The Cost of Buying Too Soon…$1,000,000+

[La Jolla Renter]

The Cost of Buying Too Soon…$1,000,000+

Couple A and B in their mid 30’s have exactly the same income, savings, disposable income, expenses, lifestyle etc.

Couple A buys a house today for $750k, 30yr fixed at 6.5% with 150k down.

Couple B buys the exact house next door a year later for $650k, 29yr fixed at 6.5% with 150k down.

Couple B puts the $600 per month mortgage payment savings into a tax differed account earning 10% and enjoys an extra $1,000,000 more at retirement.

I opted to keep this example simple and left out some other financial benefits to both couples: Couple A gets an additional tax deduction on the $600 additional payment, and Couple B saves and extra $18,000 the first year renting, etc, etc, etc.

[powayseller]

Love that example, esp. the 10% part 🙂 Where can I earn 10%? Sign me up!

[sdrealtor]

Two problems, where do you get a 29 yr loan and will you still be able to get a 6.5% fixed rate loan in a year?

[Daniel]

Well, La Jolla Renter wanted to keep things simple, hence the 29 year mortgage and the constant mortgage rate. One could do a much more sophisticated calculation and probably arrive at the same ballpark figure in the end. I think simple is good.

However, my comment would be that, although the example above looks good in theory, in practice couple B would probably just spend their extra $600/month on useless junk, thus invalidating the whole theory. Pretty cynical view, I know.

[sdrealtor]

While simple is good its not accurate. More likely B pays 7% and the actual savings is 470/month which invested with a 5% average return is $390K or 7% avg return is $570K. Of course B also enjoys paying approx $1000 per year in taxes.

[kev374]

Love that example, esp. the 10% part 🙂 Where can I earn 10%? Sign me up!

It’s called a mutual fund. For instance FDIVX has returned about 15.5% YTD 😉 There are funds out there that are pretty safe and are performing over 10%/yr.

[qcomer]

Lovely example, very simple, very direct succinct manner. One reason many folks don’t buy RE bubble theory is because most folks out there want a single paragraph executive summary or bottom line on what they should do (buy/rent).

Folks saying that the person B will get the mortgage at higher rates (7%) are at odds with the bonds market. The chances of Fed lowering rates lower next year (as recession kicks in) are higher than Fed raising rates next year. Long term rates shouldn’t change by 50bp in a year though as I don’t expect the Fed to change interest rates by a lot within the next year. So folks, person B most probably will be paying same 6.5% if not less, next year.

I accept the 10% return rate is slightly aggressive for average investor. But theoretically, SP500 or a well diversified portfolio will return from 8-10% in 30 years and this is historically correct. Problem is that an average Joe wouldn’t be disciplined enough to save these $600 for 30 years. It is also unlikely that he will have a well diversified portfolio. However, if I had to do this, I would simply choose SP500 or one of those target funds (30 year target).

[PerryChase]

Daniel, I agree that most people would spend the savings and not invest it. However, there’s something to be said about lifestyle. Living is about enjoying life and having what you want.

Was just talking to a friend earlier about his very subject. Today, $3,000/mo would rent a nice house in La Jolla or buy a mediocre house in Mira Mesa (Interest only, taxes and HOA). Why not enjoy where you live and let the owner subsidize your lifestyle? Or you can live in a rental house in Mira Mesa (same as you would buy) for $2,000/month then use the extra money to buy a Porsche. Then wait until the cost of buying is the same or lower than renting.

Even if you don’t save the money from renting, you still come out ahead lifestyle wise.

[BikeRider]

Live your lifestyle that also allows you to retire and not have to live in a van down by the river. So many young people are not preparing for their old age. I work with a guy that told me the other day he will just have to work until he falls over dead. He didn’t prepare enough when he was younger. He’s 55 now. He had a major setback about eight years ago, getting laid off from a job he’d worked at for fifteen years. The company laid him off and then offered him his job back at $20k less per year. He looked for other work, but couldn’t find much. Anyway, he finally got back into a good job, but had used up savings to stay afloat in the tight years. And he lost a lot in the market a few years back. Anyway, scary picture. Most people don’t think that they will get laid off, get sick or anything. They aren’t planning for those things. Just paying for the Porsche, the house, vacations…..

[powayseller]

Good thread. Very thought provoking.

FDIVX has a very good return in the last year. However, the other years don’t look so hot. This fund just had one good year after 5 mediocre years. 3 yr and 5 yr returns are 20.98 and 17.18%, giving us a little over 6% annually over 3 years, and 3.5% annually for the 5 year return.

There are funds which earn a high return, but typically that good fortune lasts for only one or two years. We never know ahead of time which fund will have that good fortune to outrun the pack. It’s impossible to know in advance which fund will earn 10% next year.

We can’t assume a 10% return on our money when we make calculations about alternate returns. I think 5% – 7% is more realistic, although even 7% is high in today’s bloated stock price environment.

[qcomer]

Poway,
Actually the 3 year and 5 year return numbers that you quoted are annualized already i.e. FDIVX on average has returned 17% per year for the last 5 years for a cummulative return of close to double the original investment 5 years ago. Now I know why you maybe so bearish about stocks :).If you kept applying the same math, while searching for mutual funds for your retirement, you would always be seeing that most funds end up returning less than the 5.5% CDs (just kidding).

[sdrealtor]

5 year returns in a bull market does not a 30 year return make!

[poorgradstudent]

The long term average return for the S&P 500 falls somewhere around 10.4%. Adjusted for “average” inflation, you’d get something around 7% for a real return, which is the rate most sites recommend using for retirement planning.

People need to remember how long the long term is. 1 year is really really short in the stock market. Even 5 years isn’t long enough to expect averages to work out. This example is a perfect case of where you can use this sort of averaging. It’s over a long timeframe, and utilizes dollar cost averaging, which minimizes the risk of short term fluctuations.

[an]

There are plenty of funds that average over 10% in the long term. Here are some example (they’re all averaging over 10% over the last 10 years, which include one of the biggest crash in history after 1929):
FSLBX – average 14.5% over 21 years
VGHCX – average 19.3% over 22 years
FSPHX – average 17% over 25 years
ACRNX – average 16.3% over 36 years
FLISX – average 16.2% over 22 years

I can go on and on but you can find the same list from your brokerage’s fund screener.

[gold_dredger_phd]

The statistics that are quoted for returns in the stock market are from the same people that sell mutual funds. Your after-tax, after-inflation returns are likely to be much less than is quoted from the mutual fund advertising.

Your real rate of return is more likely to look like 7% than 10% of anything. A complete market cycle should be from the years 1966 to 2000.

Another thing to remember is that this period has a preponderance of years when oil or energy was cheap and the US manufacturing base was not competing with China or India. Future returns in US markets are likely to be lower than the last 4 decades of the American Century.

[Author]

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