Cash is king, or so they say. That phrase permeated op-eds and television broadcasts amid the 2008 credit crisis and throughout the recent European debt fiasco. Typing those very words into a search engine yields over 15 million results, most of which were written during periods of high market volatility. In reality, cash is anything but king. In the words of Warren Buffett, “today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.”
Many concede that cash doesn’t produce a return. Others might even admit it’s a depreciable asset. But few understand that home prices fail to increase wealth over time. In recent months, discussion over a looming Canadian housing market bubble has intensified. Many are amazed with the difference in home prices over an extended time horizon. When taking into account inflation, however, these numbers aren’t very impressive at all. In 1966, the average Toronto home price was $21,360. Today it’s $512,879. That yields a 7.15% annual return over 46 years. Inflation over that same horizon, however, was 4.35%. All of a sudden your inflation-adjusted return drops to 2.80%.
That same $21,360 invested in the S&P 500 over the same 46 year horizon, however, would be worth $1,134,711 today after capital gains and dividends received ($908,370 after taxes paid). This beats real estate by a 2:1 margin (ignoring property taxes [0.79% of your home price per year], mortgage expenses, and leaky roofs). Even if the stock investor were to rent each month along the way, he would still beat the home owner 4:3 in total return. This is because home ownership accompanies some very serious expenses. After adding up mortgage interest, utility bills, and property taxes, there isn’t much of a return at the end of the day.
This is not to say that a family shouldn’t own a home. The emotional achievement of owning your own living space is far from a bad thing. Your kids can walk to school and never depart from their friends should the lessor sell the property you rent. Buffett adds that his home was the third-best purchase he ever made (the first two being wedding rings). But treating it as an investment is an entirely different story.
To grow your purchasing power over time, an intelligent investor cannot merely rely on their home price to increase. A higher sales price won’t affect purchasing power unless you significantly outperform the inflation rate. Historically, that hasn’t happened in Toronto. Instead, investors without stocks should reconsider their asset allocation and create a portfolio of high-quality equities. Thankfully, there are many attractive names at today’s valuations to buy and hold for a very long time.
