When we were kids growing up in the neighborhood, we would often leave our house just after breakfast and make sure that we were home in time for dinner. We spent our days playing baseball, basketball, or football at one of our friend's homes. Yes, we actually played outside all day. We had no video games or smartphones. Pac-Man and Asteroids had not yet been invented.
We knew that each house had its own set of “House Rules,” sometimes called ground rules. For instance, at one house if you hit the ball into the hedges, it was a ground-rule double. If you were running the football and went past the swingset, you were out of bounds.
Each house also had a Mom who had her own set of “house rules”. I had many Moms in the neighborhood growing up. You never questioned or disrespected your friend's Mom. You knew if she picked up the phone, which at that time had a rotary dial and a cord, and told your Mom what you did, you would be in bigger trouble when you got home.
When it comes to investing, many people think that houses and real estate also rule. It is easy to understand why you may think this. Let’s consider the house that I grew up in. It was originally built as a two-bedroom, one-bath, ranch style home in 1953. My parents bought the house for $12,000 ten years later. When I was 12, my parents added a family room addition with a master bedroom and a half bath. At that point, I was able to stop sharing a 9 x 9 bedroom with my brother and sister.
60 years after my parents bought that house, real estate websites are currently valuing the house at approximately $172,000. This means that the house has gone up in value more than 14X over the last six decades. This must mean it has been a pretty good investment, right?
Great question. Plugging these numbers into a financial calculator means that my childhood home has gone up in value at a compounded annual rate of just over 4.5%. That may not sound like a great rate of return. However, it does confirm the magic of compounding even moderate rates of return over long periods of time.
How does this compare to the stock market, as measured by the S&P 500 over the same period of time? In 1963, the S&P 500 had an average closing value of 70. As of today’s writing, the index is trading just above 4450. This would give the stock market an average annual rate of return of nearly 7.2% over that time.
How big of a difference would just 2.7% per year have made with 60 years of compounding? The same $12,000 would have grown to just over $764,000, a gain of more than 63X!! You read that correctly. The same money invested in the stock market would have more than quadrupled the value of the money invested in real estate. This is because over time, stock prices follow the growth of corporate earnings. The chart below of the S&P 500 since 1950 helps illustrate this amazing growth.
This also completely ignores the impact of what it costs to maintain a house. This would include property taxes, homeowners' insurance, and utilities, as well as the maintenance and upkeep of the property.
It also ignores the impact of dividends on the S&P 500, which are not included in the index's price performance. Understanding that dividends on the index have averaged more than 2.5% per year over the last 60 years brings us to another incredible conclusion. Adding the dividends to the compounding would have brought the value of the investment in the stock market to just over $3 million, as compared to our home’s $172,000 home.
The growth of the value of the home shows that real estate can be a reasonable investment, especially if it provides shelter for your family. However, it has historically badly lagged when compared to the wealth created by investing in the best run companies in the United States.
We all understood that there were “House Rules” when we were growing up. I hope that this simple example will show you why we believe that houses DO NOT rule when compared to investing in stocks for the long run, which has produced far greater returns. It is also important to remember that the long run includes both market ups and downs. It includes times of economic expansion and recession…and there have been plenty of both over the last 60 years.
I trust this illustration gave you some history, perspective, and even a little bit of nostalgia as we think back to our childhood homes and what they are worth today. I thought it was a great reminder as we continue “Moving Life Forward”.
© 2023 Jesse Hurst
The views stated are not necessarily the opinion of Cetera and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
Investors cannot directly invest in indices.