Questions about investing and homeownership bugged me for a long time. Is your home an investment or consumption or both? Is your mortgage a negative bond? If you invest while you have a mortgage, are you buying stocks on margin? If you don’t own a home, how should you prioritize between investing and saving for a down payment? What if you also throw paying off student loans into the mix?
Every time I tried to write down something cohesive about these questions, I always get myself confused. The only way to do it would be to go slow — take one small proposition at a time and build up from there.
Before we answer whether a home is an investment, we need to understand what is an investment. How is an investment different than an asset? Are all assets an investment? Are all investments an asset? If something goes down in value, is it still an investment? If something costs money while you hold it, is it still an investment?
Merriam-Webster dictionary defines asset as
an item of value owned
For our purpose we limit it to items of significant value. The shoes you are wearing are technically “items of value owned” but we don’t count them.
Clearly your home is an asset, because it’s an item of value owned. So is your car, money in your checking account, and so on.
The same dictionary defines investment as
the outlay of money usually for income or profit
I think limiting it to “outlay of money” is too narrow. It could be outlay of labor and other assets as well. The important part is “for income or profit.” If something isn’t expected to produce either income or profit, it isn’t an investment.
You need either income or the expectation of a profit, not necessarily both. If I buy a gold coin, even though it doesn’t produce income, I expect it to appreciate in value in the future, giving me a profit. It’s an investment. If I buy a bank CD, even though I just get my money back when it matures, I receive periodic income. It’s also an investment. My car isn’t an investment because it neither produces income nor appreciates in value.
So we see not all assets are investments. Are there investments that are not assets? My education cost money. It helps me earn a higher income. Because I can’t sell it or give it to others, one can argue it’s not an asset. It’s a rare exception. Most investments are assets. They don’t care who owns them.
An investment can be a good investment or a poor investment, depending on the outcome. The value of a gold coin or mutual fund shares can go down in value instead of up. They are still an investment. When TIPS yields were negative (yields are still negative on some short-term TIPS), they were guaranteed to lag inflation. Something that doesn’t beat inflation is still an investment. A poor investment by definition is an investment.
Having to pay a cost while holding something doesn’t make it not an investment. Mutual funds have expenses. You pay the expenses whether your funds make money or not. They are still an investment.
Your home is an asset. Is it also an investment? If it’s a rental home, it no doubt is an investment. It produces rental income. There’s also expectation of appreciation. What changes when you live in it versus someone else living in it? You still pay mortgage, property tax and maintenance. The rental income goes away. Suppose you don’t expect that the home’s value will go up after factoring in broker commissions. Is it still “for income or profit”?
That depends on whether your living there rent-free is income or not, which we will get into in the next article in this series: Is Imputed Rent Income?
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Jason says
“the outlay of money usually for income or profit”
– Just as you feel an “outlay of money” is too limiting, I think “income or profit” is too limiting. Charity can be an investment in the well being of the world.
I use a slightly different definition: “The outlay of resources for future expected return.” Resources could include money, time, labor, favors, etc. Expected is a key word – it allows for investments that turn out worse than expected, while disallowing items like lottery tickets since the expected value is negative. It also would disallow a zero percent bond (nominal, not real) since there is no expected return – this to me is not an investment, but a store of value. A negative real TIPS that has a positive nominal rate is still an investment. Return doesn’t have to be monetary either, but it does have to be positive by some definition. Otherwise, it’s charity, gifting, or potentially gambling/speculation depending on all the variables.
inf3rno says
Gambling is an investment as well, it’s just a poor one with high risk. Sometimes you win and have profit with it, but most of the times you lose everything. On the other hand if you own the casino, it is a great investment…
Dave says
If I pay for my child’s college education, am I not making an investment? It is my hope or expectation that I will not have to support him after he completes his studies. Also, he may achieve a level of success that allows him to help defray my expenses later in life.
Harry Sit says
I think most people see it as just an expense. Parents aren’t expected to support their children beyond a certain age, whether they go to college or not. Obamacare set it to age 26. Children also aren’t expected to support their parents, no matter how well they do or how poorly parents do, judging from the outrage upon learning about filial support laws in some states (although not often invoked). Google “Are You on the Hook for Mom’s Nursing-Home Bill?”
Steve@EscapeVelocity2020 says
Good go at trying to define it, but I feel that ultimately it’s in the eye of the beholder. To one person, a college degree, a house, rare car, or art is an ‘investment’ no matter how it turns out. To onlookers, it looks like an expense, especially when there is a weak market for the ‘asset’. Have you read ‘Capital’ (Piketty)? It highlights that, in aggregate, investment gains have far outpaced salary gains which has fueled the widening socio-economic gap. I point out art as an investment because it basically has no intrinsic value, yet the rich keep Sotheby’s and Christies in business trading it, to diversify away from their exposure to the mainstream economy…
KD says
(Cost of?) Education degree is a racket. Its value is what employers are willing to pay for a certain cachet & intrinsic sorting. Silicon Valley has already smarted up and and they sometimes hire kids out of high school to nurture them in-house based on certain traits they test them out for employment potential. In due course, rest of the employment market may follow. After all that’s what big data is all about. If it is truly a skill, then vocational training should grab that market. Who needs to pay for a glitzy multi-billion dollar campus for learning most of what can be done through open course ware on MIT or other online tools etc? But I digress…
Home, rather dwelling, is a necessity. Its location & opulence projects whether it is a investment – good or bad. Decoupling this from rest of one’s lifestyle is hard to do on an individual scale as it is subjective. Thus lifestyle may enable a home to be a good investment or a bad investment. A house, on the other hand, is an illiquid asset that is typical difficult to price rationally. At least that is what I think right now. I may change my mind on reading Harry’s subsequent posts.
ml says
The cost of an education is clearly an investment in your own or a beneficiaries’ human capital, which is in many cases the most valuable asset on the personal balance sheet. There is no requirement that assets or investments be transferable, any more than that we all value an asset or investment equally.
JoeTaxpayer says
An investment should provide a return, an expectation of dividends, some type of rent, or increased value over time. In my opinion, gold is speculative, and strictly speaking, not an investment.
I cringe when I hear someone say “I’m investing in a new pair of shoes” or “I’m going to invest in a new treadmill.” I have a treadmill, it’s saved me 20 years of gym memberships, but it’s not an investment.
The day I bought my house, my ‘net worth’ dropped by the full cost of the house. I include the mortgage as a negative on my net worth, yet don’t include the house as an asset. Why? Well, we need to live somewhere. If, and when we downsize, the net difference might be a welcome windfall. And when we die (far more likely when my wife is driving) my daughter will get the proceeds from the house, but right now, it’s not counted.
We’re semi-retired. And the house has its expenses, property tax, maintenance, and interest on the remaining mortgage. I don’t see the full mortgage payment as an expense, as the principal payment goes right to out bottom line, it’s the interest that’s really the expense.
Harry Sit says
That’s why it’s so confusing when people count in different ways. Your next door neighbor if renting aren’t better off but they have a higher net worth by your account (all else being equal).
Jim Hemphill says
I’m a director of an investment firm, and we’ve done a lot of thinking about this issue. Here’s our conclusion:
1) Your home is an asset, but not an investment. It is a placeholder for present and future housing costs. The more expensive your home, the greater the drag on building real investment wealth.
2) An investment must produce cash flow, even if that cash flow is not distributed. So Apple common stock is an investment, but a gold coin is not. Coins are a speculation. The longer you hold them, the more certain it is that they will produce no economic return.
3) “Investment” real estate is only an investment if it produces positive current cash flow. If you are carrying a vacation home at a negative cash flow, even if you rent it out, you are fooling yourself thinking it is an investment. You are subsidizing someone else’s leisure.
4) In our practice, we report to our clients on a subset of their balance sheet, which we term ‘functional net worth.’ It is the total of all investment assets, minus all debts. It excludes homes, non-investment real estate (no cash flow, it does not count), securities, bank accounts.
My defense of this definition is that it works, and it focuses our clients on behavior that makes them richer.
Jim Hemphill
Harry Sit says
Jim – In your #4 “minus all debts” do you subtract mortgage balance on homes or non-investment real estate as well? In other words if a client decides to pay off a mortgage using money from investment assets, does the functional net worth change?
Jim Hemphill says
Yes and no. Let me explain.
We do subtract home mortgage from investments to get functional net worth. So someone with $1 million of investments and a $500,000 mortgage has a functional net worth of $500,000.
If they pay off the mortgage, they have only $500,000 of investments, minus $0 debt, still equals $500,000 functional net worth. So should they pay off? Depends on the comparison of projected investment returns vs. mortgage rate, both net of taxes.
inf3rno says
According to Kiyosaki’s books there are assets and sources. You expect gains from your assets and you expect expenses by your sources, so assets are always investments. There are things which can be both. If you buy a house and you rent it to somebody, then it is an investment, otherwise it is a source. At least according to the Hungarian translation of these books. You can calculate whether an investment is good or poor with the price per earnings ratio. The P/E is considered good around 5 years or the annual E/P around 20%. If the P/E is not something robust, then it is a risky investment.
inf3rno says
I checked wikipedia to clarify these terms and find errors in the translation of my books, but it is full of errors and incoherent terminology. Just a small example: according to them “net income = gross profit − expenses”, and “gross profit = net sales – cost of goods sold”. By the definition of “cost of goods sold” you find that it is an “expense” as well, so you subtracted it twice by the first equation. Another confusing thing that in my country “profit = incomes – expenses” and in English “net income” is the same as “net profit”. No wonder it is hard to understand economics if these words can have multiple different meanings. :S :S :S