In 1972, Shirley Smith bought a 900 square foot house in Sebastopol, CA for just $18,000.
I know Shirley and she called me last week to let me know that she is selling her house for $694,000 after living in it for 45 years. Even Shirley couldn’t believe how much she would be receiving (she had no mortgage). “I paid 18,000 and I’m walking away with $650,000 after closing costs. I never could have imagined that my house would have gone up so much.” I congratulated her and said yes, it sounds like an amazing return. I did the math, it was actually a return of 8.3%. Very respectable.
We love real estate at Abacus (albeit commercial real estate) and it’s in all of our portfolios. Still I wondered: what would have been Shirley’s return if she had invested the $18,000 in the stock market (the S&P 500 Index) on Sept 1st, 1972 and patiently waited for 45 years until October 27,2017 (the sale date)? In fact, she would now have approximately $1.2 million (almost twice as much money!).
Even though she invested in a house in an up-and-coming town, to my surprise, a simple diversified mutual fund actually did better. I’m assuming that the money she spent on repairs, improvements, insurance, and real estate taxes over the 45 years would have gone to rental payments if she didn’t buy, so I didn’t dampen the 8.3% return with these costs.
Yes, her house investment was a good one, and Shirley loved living in her house. I, too, own my home, and I generally recommend home ownership to most clients. However, I am careful not to allow the noise of how much house prices have risen over the past few decades to lead me to ignore the potential to make money from the stock market. In other words, our tendency is to be over confident in our real estate purchases and under confident in our stock purchases despite the contrary evidence. I see many new clients who have portfolios over-weighted in residential real estate, for example.
Real estate is tangible and exciting, but it is important to be aware of our American bias towards real estate and away from stocks. Perhaps this bias results from real estate being tied in with the American dream. It is natural to be less enchanted with a mutual fund, especially today with the stock market reaching all-time highs and many predicting a likely setback. However, let’s keep in mind that everyone who has been diversified and patient has made money in the stock market. Over the last 100 years, any diversified portfolio held for at least 10 years has increased in value. So, buy a house or two because you enjoy home ownership, just don’t assume that buying houses will earn you more money than the overall stock market.
Disclosure
Past performance is not indicative of future performance. The S&P 500 was used as it is generally recognized as indicator or representation of the stock market in general. The index results do not reflect fees and expenses and you typically cannot invest in an index.
