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Old 01-27-2008, 08:24 PM   #1
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Question for Millionaire Mommy...

MMND, I was looking at your blog and saw your piece on how renting a home is financially better than buying. What really caught my attention was the example you used of a retired person age 63. I recognize that using your home as a savings account has some potential drawbacks and agree that renting can be better financially in some cases, but in the comparison you show I have some questions about the real world relevance of some of your assumptions.

Based on a 63 year old renting vs. buying (with cash) a $300,000 house, you show the difference over 30 years is the lost opportunity cost of investing that $300,000 and recognizing a 10% compounded return (7.5% after tax) for 30 years. You show the renter would end up $690,000 better off than buying.

Would it be wise for someone retired in their 60's to invest that $300,000 with an expectation of realizing 10% compounded returns for 30 consecutive years? Yes, the S&P 500 may have averaged something like that in the past, but how realistic is it to project that someone in their 60's would (should) put the $300,000 in an S&P 500 index fund and "let it ride"? Most of us at this age are more interested in making sure we don't run out of money before we croak than trying to run the table and leave our children and our favorite charity a huge windfall. If you polled the members of this forum age 60 or over and asked who would be willing to sell their homes and invest all the proceeds in the stock market, I don't think you'd have too many say yes (contrarians aside ).

When you factor in how a retired person in their 60's should probably be invested (diversified, mixture of stocks, bonds, etc.), it looks to me as if the net return on the invested $300,000 after 30 years would likely be similar to the net return you could expect from the appreciation of the house, which you show as a compounded 4%. In short, not much difference either way.

There are always exceptions (those who have good pensions for example) but it appears to me your rent vs. buy comparison may be more applicable for someone younger and still working. It doesn't seem to offer much when it comes to a retiree such as myself.

Am I missing something?
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Old 01-27-2008, 08:33 PM   #2
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If you polled the members of this forum age 60 or over and asked who would be willing to sell their homes and invest all the proceeds in the stock market, I don't think you'd have too many say yes (contrarians aside ).
I couldn't help but laugh, because my immediate kneejerk response was, "What? You think I'm nuts?" And I'm only 59 1/2, with ER 22 months out.

Interesting topic, no matter how many different aspects we examine. I'm looking forward to MMND's response and viewpoints too!
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Old 01-27-2008, 08:34 PM   #3
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Can you provide the link so we can see the math?
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Old 01-27-2008, 08:59 PM   #4
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If you click on her username and look at her profile, she has her blog listed as her home page.

On the right side of the blog, click "More about me".
Scroll down to "Top 10 Discussions (in comments)".
Click on #1, "Renting beats owning, even in retirement; even if your mortgage is paid off. Here's why"
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Old 01-27-2008, 09:53 PM   #5
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who is this? whereisi it?
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Old 01-27-2008, 10:06 PM   #6
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I did not see the specific post referenced..........
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Old 01-27-2008, 10:34 PM   #7
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Here is a link of what REW is referring to: Millionaire Mommy Next Door: Renting beats owning, even in retirement; even if your mortgage is paid off. Here's why.
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Old 01-27-2008, 10:50 PM   #8
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I almost missed this thread. You asked, "Would it be wise for someone retired in their 60's to invest that $300,000 with an expectation of realizing 10% compounded returns for 30 consecutive years? Yes, the S&P 500 may have averaged something like that in the past, but how realistic is it to project that someone in their 60's would (should) put the $300,000 in an S&P 500 index fund and "let it ride"?

Boy, there's a bunch of things to say about this. Let me start by asking you this question - would it be better for a retired 60 year old to buy a home with her $300,000 cash?

I'd have to say no. Why? Because if she did, she wouldn't earn ANY income from her home investment. In fact, she'd still have to pay property taxes, HOA fees, repairs, maintenance, remodeling, insurance, etc. This creates a negative cash flow, not a positive one. Plus, in order to use the home appreciation, she'd have to sell her home eventually anyway.

Second, I'd never suggest that anyone put 100% of their money in an S&P 500 fund and let it ride. Not enough diversification. Diversification reduces volatility and increases ROI. I am invested 100% in equities, but I spread my portfolio around (diversify) to include 18-20 different no-load mutual funds and ETFs. IMO, placing all eggs in one basket is gambling.

Before I continue, please let me know if you get what I'm saying and visa versa.
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Old 01-27-2008, 10:57 PM   #9
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Methinks we have a new guru.

Help us Mommie, do.

Ha
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Old 01-27-2008, 11:21 PM   #10
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Originally Posted by MillionaireMommyNextDoor View Post
Boy, there's a bunch of things to say about this. Let me start by asking you this question - would it be better for a retired 60 year old to buy a home with her $300,000 cash?
I'd have to say no. Why? Because if she did, she wouldn't earn ANY income from her home investment. In fact, she'd still have to pay property taxes, HOA fees, repairs, maintenance, remodeling, insurance, etc. This creates a negative cash flow, not a positive one. Plus, in order to use the home appreciation, she'd have to sell her home eventually anyway.
Isn't it possible for some areas of the country to have homes appreciate faster than rental inflation? In other words, a 63-year-old might have the value of their $300K real estate rise faster than the value of their investment portfolio, especially if rents are rising rapidly.

Many "senior citizen" homeowners are exempt from or pay reduced property taxes. As far as the rest of the numbers, while I don't disagree with anecdotal evidence, I'd be interested in a study. Got any links?

Then there's the issues of reverse mortgages or downsizing.

I think that many people, investors or otherwise, will feel more secure in a home they own (reverse mortgaged or not) than in a home subject to the vagaries of landlords, rising rents, and décor restrictions. There's a strong emotional component to ER decisions that has to be recognized, or an "investor" will flee at the first sign of discomfort.

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Second, I'd never suggest that anyone put 100% of their money in an S&P 500 fund and let it ride. Not enough diversification. Diversification reduces volatility and increases ROI. I am invested 100% in equities, but I spread my portfolio around (diversify) to include 18-20 different no-load mutual funds and ETFs. IMO, placing all eggs in one basket is gambling.
If you're suggesting diversification then perhaps that 10% return is a bit high. What's your recommended portfolio asset allocation and where is the returns data coming from? The reason we're asking questions like this is because, on this board particularly, that issue is subject to a lot of data mining. Even after resolving that issue there's a significant sentiment that future S&P500 returns will be more along the lines of 6-7% before taxes... which would make a diversified portfolio's returns even lower.

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Before I continue, please let me know if you get what I'm saying and visa versa.
Uhm, yeah, I think you could say that for most of the experienced posters on this board. We'll raise our hands if we think things are going too fast...
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Old 01-28-2008, 12:05 AM   #11
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Quote:
Originally Posted by MillionaireMommyNextDoor View Post
...I'd never suggest that anyone put 100% of their money in an S&P 500 fund and let it ride. Not enough diversification. Diversification reduces volatility and increases ROI. I am invested 100% in equities, but I spread my portfolio around (diversify) to include 18-20 different no-load mutual funds and ETFs.
Would you mind listing your funds and EFTs for us? If you look around the board you'll see comparing asset allocations and investments is a favorite subject around here.

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Originally Posted by MillionaireMommyNextDoor View Post
Before I continue, please let me know if you get what I'm saying and visa versa.
I think I'm following you, but knowing how you'd recommend a retired 63 year old invest that $300,000 would be very interesting to learn.
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Old 01-28-2008, 12:15 AM   #12
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Momentum: the 4th factor that Fama & French don't like to talk about.

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Old 01-28-2008, 12:45 AM   #13
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Renting versus paying cash for a house seems to be a non-sequitur. The analysis should center around renting versus carrying a mortgage in retirement and then carrying a mortgage versus paying off principal in retirement.

In the case of the first, individual markets and assumptions should be taken into account. Locally (suburb of Minneapolis), I can buy a decent 2 br/1 ba townhouse for $170-200k. I could buy my townhouse for $260-270k (3br / 3.5 ba). I purchased my townhouse 5 years ago and currently pay $1900/month for everything (HOA, mortgage, second mortgage, condo rider insurance). Our first repair not covered by HOA will probably be the hot water heater in a few years. We're nowhere near a 1.5% budget for repairs.

In contrast, I could rent my townhouse for $1700. I could rent one of those 2br/1 ba deals for $1400. Or, I could rent a 2 br apartment down the street for $1200. That means that, at the high end, my cash flow picks up $700 extra a month (and that doesn't account for the tax write-off while I'm paying interest on the loan... it's not a good deal, but it's still worth accounting for in this scenario). That $700 comes with sacrificing my current standard of housing.

It seems that renting is a better option in my case if any of the following are true:
- I want to 'sacrifice' my standard of living now for an increased payout later
- I expect deflationary measures which would negate the 'cheapness' of my loan over time ($1900 a month in 30 years will seem like chump change)
- I want the mobility and flexability of renting
- I live in an area where home ownership is a significant premium compared to renting.

I anticipate rent to rise with the rate of inflation. Further, I expect my mortgage to stay constant. In effect, the mortage becomes cheaper with time because the value of the dollars used to finance it declines with the rate of inflation.

In my humble opinion, the first analysis should be between renting and carrying a mortgage. It's an unfair leap to compare home ownership with renting by way of assuming that paying cash for a house is equivalent to carrying a mortgage.
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Old 01-28-2008, 01:02 AM   #14
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It's an unfair leap to compare home ownership with renting by way of assuming that paying cash for a house is equivalent to carrying a mortgage.
True enough. But that wouldn't work nearly as well.
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Old 01-28-2008, 03:34 AM   #15
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here in nyc we rent our apartment. to buy the co-op would be 330,000 plus maintaince of 1,000 per month. our rent is only 1650.00. just the interest is covering the rent and we save 1,000 a month in maintaince charges.
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Old 01-28-2008, 04:13 AM   #16
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Quote:
Originally Posted by MillionaireMommyNextDoor View Post
Boy, there's a bunch of things to say about this. Let me start by asking you this question - would it be better for a retired 60 year old to buy a home with her $300,000 cash?

I'd have to say no. Why? Because if she did, she wouldn't earn ANY income from her home investment. In fact, she'd still have to pay property taxes, HOA fees, repairs, maintenance, remodeling, insurance, etc. This creates a negative cash flow, not a positive one. Plus, in order to use the home appreciation, she'd have to sell her home eventually anyway.

.
Let's start with tautology that is pretty much true of all things financial in retirement. (ok maybe not annuities in IRAs...) The answer to rent vs is buy is It depends

Given your assumptions of current rents, future rent increases, insurance and maintain costs and future housing appreciation vs future equity gains etc. then yes it makes more sense to rent then buy.

On the other hand change a few assumptions rent increase=home appreciation, higher inflation, equity investments return 8% vs 10%, lower insurance and maintaince cost and the results would come out differently.

I know that despite living in one of the hottest real estate markets Silicon Valley from 84 to 99, my stock appreciated faster than my house. On the other hand in Hawaii from 2000 -2007 real estate did a lot better than stocks.

However, my biggest problem with your analysis (and also IIRC the MS money retirement calculator) is your assumption of constant rates of anything. Probably the number one thing that I learned when I retired 8 years ago is that returns are ridiculously lumpy. Money market/CD go from 1% to 6% back to 4% real rates on TIPS bonds go from 4% to 1.5% and of course annual stock returns look like a yo yo, +10%, +30%, -20% -15%, +30%. It is worth noting as bad as the housing market has been in the last 6 months most stock market returns are worse.

The beauty of a paid off house/fixed mortgage is reduces the volitality of returns. I agree with you that in general equities out perform real estate over long periods of time. But the number 1 rule in retirement planning is not to try and accumulate the most money when you die it is to make sure you die with some money!
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Old 01-28-2008, 06:11 AM   #17
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Momentum: the 4th factor that Fama & French don't like to talk about.

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Old 01-28-2008, 07:33 AM   #18
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There is a big difference between total earnings of a portfolio and its failure rate. 100% stocks may statistically lead to the highest average balance after 20+ years (which is why it seems OK for a 40 y.o.) but it does so with a volatility which leads to catastrophic running-out-of-money too often for my taste as I approach 60. And, of course, a mixed portfolio brings the 10% annual return assumption into question.

As always, certain specifics (e.g. having way, way more than you need for expenses) may change that but your "model" seems very naive to that kind of real-world inspection. I would not trade a higher return with a 25% failure rate for a lower return with a 5% failure rate in retirement.
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Old 01-28-2008, 08:29 AM   #19
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Boy, there's a bunch of things to say about this. Let me start by asking you this question - would it be better for a retired 60 year old to buy a home with her $300,000 cash?

I'd have to say no. Why? Because if she did, she wouldn't earn ANY income from her home investment. In fact, she'd still have to pay property taxes, HOA fees, repairs, maintenance, remodeling, insurance, etc. This creates a negative cash flow, not a positive one. Plus, in order to use the home appreciation, she'd have to sell her home eventually anyway.
Government policies, like breaks that senior citizens obtain for home ownership, might push one towards investing that $300K in a home. Long term health care costs could quickly dissipate the $300K portfolio invested by the retired 60 year old, leaving her (and her spouse) penniless and dependent entirely on Medicaid, unless your portfolio grows a lot or you have long term health care insurance. At least if $300K were invested in a home, a married couple might be better protected from homelessness and financial ruin under the existing Government policies for Medicaid assistance if a spouse wound up in a nursing home.
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Old 01-28-2008, 09:05 AM   #20
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The comparison is being done on a $300,000 house that she says can be rented for $1300/month. That seems like an unusually low rent to me.

From a spot check of houses for rent in my area (outside of Austin), craigslist shows $1325 will rent you a house worth about $167K. My impression is that this is a more typical ratio of monthly rent vs price. I could be wrong, but at a minimum one should run the numbers in their own area before deciding.
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