glance, you’d say that’s a 3 percent return, the same as you might get from a savings account. But here’s the secret that makes a house such a great investment. Of the $100,000 it takes to buy the house, only $20,000 comes out of your pocket. So, at the end of year one, you’ve got a $3,000 profit on an investment of $20,000. Instead of a 3 percent return, the house is giving you a 15 percent return.

Along the way, of course, you have to pay the interest on the mortgage, but you get a tax break for that (unless the government decides to take away the tax break), and as you pay off the mortgage, you’re increasing your investment in the house. This is a form of savings that people often don’t think about.

Fifteen years up the road, if you’ve got a fifteen-year mortgage and you stay in the house that long, the mortgage is paid off, and the house you bought for $100,000 is worth $155,797, thanks to the annual 3 percent increase in the price.

Let’s take an example of two friends, Joe Bigbelly and Sally Cartwheel.

They’ve both moved up to assistant manager at WalMart, making identical salaries. Cartwheel is living in her own house, while Bigbelly’s parents have kicked him out of theirs. He would have preferred to buy a house or an apartment on his own, but since he lacked a down payment, he had no choice but to rent an apartment.

Bigbelly’s monthly rent is somewhat lower than Cartwheel’s monthly

mortgage payment, plus she has to buy home insurance, pay the lawn service, and make the occasional repair. So Bigbelly has more cash in his pocket at the outset. In theory, he could take this extra cash and invest it in the stock market and build up his assets for the future, but he doesn’t. He spends it on stereo equipment, scuba gear, golf lessons, and so on.

A person who won’t save money to buy an apartment or a house isn’t likely to save money to invest in stocks. It’s routine for families to make sacrifices so they can afford to own a house eventually, but when have you ever heard of a family making sacrifices so it could buy its first mutual fund?

By owning a house, Cartwheel already has gotten into the habit of saving and investing. As long as she’s paying the mortgage, she’s forced to invest in the house, and since she already invested in mutual funds to secure the down payment, there’s a good chance she’ll invest in mutual funds in the future, whenever she has money to spare.

In fifteen years, when her mortgage is paid off, Cartwheel will be living in a valuable asset, and her biggest monthly bill will have disappeared. Bigbelly will have nothing to show for all his rent payments, which will be much higher than they were when he first moved into the apartment. They will also be much higher than the final payment Sally Cartwheel had to make.

 

Conclusion 

After reading this we assume you have got an insight into how the housing market works and how one doesn’t have to pay rent when one can own a house with proper savings and right investment. Let’s make right investment like Sally Cartwheel and not make the mistake Bigbelly did. So what are you waiting for, if you have the necessary resources then go, start looking for properties worth buying that will help you own an asset for life.

In the next post we will learn about ‘buying bonds’. 

 

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