For many homeowners, the house is one of their biggest investments. However, is it a good idea to have so much of your wealth tied up in property?
Defining net worth
Your net worth is a sum total of the value of all your assets, including your liquid cash, physical assets like your home and investments, minus whatever debts you owe. Your net worth distribution plays a significant role in your potential growth and potential risks, hence why it’s important to consider how much of your net worth is in home equity.
The equity advanatage
For those with the money to invest, buying real estate is a better option than renting, as rent payments add to the wealth of someone else while mortgage payments add to your own wealth.
Real estate assets are equity investments that have the additional advantage of tyically having more stable value over time than more volatile stock positions.
Diversification
Building equity in your personal home is a great way to gain exposure to the real estate market and diversify your portfolio. Distributing your wealth into a wide variety of different assets will help protect you against catastrophic losses from the failure of any one type of asset. It’s also a clever way to achieve steadier growth, since your total growth rate will be an aggregate from many different sources.
However, if your entire wealth is sitting in the form of home equity, you’ll be overexposed to fluctuations in the real estate market and you’ll miss out on potential investing opportunities elsewhere. This being the case, I do not recommend investing all of your money in real estate after buying your first home. Investors should only seek to increase their wealth through real estate if they already have a diversified portfolio after taking their investment in their personal home into account.
Property prices
It’s worth noting that property prices have increased steadily over time in most areas, as measured by information collected by CEIC Data. If you buy a home and hold it for several years, there’s a good chance you’ll ultimately see a return on your investment. This is especially true if you buy a home in a neighborhood with long-term development prospects, or an area that becomes exceedingly popular in the years that follow. For this reason, it’s fair to treat your personal home purchase as just as much of an investment as a home purchased to rent out to tenants.
However, over time, stocks tend to consistently outperform real estate investments, as per data from the Motley Fool. Stocks have other weaknesses to consider, including higher volatility, but they tend to be a higher-returning investment overall (if you’re in it for the long haul). Accordingly, it may not be a good idea to have the majority of your net worth allocated to property.
Your home vs. other property investments
Oftentimes, your primary residence isn’t capable of generating additional income for you. However, if you purchase a rental property, you can accept a tenant and collect rent from them in excess of your property loan payments, resulting in a profit.
Real estate investment trusts and other real estate stocks are another option. These tend to be far more volatile in price than the real estate they represent, but they are required to return most of their income to shareholders. They also make it possible to invest smaller chunks of money in real estate.
Bottom line
There are some cases where you won’t be able to help how much of your net worth is tied up in real estate. You may not have many assets, or you may not be able to afford a house at all.
However, if you have significant assets and control over how they’re distributed, I believe it is beneficial to keep a decent portion of your net worth in real estate, though not so much that it throws off the balance of your portfolio. I am for 10% to 30% as a good target, but this will change depending on your net worth and risk tolerance, as well as other factors.
Disclosure: I do not own any of the stocks mentioned in this article.
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