> Guess which one will give you a better return on average
Hard to say. Depends on inflation levels.
In particular, a home is one of the few leveraged investments most people can make. And if inflation is somewhat high (which it hasn't been recently), a leveraged investment that just grows at the rate of inflation can beat out an index fund that grows several percent above the rate of inflation but is not leveraged.
Just to put numbers to this, if you are levered 5 to 1 (20% down), inflation is 3%, home price grows at inflation, you are getting a 15% nominal return on your investment in the home, and a 12% real return.
For a more realistic estimate, say leverage is 4 to 1 (you've paid off part of the mortgage), inflation at 2% as it has been recently. Still 6% real return.
I will grant that the index fund is more liquid, obviously.
> Just to put numbers to this, if you are levered 5 to 1 (20% down), inflation is 3%, home price grows at inflation, you are getting a 15% nominal return on your investment in the home, and a 12% real return.
I'm sorry I didn't follow that calculation perfectly. I (sort of) understand the part where you get a 15% nominal ROI for 20% down. But if you're paying your mortgage every month you're leveraged less and less each successive month right (as you pay off principal and accumulate equity)? Would that change the calculation?
Valuation and ROI (beyond simple stuff) is not one of my strengths unfortunately.
> Hard to say. Depends on inflation levels. And if inflation is somewhat high (which it hasn't been recently),
That's what I was getting at with "on average". Inflation hasn't been high for quite a while. I will grant you that it's not cut-and-dry in favor of index funds under all circumstances.
> if you're paying your mortgage every month you're leveraged less and less each successive month right (as you pay off principal and accumulate equity)? Would that change the calculation?
Yes. But you can keep your leverage ratio the same by upsizing every few years and remortgaging when you do. As you get towards retirement you generally delever but that's what you would want to be doing anyway (sacrificing some return for lower risk).
Yes, it would. As Imm says, this is actually conceptually similar to shifting out of stocks into bonds as you get older: lower returns, less risk. And of course some people do interest-only mortgages and whatnot, just like some people invest all their money in risky stocks...
I agree that if one were actually approaching this as a personal financial decision one would need to do some careful calculation, as well as modeling of different inflation expectations and so forth. And that no one does this in practice.
Hard to say. Depends on inflation levels.
In particular, a home is one of the few leveraged investments most people can make. And if inflation is somewhat high (which it hasn't been recently), a leveraged investment that just grows at the rate of inflation can beat out an index fund that grows several percent above the rate of inflation but is not leveraged.
Just to put numbers to this, if you are levered 5 to 1 (20% down), inflation is 3%, home price grows at inflation, you are getting a 15% nominal return on your investment in the home, and a 12% real return.
For a more realistic estimate, say leverage is 4 to 1 (you've paid off part of the mortgage), inflation at 2% as it has been recently. Still 6% real return.
I will grant that the index fund is more liquid, obviously.