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Home Ownership or 401(k)?

Contributed by mm | May 20, 2005 6:57 AM PST

Since when did people start to question the usefulness of 401(k)? Scott Burns from MSN Money thinks if you happen to live in a state with high home price appreciation, you don't have to stash too much cash to 401(k) accounts while still having enough money at retirement.

To explain Scott's calculation, let's take California as an example. First, OFHEO reported a 102% property price appreciation in the last five years. Scott assumes average property sells at three times annual income, so the appreciation earns you 3.07 years of income in 5 years (actually, even more in California). For 401(k), Scott assumes people save 6% in 401(k) plan, receive 50% company match, and earn 9% on 401(k) investments. The result? It takes 17.6 years to earn 3.07 years income from the 401(k) approach.

Using this calculation, even people in moderately appreciating Texas (24% home price appreciation in five years) will fare better in home investment.

Yes, real estate investing made too many average-joe millionaires in the last few years, but before you buy into Scott's claim and jump to the real estate investing bandwagon, make sure you understand the holes in his analysis:

First, the comparison is not apple-to-apple. Why? The 401(k) approach only asks you to save 6% from your income. Can you service your home with 6% of your income? In our "ownership society," it is not uncommon that people stretch their affordability and end up with commiting 40% or more monthly income to big houses. What if you save the same amount in 401(k)?

Second, this is typical rear-mirror view. Do you realistically think there is a guarantee that California will continue to see property price to double every five years until your retirement? Think again. In the long run, home price only marginally beats inflation.

I'm not saying real estate investing is bad. I myself am benefitting (modestly) from my house appreciation in the last two years. Nevertheless, I don't see my house as an investment per se, and really don't count on it for a quick and easy retirement. Nothing prohibits you from placing the bets on both sides, and this is what I am doing -- keeping servicing my house and moving more to 401(k) every month.

This Post Has Received 36 Comments. Share Your Opinions Too.


dman Commented on May 20, 2005

Very astute response to this strategy. When people start talking about turning down guaranteed immediate 50% returns to get a potential 100% return over 5 years it sounds bubblicious to me. The top is when grandma wants to cash out her retirement and buy a bigger house for investment purposes. :)


FMF Commented on May 20, 2005

I'm with you. I max out my 401k every year and have for the past several years. It's a solid investment that should be a priority for every person (especially with the viability of Social Security in question) who cares about his/her financial health.


MM Commented on May 20, 2005

Remember this

"Past performance is no guarantee of future results". Be it in real estate or 401k. What any market will do in future is completely random and current prices are a sum of everybody's hopes and fears about future


JR Commented on May 20, 2005

Isn't it true though that you only get the gains when you realize them? That means for a fast appreciating home to yield a tangible gain that outpaces a 401k, you have to sell your house, or alternatively, get a reverse mortgage from a bank, which dissipates the asset. My only point is that by not saving liquid investments in the form of cash, stock, or something other than one's home for retirement, a person who puts all or most of his/her eggs into one basket (their house) seems to be guaranteeing themselves that they will have to move to a lower-cost housing market during retirement in order to reap the benefits of their home market's rapid appreciation. After all, isn't this reason for the abundance of New Yorkers in Florida?

Anyone have any comments on this?


Matt Commented on May 21, 2005

"In our "ownership society," it is not uncommon that people stretch their affordability and end up with commiting 40% or more monthly income to big houses. What if you save the same amount in 401(k)?"

Yea, but can you live in your 401(k)?


Josh Commented on May 22, 2005

"Yea, but can you live in your 401(k)?"

In todays market, you can save by renting and perhaps invest the remainder in your 401(k)!


Nathan Commented on May 22, 2005

A couple more points to add.

You can get 500k tax free earnings on your house if you live there for more than 2 years.

Houses are fair game in bankruptcy and civil suits, whereas your retirement accounts like your 401(k) are much harder to touch.


mm Commented on May 23, 2005

Thanks for all the comments.

To Josh, yes, you cannot live IN a 401(k),but using 40% of income to service a shelter is excessive.

Nathan, good point on tax! On the other hand, 401(k) is fully protected in backruptcy courts.


LSP Commented on May 23, 2005

Yes, you can get 500k tax free earnings if you live there for more than 2 years, but most people are selling under that because of the insane appreciation.

Then you are subject to capital gain taxes


JR Commented on May 23, 2005

I still don't understand where those people who sell for their tax free income are going? Presumably all of the houses in their markets are appreciating, so if they're selling their primary residences, they have to live somewhere, right? Are they renting? Anyone with actual experience out there care to comment?


RE2GOLF Commented on May 26, 2005

I live in Phoenix, AZ and the real estate market has been crazy this past year.

We plunked down less than $10K in 1998 for the down payment on our house. Our payments were only slightly more than what renting a house would have been at that time. We recently sold the house and cleared over $120K in a little less than 7 years. We had even refinanced a couple years back and were paying less than what the rental market was for the last 2 years. Not a bad investment at all. Our retirement accounts are only up about 20% from that time, including dividends.

On the other side of the real estate market we are also buying a house (in the same locale) that we had under contract back in October 2004 (a resale - retirees...). Did we think the market would go up between then and now - yep. But we just wanted to get into the nicer neighborhood with a park system in it. We've probably gained close to $80K so far and we haven't even closed on it yet. Would we be able to buy it at today's prices - NOPE. We probably couldn't qualify for it now if we bought it at today's price.

I don't know where all the money will go from others that have sold their houses lately, just into bigger mortgages as they move up into better neighborhoods I guess.

It sure smells like the stock market in 2000 to me... I would be very careful when buying any real estate right now - I would think things could more easily go down 20% than up 20% in the near future.


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