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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 734857  
Subject: Relationship Of Non-Income Producing Assets Date: 2/6/2000 10:57 AM
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Each of us here at the REHP are either "financially free" or are working diligently to get there in short order. In this regard, I wonder about the influence of non-income producing assets versus income producing assets and one's ability to in fact become financially free.

Let me be a little more specific. We have all seen the proverbial Bob who has a big house/condo, a couple of expensive cars, fully stocked wine cellar, maybe a boat & is generally well stocked in the toy department. Bob is trapped twice: once, in that he is almost certainly not living below his means or not by enough; two, in that all of his toys & life style need maintenance, periodic replacement, etc. just to stay even much less create a life style enhancement in Bob's eyes.

Thus, I wonder about the ratio of one's invested / investable assets to total assets. Mine was just about 6% as of 1/31/00 meaning that of my total net worth 6% is devoted to: investment in home, cars, collectibles, etc. Therefore, 94% of my net worth is out there in the markets creating additional wealth and income. Bob up above might be 30% or 50% or 80% in personal assets compared to invested assets and can clearly not be financially free simply because his ratio is way too high --- his invested assets can not possibly create enough income to support & maintain his non-invested asset base.

In a way, I am implicitly suggesting that there might be more than one test in order to retire and stay retired. Test one we regularly beat to death, e.g. somewhere between 3% & 5% of investable assets can be consumed each year and one can remain highly confident to certain of dying before becoming broke. I am suggesting that test two is some relationship between non-income producing assets & income producing assets, but I don't know where the frontier is.

Thus, I wonder if there is an obvious right answer here or a maximum we should all stay below? Is 6% okay? Well it works for me. Is 12% okay? Is 20% okay? At what percentage does the house collapse?

TheBadger
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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3197 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 11:22 AM
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TheBadger wrote,

In a way, I am implicitly suggesting that there might be more than one test in order to retire and stay retired. Test one we regularly beat to death, e.g. somewhere between 3% & 5% of investable assets can be consumed each year and one can remain highly confident to certain of dying before becoming broke. I am suggesting that test two is some relationship between non-income producing assets & income producing assets, but I don't know where the frontier is.

Thus, I wonder if there is an obvious right answer here or a maximum we should all stay below? Is 6% okay? Well it works for me. Is 12% okay? Is 20% okay? At what percentage does the house collapse?



I agree that "non-income producing" assets will delay your retirement. (I don't own a home, so I've been able to keep my "non-income producing" assets below 1% of net worth.)

I think the best way to handle this is to remove the "non-income producing" assets from your retirement calculation. Remember, "safe" withdrawal rates are "3% to 5% of your retirement assets", not your "net worth."

The most important thing is to get a good handle on the annual cost of supporting and maintaining your "non-income producing" assets. As long as a 3% to 5% annual withdrawal from your retirement portfolio allows you to pay taxes on a big home and the maintenance costs on your BMW, you should be OK.

intercst

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Author: FoolMeOnce Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3198 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 11:29 AM
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TheBadger wrote:
In a way, I am implicitly suggesting that there might be more than one test in order to retire and stay retired. Test one we regularly beat to death, e.g. somewhere between 3% & 5% of investable assets can be consumed each year and one can remain highly confident to certain of dying before becoming broke. I am suggesting that test two is some relationship between non-income producing assets & income producing assets, but I don't know where the frontier is.

When applying for mortgage loan approval, most lenders qualify applicants based on not exceeding a ratio of total housing/non-investment debt to income of 33 to 40%. So this probably represents a reasonable limit to what can be carried and still remain economically viable. This level would also represent that at which virtually nothing is being set aside for the future. I am not sure it is reasonable to prescribe a specific test for the level of noninvestment assets. Most of this will be represented by the cost of housing yourself. The ratio of housing cost to total assets will be very high when first starting out but should reduce thereafter. In order to retire early, it would appear difficult to designate a specific ratio beyond saying that noninvestment assets should be kept to a level which does not prevent set aside of at least 10% (and preferably much more) of your income for investment purposes. It is probably easier to look at this from the standpoint of percent of income invested rather than percent spent on housing and toys.


In order to stay retired .....
Test 2: Funds required to acquire and maintain noninvestment assets should not be so large as to cause Test 1 to be violated.

Regards,
FoolMeOnce





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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3203 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 12:14 PM
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In a way, I was suggesting earlier that maybe we should think just like a mortgage banker (they may be difficult to deal with but they are not stupid) about to make a loan. The banker always applies two tests: an asset test (loan-to-value) and an income test (mortgage payment divided by gross income). If we are betting on ourselves and our continued retirement maybe we too should apply two tests:

(1) The income test equivalent is that we need a sufficiently large invested asset base such that we withdraw somewhere under X% per year upon which to live. Remember that whatever percentage we withdraw, we are really feeding three entities: we feed ourselves (food, clothing & entertainment), we feed others (governments & charitable giving)and we feed our assets (depreciation, repair, fuel, etc). Current postings suggest that this percentage is under 5% and maybe at or under 3%.

(2) The asset test equivalent is non-income producing assets divided by total net worth; kinda the equivalent of the loan-to-value banker test. Actually, the more I think about it, I don't think this percentage can go over 15% to 20%; because, if it does, the theoretical feeding of (depreciation on) the non-income producing assets becomes too high to be supported by the income stream from the income producing assets.

TheBadger


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Author: 4gonefool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3204 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 1:02 PM
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I am suggesting that test two is some relationship between non-income producing assets & income producing assets

While I think it might be useful to look at the ratio you describe, it seems that we already address the issue by focusing on ROI and expenses. In other words, what difference does it make if a guy has a warehouse full of classic cars that he never drives and the total value of those cars is 10 times the value of his income producing assets? The only expenses are the cost of warehouse maintenance, security and the insurance on the collection. So long as his ROI for his invested portfolio covers his expenses, can't the non-income producing assets be otherwise ignored?

4goneFool


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Author: 4gonefool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3206 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 1:39 PM
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The Badger (whom I have great admiration for) said:

(2) The asset test equivalent is non-income producing assets divided by total net worth; kinda the equivalent of the loan-to-value banker test. Actually, the more I think about it, I don't think this percentage can go over 15% to 20%; because, if it does, the theoretical feeding of (depreciation on) the non-income producing assets becomes too high to be supported by the income stream from the income producing assets.

Maybe I'm just dense, but I don't see how depreciation is an expense. It has an influence on net worth, but not survivability of one's income producing portfolio. If one buys a car, the cost of the car is an expense and the value of the car is a non income producing asset until it is sold. The difference is depreciation. The depreciation in the value of the car is not an additional expense, just an opportunity cost.

Mortgage lenders use non-income producing assets for several reasons. They want an accurate picture of total net worth. They want a reasonable picture of likely expenses vs. income. They want an idea of what the borrower could liquidate in order to prevent the loss of the house. They want a feel good picture of the borrower's life style (if you're buying a mansion and your furniture value is $10, they will think something is fishy).

The mortgage lender has the luxury of knowing that their money is at least partially secured by virtue of forecloseability. They believe that responsible individuals do not easily walk away from 20% equity. That's where LTV comes in. If you appear to be responsible and if they only have an 80% stake in the value of the house, they feel confident that they are investing wisely (betting with the odds stacked in their favor).

To bring this back on track, the decision to retire, when based on a fairly accurate picture of probable expenses and reasonable returns on income producing assets can imho ignore non-income producing assets.

4goneFool

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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3208 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 2:06 PM
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Maybe I'm just dense, but I don't see how depreciation is an expense. It has an influence on net worth, but not survivability of one's income producing portfolio. If one buys a car, the cost of the car is an expense and the value of the car is a non income producing asset until it is sold. The difference is depreciation. The depreciation in the value of the car is not an additional expense, just an opportunity cost.

We are probably both saying the same thing a little differently. Depreciation in this sense is a periodic representation that if you have purchased a car on average every three/four years; you will, all else being equal, continue to do so. Thus, do you have a big expense once every four years (your method) or do you have one-fourth of the expense every year (depreciaiton). I think we get to the same place. My idea here, in a broader sense, was we each have collections of non-income producing assets, some big, some small; but the larger one's non-income assets; the larger the implicit depreciation on them as they all, for the most part, depreciate & eventually expire. Thus, if one wants to maintain a steady-state life style, the person with the larger pool on non-income assets will have higher implicit depreciation and will proportionately need more income for periodic replacements.


Secondly, and this is only the accountant in me speaking, I like the idea of depreciating my vehicles (because they unfortunately do depreciate) and charging myself with a non-cash expense becuase it then gives me a more accurate picture of vehicle market value. Actually, were depreciation to be perfect (which it never is) then original purchase minus the accumulated depreciation would exactly equal what you sell it for some years down the road. To not depreciate the vehicle is to give yourself an inflated personal net worth during the interim. All this being said, the correct non-accountant answer is: Who gives a flying #$$^%^).

TheBadger



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Author: Chipsboss Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3209 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 2:07 PM
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I don't see my house as a "non-income producing asset." It saves me the trouble of paying rent. The fair rental value of owner-occupied houses is counted in gross national product. As I see it, this GNP calculation is correct -- the imputed rent, although not paid in cash to anyone, is real income. How can you avoid paying rent or imputed rent? The only ways that occur to me are either to have someone support you or to be homeless.

Chips, who finds his home warm and comfortable, although it is not covered by a mortgage

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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3210 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 2:11 PM
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To bring this back on track, the decision to retire, when based on a fairly accurate picture of probable expenses and reasonable returns on income producing assets can imho ignore non-income producing assets.

Sorry, I menat to clip this into my last message and didn't.

Again, I think you are correct in this statement provided that one includes in "probable expenses" the proverbial vehicle replacement, once every X years; whatever your pattern happens to be. This also pertains to all the other "things" we acquire that are durable goods which all eventually break or we simply get tired of them & want something new or different.

The "accountants" way of handling this whole issue of durable goods periodic replacement is to depreciate those items with an expense entry.

TheBadger




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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3212 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 2:24 PM
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Let me try this a slightly different way. Let's say Bob has $2,000,000 in investable assets; thus being very safe Bob can withdraw $70,000 (3.5%) per year. Bob also figures out that he needs $40,000 to feed himself (food, clothing, shelter, entertainment) and needs $20,000 to feed others (goverments, charitable giving, etc.). This leaves $10,000 a year to "feed" or replace durable goods (cars, boats, stereos, etc).

If Bob has $500,000 now of non-income producing assets; e.g. durable goods; then his ratio of non-income producing assets to total net worth is 20% ($500k / $2.5mm) and it is too high. With only $10,000 per year to work with, his average durable good has to last 50 years which won't happen. In short, Bob can not support a steady state life satyle because hew will run out of money trying to periodically replace durable goods. Bob really needs more like an extra $50k on the presumption that all of this stuff lasts 10 years on average (cars potentially shorter but refrigerators longer).

Conversely, if Bob has $100,000 of non-income producing assets; then his ratio is 4.76% ($100,000 / $2.1mm) and his average durable good has to last 10 years, again on average; potentially very doable. It matters not whether we count this $10,000 a year as depreciation on existing assets or whether we simply build in durable goods purchases in years 2, 4 & 6, etc. of $20,000 in those years.

TheBadger

Nuts as usual when there is no football.






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Author: galeno Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3213 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 2:25 PM
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TheBadger started an excellent thread as usual.

My wealth picture used to look like this:
20% cash (6 years living expenses)
80% stocks
***********************************************
100% income producing assets and 0% non-income producing assets

Now it looks like this:
10% cash (4 years of living expenses)
20% house
70% stocks
***********************************************
80% income producing assets and 20% non-income producing assets.

If you believe the mortgage lenders and go to 40% non-income producing assets (e.g. "mortgagitis") I would bet that you aren't going to retire anytime soon.

A long time ago, a smart friend told me that if I ever wanted to retire early, I'd better keep my TOTAL housing expenses under 20% of my NET monthly income. AND, if I were to ever buy a house while retired, to make sure that it did not represent ANY more than 20% of my net worth---hopefully less.


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Author: rjstanford Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3214 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 3:34 PM
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One of TheBadger's statements: Bob also figures out that he needs $40,000 to feed himself (food, clothing, shelter, entertainment) made me think:

This is assuming that none of this is producing durable goods. Kick the shelter funds towards a house, move some of the entertainment money towards a better stereo or a niftier car than is necessary (IMO a fair and legitimate entertainment expense if you like that sort of thing (I certainly do)).

This type of equation always reminds me somewhat of the 'working days' one (IIRC):

Days in year: 365

Weekend days (52 * 2) 104
Sleeping (8 hours / day) 122
Breakfast, lunch, dinner (2h/day) 30
Vacation days (3 weeks) 21
...

You get the idea. The classic one ends up with ~2 days per year of work by counting the same time more than once -- I think that (to a lesser extent) you may be doing the same thing with durable goods.

Conversely, if Bob has $100,000 of non-income producing assets; then his ratio is 4.76% ($100,000 / $2.1mm) and his average durable good has to last 10 years, again on average; potentially very doable

Interesting point here -- this feels somewhat like Intercst's comment about needing 80% of your money to live on in retirement (don't take that promotion at 65) -- If Bob had his $.5mil in durable goods he'd be in a better position if he burnt $400,000 worth of them.

One approach might be to ignore all thoughts of ratios. If you're happy with your standard of living pre-retirement (really happy, as in you know you'd be happy with the same lifestyle 20 years from now) then don't worry -- the math is simple.

1) Figure out your total after-tax annual income (after FICA, SS tax, et cetera too), not including savings. Basically, your take-home pay after you've paid yourself first.

2) Calculate (there are many calculators to help you) how much money you'd need to withdraw, pre- or post- tax depending on your situation, to provide the same income level. This should take into account capital gains taxes, et cetera.

3) Divide this number by .04 (4 percent) or your favorite inflation-adjusting rate.

That's how much you need to save before you retire. Period. It really doesn't matter if you rent, buy, or live in a car -- if you're happy doing it now, and you want the same standard of living, this is what you need.

I'd add a step 2.5 -- 'add a bit' -- but I realize that an awful lot of people seem to want to retire ASAP, not ASAConvenient. Just think though -- if you maintain a small (10%) savings program, you can go on that 50th wedding anniversary cruise you're neglecting to budget for now. Chances are, you'll only need to work another year to make a huge difference in later life. Don't sacrifice the future because you're happy in the present. Needs, and (dare I say it here without being flamed) 'wants' do change with us.

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Author: hocus Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3215 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 4:13 PM
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TheBadger wrote:

I wonder about the influence of non-income producing assets versus income producing assets and one's ability to in fact become financially free.

Leaving aside the issue of whether this ratio is needed to ensure that one is safe in early retirement, it might have value for those trying to determine whether they are doing the right things to achieve early retirement.

One reason why the idea of early retirement is so counter-intuitive is that most financial planners suggest such goals as trying to save 10 percent of income. You'd have to be making an awfully large salary to acquire enough assets to retire early if saving only 10 percent. A rule such as "you should have at least x percent of your wealth in income-producing assets" might provide a shorthand way of helping people who have not studied the matter to tap into the concepts that make early retirement possible.

I have paid off my mortgage, yet "housing" remains the biggest item in my budget--because of categories for "condo fee," "property insurance," "home repair," and "utilities." I don't even want to think about what it would do to my savings plan to have to pay a mortgage on top of all this. Yet many people don't think of a house purchase as a dramatic reduction in their prospects for early retirement. Regular reiteration of the The Badger Ratio--once we determine what it actually is, of course!--might help change this.


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Author: rjstanford Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3216 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 4:34 PM
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hocus typed:

I have paid off my mortgage, yet "housing" remains the biggest item in my budget--because of categories for "condo fee," "property insurance," "home repair," and "utilities." I don't even want to think about what it would do to my savings plan to have to pay a mortgage on top of all this.

I still lean towards the 'mortgage the home and invest the difference' approach myself. After all, to be fair, you have to consider what it would have done to your savings plan to have paid off the mortgage slowly -- or, alternately, what it would do to a savings plan if you had $75k (or whatever) to invest with an 8% tax-deductible interest payment in exchange for it. Its all a matter of perspective.

Leaving aside the issue of whether this ratio is needed to ensure that one is safe in early retirement, it might have value for those trying to determine whether they are doing the right things to achieve early retirement.

This I agree with. However, be careful about skewing the ratios too much. If I can pay the same amount for my house payment as a cow-orker pays in rent, and I'm not planning on moving, my house really shouldn't be counted against me (IMO). If this is the case, I can choose to leverage my house and realistically charge all my interest payments to a housing expense, since I'm paying no premium to own vs. rent. This would allow me to (theoretically) spend the money recieved from the mortgage company on stocks (or whatever),
effectively turning a non-income producing asset into an income-producing one. I believe that this interpretation of the ratio has the opposite outcome of the one you were leaning towards?



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Author: goinfishin One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3217 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 4:40 PM
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This I agree with. However, be careful about skewing the ratios too much. If I can pay the same amount for my house payment as a cow-orker pays in rent, and I'm not planning on moving, my house really shouldn't be counted against me (IMO).

Please don't forget the amount of money tied up in your home: Downpayment, costs put into upkeep, and infastructure(Shed, Tools, Lawnmower, Asphalt Sealant......)

My intent is not to say you are wrong but only to point out that you have probably spent a lot of money to get your mortgage equal to an equivalent rent. $1000 mortgage payment does not equal $1000 in rent.

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Author: SUSIQ One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3218 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 4:41 PM
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Leaving aside the issue of whether this ratio is needed to ensure that one is safe in early retirement, it might have value for those trying to determine whether they are doing the right things to achieve early retirement.

I cannot believe that I am posting two messages in one day, but it just so happens that, thanks to the postings I have been reading, I figured that it will take me an extra $275K to retire if I stay in the house I just bought this fall (as opposed to house I had lived in for 15 years).

To keep myself from jumping off a roof about it, I am just figuring that it's the place I'd be retiring to, anyway. I just bought it early, and at least I've got the cash from the old house producing income.

Susi



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Author: rjstanford Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3219 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 4:50 PM
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Please don't forget the amount of money tied up in your home: Downpayment, costs put into upkeep, and infastructure(Shed, Tools, Lawnmower, Asphalt Sealant......)

The downpayment is an issue, I'll agree with that. However, house maintenance (at least here outside of Dallas) is far from terribly burdensome. A concrete driveway rarely if ever needs work (in fact, our last house had no serious problems in the 15 years we stayed in it). As for some of the other charges..

A shed is a) not expensive, b) not necessary, and c) more of a lifestyle choice. If I want to repot plants, for instance, I might choose to purchase a shed. If I was renting a house, I might choose to purchase the same shed. In an apartment, I don't even have that option (or indeed a yard).

Tools? Why would a homeowner need more tools than a homerenter? Either you like woodworking, et cetera, in which case you have tools -- or you don't (and you don't).

Last time I checked most houserenters owned lawnmowers too. Of course, you won't need one if you're in a condo -- your condo fees take care of the rental though (often at 1.5 lawnmower purchases per month). Again, if you're in an apartment you don't have a lawn, then again this tends more towards a lifestyle decision.

I will agree that renting an apartment may cost less than renting a house. However, I'd be willing to bet that you'd be getting a lot more for your money in a house -- unless you're buying a 900 sq. ft. house with no yard. While a $1000 mortgage payment does not equal $1000 in rent, a $1000/mo house is in my experience nicer than a $1000/mo apartment.

As for renting a house, you're stuck with many of the same costs as purchasing one, without the option to make any real lasting repairs (or perform long-term cost saving measures like adding better insulation or replacing an old air-conditioner for a more efficient model). Remember, you're supporting somebody else's house payments (and generally a bit extra for their trouble).


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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3220 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 4:52 PM
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rjstanford wrote,

However, be careful about skewing the ratios too much. If I can pay the same amount for my house payment as a co-worker pays in rent, and I'm not planning on moving, my house really shouldn't be counted against me (IMO).

I agree. And that's why I think removing "non-income producing" assets from the retirement calculation simplifies things.

Let's say you own a $150,000 home, pay $4,000/yr in property taxes and home maintenance, and have total expenses of $40,000 per year. (i.e. $4,000 in housing costs and $36,000 in "non-housing costs.") If you are using a 4% withdrawal rate, that means you'll need $1 million in addition to your $150,000 home for a total of $1.15 million.

Let's say your next door neighbor rents a similar home for $1,000/month and has the same $36,000 annual "non-housing costs." His total expenses are $48,000 annually. At a 4% withdrawal rate, our "renter" would actually need to be slightly wealthier $48,000/0.04 = $1.20 million.

intercst

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Author: goinfishin One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3221 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 4:56 PM
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The downpayment is my biggest issue, I agree.

Tools. my feeling is homeowner has to fix things or pay someone else, a renter does not. A small point I grant.

We have debated the rent vs. buy before, but I couldn't help myself : )

While a $1000 mortgage payment does not equal $1000 in rent, a $1000/mo house is in my experience nicer than a $1000/mo apartment.

Here in downtown Chicago, a $1,000 a month mortgage will get me nothing (Literally), but a $1,000 a month has me in a pretty nice loft and walking to work means no car.

Fishin

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Author: jgoss1074 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3224 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 6:57 PM
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intercst wrote:

"At a 4% withdrawal rate, our "renter" would actually need to be slightly wealthier $48,000/0.04 = $1.20 million."

In addition, his housing costs will rise with inflation (actually, the housing market, which presumably will be greater than inflation) while the homeowner's will not.

So the withdrawl required 5, 10, etc years from now by the homeowner would (in theory) not increase as dramatically as those of the renter.

Jim

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3225 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 7:25 PM
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jgoss1074 wrote,

intercst wrote:

"At a 4% withdrawal rate, our "renter" would actually need to be slightly wealthier $48,000/0.04 = $1.20 million."

In addition, his housing costs will rise with inflation (actually, the housing market, which presumably will be greater than inflation) while the homeowner's will not.

So the withdrawl required 5, 10, etc years from now by the homeowner would (in theory) not increase as dramatically as those of the renter.


That's what the realtors want you to believe, but it's not necessarily so. Over the past 30 years, the S&P500 has returned 13.67% annually vs. 5.71% annually for real estate (nationwide average). Source: Chase Investment Services.)

Let's see what would happen to $150,000 over 10 years.

1.0571^10 x $150,000 = $261,000 for the homeowner.

1.1367^10 x $150,000 = $540,000 for the renter who invests the $150k in the S&P500.

Our renter has considerable funds available to cover any rent increases.

Also, there's no guarantee that rents will keep up with inflation. In Houston where I live, an apartment that rented for $400/mo. in 1980 is about $600/mo today. That averages to about a 2% annual increase over 20 years. The CPI over the same 20 years (1980-2000) increased an average of 3.8% per annum.

intercst





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Author: rjstanford Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3226 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 7:34 PM
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The downpayment is my biggest issue, I agree.

This could actually, compounded, make homeownership a bad deal on its own. This is speaking strictly financially, not including the feelings of comfort and control that owning a home brings (to me at any rate). This could also be mitigated by a 0-down 0-point 0-closing cost loan (they're out there).

Here in downtown Chicago, a $1,000 a month mortgage will get me nothing (Literally), but a $1,000 a month has me in a pretty nice loft and walking to work means no car.

Ah. I'm outside of Dallas, currently looking for a house to buy after renting an apartment for a few years. Nice apartments here run a little under ~$1/foot, we're currently paying $1325 for a three bedroom (including extra fees for the dogs and a garage). I'm looking at a nice, older neighborhood where I can pick up ~2,000 sq. ft. of house with an oversized yard (I've promised the pups) and a bigger attached garage, with the added bonus of having no immediate neighbors, for around $130k which works out to less actual money per month (PITI). I could spend about 25% less, but there's an element of lifestyle choice at work here -- I like the idea of a larger kitchen and an older double-size lot with older growth trees.

From my standpoint its a no-brainer, and the added maintenance shouldn't make more than a 5% difference in our housing expense (which our apartment complex could raise our rent by next year anyway). I also like the freedoms that come with homeownership more than I dislike the burdens. I've assumed that I will accumulate no equity in the house in all my calculations.

Here in downtown Chicago, a $1,000 a month mortgage will get me nothing (Literally), but a $1,000 a month has me in a pretty nice loft and walking to work means no car.

As you point out -- everybody's situation is different. If I lived by myself, I might stick to an apartment for financial reasons -- not sure. If I didn't have dogs, a loft in downtown Dallas would actually be interesting. As it is -- I'll be back in a house in ~3-6 months.

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Author: rjstanford Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3227 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 7:42 PM
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intercst pointed out:

That's what the realtors want you to believe, but it's not necessarily so. Over the past 30 years, the S&P500 has returned 13.67% annually vs. 5.71% annually for real estate (nationwide average). Source: Chase Investment Services.)

I've still yet to see a financial argument for renting over owning in a situation where your monthly payment (PITI) is the same as your rent check. Ignoring wealth accumulation altogether you can treat it as a guarantee of no rent increases. Any equity that builds up can be thought of as 'free' money, since its a hard asset that was 'paid' for out of your housing budget.

I'm not saying that everyone should own a house, but if you're not planning on moving for a while anyway I don't see that it really makes a significant financial difference; unless you're planning on living one-person to a small apartment. Even then, (here at least) you can find nice suburban houses (small, nothing fancy) for <$90k -- with $5000 down, that's less than $700 per month (PITI) or about the price of an 800 square foot apartment around here.

As long as its reasonable (by your definition of reasonable), housing should be a lifestyle decision pure and simple.

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3231 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 8:14 PM
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rjstanford wrote,

I've still yet to see a financial argument for renting over owning in a situation where your monthly payment (PITI) is the same as your rent check.

I'd agree as long as you are making an apples vs. apples comparison.

A homeowner typically has maintenance responsibilites that a renter avoids. Contracting out lawn care, snow shoveling (I lived in New York for a while.), plumbing emergencies, etc. can easily add several hundred dollars a month to PITI (i.e. principal, interest, taxes, and insurance.) A large apartment complex enjoys economies of scale in providing these maint. services that a single family homeowner can't match. (May apt manager actually sends someone around to clean up after my dog. What would be the monthly cost of having someone visit your (single family) home to provide the same service?)

intercst

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Author: 4gonefool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3233 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 8:45 PM
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The Badger wrote:

Conversely, if Bob has $100,000 of non-income producing assets; then his ratio is 4.76% ($100,000 / $2.1mm) and his average durable good has to last 10 years, again on average; potentially very doable. It matters not whether we count this $10,000 a year as depreciation on existing assets or whether we simply build in durable goods purchases in years 2, 4 & 6, etc. of $20,000 in those years.

Okay, the picture of what this ratio would do is starting to come through. I'll use an example that I can relate to and you can tell me if I'm on track or not.

You're saying that if hypothetical Bob has "way too much house" it doesn't really matter that it is paid off, because every 20 years he has to reroof that sucker and nobody remembers to include 1/20th of the cost of a roof in their expenses. And besides that, the cost of reroofing is subject to inflation just as rent is. This ratio might tell him that he has a potential problem. Since a roof is essential to maintaining his standard of living, he either needs to change his standard of living (sell Shangri La) or postpone retirement until the ratio decreases.

The message seems to be don't plan to retire if your means are out of whack with your apparent material status.

4goneFool


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Author: rjstanford Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3235 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 9:30 PM
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A homeowner typically has maintenance responsibilites that a renter avoids.

I'll agree with just about all of your points if you're only talking about an 'apartment' renter. There's a huge lifestyle difference between an apartment and a house though -- I believe that (for me) the potential additional costs of a single-family dwelling are offset by the nicer lifestyle benefits.

When you're talking about living in a house, I don't see any real advantage to renting verses buying.

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Author: Tomcat98 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3244 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/6/2000 11:06 PM
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What a timely post. For my wife and I we like owning a home. I have a question about trading up to a larger house.

Our current home is nice. Our Equity is about $40k of a value total of $160K. We are thinking about buying another home that is a lot larger. This would be a house that would be our final home. We plan on retiring in 10 years. This house is $260k and we would put down 20%. Looking at what it would cost us in future investment earnings is about $220K over the 10 year period. Looks like our projected investment portfolio would be $750k at the end of the 10 year period.

My question really centers around is it wise to make that plunge now or wait til 10 year point? I think about the higher housing cost and that bigger point further out in the future.

Thanks

JDW

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Author: jgoss1074 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3246 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 12:30 AM
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rjstanford wrote:

"I've still yet to see a financial argument for renting over owning in a situation where your monthly payment (PITI) is the same as your rent check. Ignoring wealth
accumulation altogether you can treat it as a guarantee of no rent increases. Any equity that builds up can be thought of as 'free' money, since its a hard asset that was 'paid' for out of your housing budget."

This is closer to the point I was trying to make. Certainly if you compare purchasing a house flat out to investing that money, the renter will come out ahead.

I just did a quick little dealie in Excel (though I'm not an expert) with the following scenario:

Two folks, each with $1000000 retire. One decides to rent an apartment for $880.52/mo., and one buys a home for $150000 with 20% ($30000) down and an 8% 30 year fixed mortgage (payment is $880.52/mo.).

So Joe Renter starts with $1000000 in the market and Bob Buyer has $970000 at the start. Both withdraw 4% per year for all expenses (including housing). I also assumed that Bob Buyer spends an extra 5% of the current value (w/ appreciation) on maintenance and taxes. I also used intercst's s&p @ 13.67% and 5.71% for real estate. For rent rate increases I was more conservative and used %3 for annual increases. Obviously this doesn't account for normal market fluctuations, instead steady rates for simplicity.

The end result was that after 30 years they were darn near equal to each other (I included the value of the house in net worth calculations - without that I'm sure it would have been in favor of the renter). I'm no Excel wiz or finance guy, but this seems to support that idea that rent vs. buy is more of a lifestyle choice and not a financial one.

However, one could argue that after 30 years the buyer no longer has any house payment ('cept taxes & maint) whereas the renter is still paying rent. In addition, the homeowner has enjoyed 30 years of life with a yard, his own home, no landlords, etc. On the other hand the renter has maybe moved several times at his whim - or maybe even moved to follow the down real estate markets, invested the difference, and come out ahead.

Just my $.02, whatever that's worth.

Jim

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3247 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 12:48 AM
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jgoss1074 wrote,

The end result was that after 30 years they were darn near equal to each other (I included the value of the house in net worth calculations - without that I'm sure it would have been in favor of the renter). I'm no Excel wiz or finance guy, but this seems to support that idea that rent vs. buy is more of a lifestyle choice and not a financial one.

However, one could argue that after 30 years the buyer no longer has any house payment ('cept taxes & maint) whereas the renter is still paying rent. In addition, the homeowner has enjoyed 30 years of life with a yard, his own home, no landlords, etc. On the other hand the renter has maybe moved several times at his whim - or maybe even moved to follow the down real estate markets, invested the difference, and come out ahead.


Great post.

The two paragraphs above are the most succinct summary of the whole "rent vs. buy" issue that I've seen to date.

intercst



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Author: baanista One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3249 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 3:24 AM
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Regarding non-income producing assets, the "toys" you have are more a liability than an asset. Their existence obligates you to maintain, insure and eventually replace them or dispose of them. If you include them in your net worth, I think you should do so at their net value in a "distress" sale situation.

Your "toys" are part of your permanent lifestyle infrastructure. The Badger is correct in pointing out that too much infrastructure will kill your retire early possibilities. But I think this is more of a P&L issue than a balance sheet issue. Some toys need far more care and feeding than other toys. The trick, I think, is to include accurate costs for their care and feeding on your expense side. Then you can back into the amount of income producing assets that you need to support them.

I would disagree on your home being non-income producing. It is, in fact, generating non-cash income (and non-taxable as well) in the form the imputed rent you would otherwise have to pay.

Which then leads us to our old favorite "Rent vs. Buy". I believe there are actually three issues at work here.

1. Where you live is life style decision.

2. Whether you buy or rent is an investment decision. If you buy, you are investing in an asset that generates non-cash, non-taxable income in the form of imputed rent. This asset is also an inflation hedge. If you rent, you are investing in something else. Note: Decision #1 may force your hand on #2. Low end housing is more likely to be rental than higher end housing.

3. How you pay for your home if you choose to buy is a decision in portfolio leverage. A $100,000 mortgage is similar to $100,000 in margin debt when you look at your total portfolio. They each have their advantages and disadvantages, the real question is do you want a leveraged portfolio.

Regards,
Baanista

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Author: jpkiljan One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3250 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 3:33 AM
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Tomcat wrote and jpkiljan replied:
". . .
Our current home is nice. Our Equity is about $40k of a value total of $160K. We are thinking about buying another home that
is a lot larger. This would be a house that would be our final home. We plan on retiring in 10 years. This house is $260k and
we would put down 20%. Looking at what it would cost us in future investment earnings is about $220K over the 10 year
period. Looks like our projected investment portfolio would be $750k at the end of the 10 year period.

My question really centers around is it wise to make that plunge now or wait til 10 year point? I think about the higher housing
cost and that bigger point further out in the future."

This is a great question and the answer depends upon so many things that you didn't mention like the size of your family (present and future), kids to put through college, typical housing costs in your market, your ages, and why you'd want to retire and live in one house for 30 more years and what makes you think the market growth for big houses is going to be as good or better than the stock market for the next ten years, etc.

Anyway, my gut feeling is that the best strategy is oft-stated 'buy the least house that meets your needs and that you can afford' and that this will also be the case for you--but only you can decide that. But, don't me dissuade you from thinking about thinking this through.

The reason I replied is that, when I am faced with a decision like this, I always fire up my spreadsheet program and do a 'what-if' scenario for my potential investment decision. They always start out the same way: A column with years (months if you want, but years are close enough) on the left side and a series of columns next to that showing what happens to my assets if I don't make the investment (keeping the old house in your case) and a series of columns to the right showing what happens to my assets if I do make the investment (buying the new house in your case). Typically, you should interpret the year 2007 as meaning the financial condition at the END of the year to do it like the pro's do.

Include every thing that matters! The 7%-8% sales commissions, the increased property taxes, the larger maintenance cost, the estimated growth of the stock and real estate markets, the falling price of large homes expected when the baby boomers all start to retire ten years from now and move to Arizona (maybe you're there now?), additional commute costs, increased redecorating/furnshing costs, the probable cost of purchasing anther retirement home after ten years if you didn't do it now, your risk tolerance and most importantly a plausible scenario of how you'd invest the savings of not upgrading your house right away adn what return those invested monies would bring to you.

If you need another column for some other expense/savings, just add one. Set up expected interest/growth rates (property tax increases, appreciation of stock/bonds/land, etc) as single cells and refer back to them in your annual formula (eg, =B6*$E$2+B7 instead of =B6*.07+B7, where $E$2 contains the rate you are using and the $ signs fix the cell reference so it doesn't move as you add stuff). That way it is easier to do 'what-if's' with rates you are not too sure about instead of re-writing each cell.

At the bottom of the spreadsheet add up all these columns (or combination of columns) for the year 2010 to get a net worth for each scenario. If you do it right, what what you will get is an implied statement such as, "If I go ahead and upgrade now, my net worth will be $50K less than if I waited to 2010." or something similar. Then, you can go ahead and make your decision based on the intangibles (things like better schools, getting away from crazy neighbors, shorter commute, cozy fireplace, etc). There is no right answer--a quieter neighborhood may be worth $50K to you but not $100K. For others, it may have no value at all.

Using these spreadsheet techniques, I have decided whether or not to pay off my house early, whether to invest in tax-exempt securities, how soon I can retire, how much I will have to spend in retirement, how much each additional month of paid employment really pays me, whether to invest in a 401(k), Roth IRA or an after-tax account, and whether to invest in a vacation home.

Take your time and allow 3-4 hours for your first go at one of these. You can't loose by trying. At the very least, you will learn how to think quantitatively using spreadsheets--a fantastic planning resource the computer age has given us.

Don't forget financial planning Rule #1 when you do all of this: Only you are responsible for how your investment plans turn out. Not your broker, not your mutual fund manager, not your relatives, not your accountant, not your knowledgible friends and not even the considerably talented people you see posting messages on this board.

Whatever your final choice, good luck.

-- John



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Author: markr33 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3252 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 5:47 AM
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<While a $1000 mortgage payment does not equal $1000 in rent, a $1000/mo house is in my experience nicer than a $1000/mo apartment.>

Here in downtown Chicago, a $1,000 a month mortgage will get me nothing (Literally), but a $1,000 a month has me in a pretty nice loft and walking to work means no car.


I can't imagine retiring to downtown Chicago :-) Too cold for me - even now in my 30's !!! Though I had to travel there a dozen times last year and enjoyed it.



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Author: rjstanford Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3260 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 10:50 AM
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Baanista claims:

Whether you buy or rent is an investment decision.

Respectfully, "No, no, no! Well, maybe."

Buying a house becomes an investment decision only to the extent that you are spending more money that you would otherwise spend to rent a place to live. For the purposes of this discussion, you should assume 0-down 0-cost mortgages too (not the best rates, but available and competitive). At that point, even if I'm paying more to buy than to rent (say $1000 vs. $900) my 'investment' is only $100.

If you buy, you are investing in an asset that generates non-cash, non-taxable income in the form of imputed rent.

That's the same perspective from a more financial standpoint, but your next comment, If you rent, you are investing in something else, is an interesting one -- are you referring to the $100/mo (or whatever, often $0/mo) difference between renting and buying, or the fact that you're helping someone else's real-estate investment pay off?

I would be willing to bet that most people could find purchasable housing at the same level as their current rental housing for the same (or probably less) total outgo per month, even on a 0-down loan. They probably wouldn't go for it though -- most people seem to have higher standards about what they'll put up with in an owned property than a rented one. I work with many long-term apartment dwellers who have said that they wouldn't buy a condo. One even turned down the purchase of the very unit he was renting, even though he planned to stay there several more years (and is still there in fact), because he felt that if he bought a house it would have to be a nicer, larger one. He could have saved substantially on his monthly payments, even ignoring the fact that he was building equity.

A $100,000 mortgage is similar to $100,000 in margin debt when you look at your total portfolio.

With the side note that its not subject to margin calls, its tax deductible, and that your portfolio value has also risen by $100,000 when you incur the loan. I wish my margin terms were this generous :-)

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Author: Chipsboss Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3263 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 11:10 AM
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for John:

Good post. Thank you.

You said ...when the baby boomers all start to retire ten years from now and move to Arizona (maybe you're there now?), ...

My retirement house is being build right now, about 12 miles south of the Las Vegas strip. It is larger than I need and about twice the size of my present house. It's in an age-restricted, active retirement community with a 75,000 square foot recreation center for us geezers. So, I spent more than I "needed" to, but, hey, I'm not saving for retirement any more, I am retired. (Now 60, I retired at 53.) If I get a decent price for my present house, I'll pay off the new one this year, with the difference coming from the new-house saving account and from current income. I'm not dipping into the investment capital for this venture.

Nevada has the further attraction of ZERO state income taxes, reasonable cost of living, and a mild climate. Of course, if you crave natural greenery, you'll live in a place with more rainfall.

At some point, it makes sense to switch from planning for retirement to being retired and enjoying it.

Regards,

Chips, the desert rat with no taste for casinos

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Author: goinfishin One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3266 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 11:28 AM
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I can't imagine retiring to downtown Chicago :-) Too cold for me - even now in my 30's !!! Though I had to travel there a dozen times last year and enjoyed it.

Ahh yes, but when your retired, cold weatehr can be enjoyable, it's only a pain when you have to get dressed up for work. But I probably won't stay here forever. I will move by Intercst and get twice the apartment for half the cost.

Other factor for me is the car, I'd like to hear from others, but from my travels there are very few cities you can truly live without a car and enjoy yourself. Downtown Chicago is great, great neighborhoods, entertainment, everything is easy to walk too and public transpo. is excellent. So I pay a little more in rent but we all know what even a cheap car costs a month.


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Author: 4gonefool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3269 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 11:51 AM
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Other factor for me is the car, I'd like to hear from others, but from my travels there are very few cities you can truly live without a car and enjoy yourself. Downtown Chicago is great, great neighborhoods, entertainment, everything is easy to walk too and public transpo. is excellent. So I pay a little more in rent but we all know what even a cheap car costs a month.

I know this is OT, but the best blues I ever heard was at Kingston Mines in Chicago. It's worth a trip to Chicago from anywhere in the world just for one night of that.

I personally don't like living in cities and would never retire to one. To each his own. I don't have a problem with visiting them. I'll be moving to a place that's cold in the winter, because that's the only way to live in a place that isn't too hot for too long in the summer. At least in the cold, you can do things outdoors. When it gets too hot, all you can do outdoors is sit, drink, breath and in my case burn.

4goneFool


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Author: hocus Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3279 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 1:37 PM
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Most people seem to have higher standards about what they'll put up with in an owned property than a rented one.

This is the factor that I fear is missed in attempts to quantify the rent vs. buy with mortgage vs. buy without mortgage decision (not that the attempt to quantify does not shed light!). Those who buy spend more--so all else is not equal when we try to compare whether it is better to buy or rent. What do we mean by "better?" I think we mean better from the standpoint of achieving early financial independence. From that standpoint, buying and thereby spending more is not better even if one gets a good deal for the money.

The only way I can see that you could quantify the downside associated with this effect (that those who buy tend to spend more) is to do a survey of people at the same income level and see whether those who buy homes end up with more savings in a few years or less.

My guess is that a good number of those who decline to buy would end up with small savings because the reason they decline to buy is that they don't care about finances and can't be bothered to take on a home purchase. Others, though, decline to buy because they realize that the step of buying a house starts one down a road that frequently leads to a lot more spending, much of it unanticipated when the decision to buy is made.

It's this latter group that makes up the best candidates for early retirement, in my view. That's why I think that a ratio of the type proposed by TheBadger might provide a shorthand means of communicating what needs to be done to reach early financial independence.

Quantification works only if we are engaging in a rational process when we decide how to house ourselves. All else being equal, perhaps one can buy for the same cost as one can rent. Rarely is all else equal, though. Once you buy, you next start thinking of furnishing. Then you start thinking about entertaining. Then you start thinking of buying a car that lets you fit in with what the neighbors have in their driveways. Soon you find yourself satisfied with a 10 percent saving rate and the goal of early retirement slips from your grasp before you even recognized it as a possibility.

Please understand that I am not saying that one should not invest in a house if that is what one likes. As several posts noted, that's a lifestyle decision. All I am trying to say is that it is a lifestyle decision that makes it harder to retire early for many people. If you earn enough and start saving at an early age, you may be able to get the best of both worlds (a higher-priced lifestyle and early retirement).

My concern, though, is with those who won't make it to early financial independence without making some tough choices. My impression is that a whole lot of potential candidates fall off the train leading to FI World when they buy that first house. A cycle begins, and it is hard to get off the spendevermore treadmill.

I've made some big mistakes in my financial planning history. For one thing, I had zero savings at age 35; that's a tough one to overcome. I also have managed to not make a penny in the stock market boom of the past 18 years. Nor have I made a penny in real estate investments. Despite those three strikes, I'm close to reaching my financial independence goal at a relatively young age (43 or 44)because I learned about financial independence concepts just at the time I started earning enough that I would have engaged in dangerous spending had I not known about them.

Here's my evidence that many people (not people on this board, of course!) are not engaging in the rational process described in some of the quantification posts. The average square footage of the American home has doubled since the 1950s, while the size of the average family dropped. Now, if the average American made a concious decision to buy twice as much home at the cost of delaying financial independence, that's fine.

I suspect otherwise. I suspect that many are buying homes without knowing what I consider to be the real cost--giving up a chance at early financial independence. For most, early retirement is not even on the radar screen. So making even small sacrifices for this purpose makes no sense. The Badger Ratio might help a few realize what is at stake.

Again, I'm not against people who buy "higher standards," as rjstanford notes they do. I also agree that there is a real benefit associated with the higher standards (more room for the dog to run around, more rooms to entertain company, a garden to plant flowers in). I don't want to take these things away from people who want them.

My own inclination, though, is to sacrifice the higher standards until I reach the point of financial independence. Then I can think clearly about whether those extras are worth the additional time I will need to work to pay for them. My personal view is that I can not think clearly so long as I have a gun at my head that comes with knowing that one's family will suffer if one loses one's job (sometimes for reasons beyond one's control).

Spending money on housing (or any other non-income producing asset) is not bad. But those who want to sell us things work hard at making the cost appear to be less than it really is. The key concept in achieving early financial independence is getting ahold of some capital at an early age and getting that capital working for you. My advice is to make substantial progress on that goal first, and only then start looking into the many lifestyle enhancements that will always be for sale out there.

One last point, and I promise to shut up. Another problem with the quantification approach (and I repeat, I like efforts at quantification!) is that housing is frequently not available in an "apples to apples" form. My wife and I would like to move to a small town when we reach financial independence since there seems no need at this point to spend the premium that is attached to housing in areas where there are lots of corporate jobs available.

As a general rule, I can find small-town housing at one-half the square-foot price of the house I own. So in theory, I could trade for an equivalent house and put the difference in price in income- or capital-producing assets. Generally, though, most of the housing available in places I want to move to is twice as large as the townhouse we live in now. So I can save on a per-square-foot basis, but not in a way that adds to my capital. This does not serve my purposes.

So I don't really have a choice to buy the same amount of house in a less expensive area. As rjstanford's post and other posts in this thread suggest, you sometimes need to pay more when you buy than when you rent. You usually get more, which is nice. But it's not as nice as paying less if that is your personal first priority. As Americans in general accept a preference for spending more on housing, it forces the rest of us in this direction a bit because builders build what most people want.

OK, one last last point. This thread has one of the highest insight-per-post ratios on the board, in my view. So I hope we are not frustrated that we never seem to quite solve this rent vs. buy issue. It's just that there's a lot to chew on.

Oh, one more thing (call me a liar!). One of the problems we are having with the housing issue is that housing is part consumption and part investment. I agree with posts suggesting that the investment component is exaggerated by real estate agents. Despite this belief, I probably have a higher percentage of total assets invested in real estate than most of those who love real estate but only put a small percentage down and pay a mortgage.

I don't count my housing equity the same as I do my income-producing capital, when determining whether I have enough to be financially independent. However, I don't think it is quite fair to count it as zero either. Real estate may not be the best investment in town, but I do expect some return. And I won't move if I can't replace the running trail that starts in my backyard (which the real estate agent didn't even mention, and which I don't "own," but from which I derive lifestyle advantage on about 350 days of the year).


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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3281 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 1:55 PM
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Actually, when I started this whole thread on the ratio of non-income producing assets vs. total assets, I was not thinking about rent v. buy for several reasons:

1. rent v. buy is an emotionally charged issue with no apparent winner.

2. If one is a buyer, the whole ratio can produce very different results depending in whether the buyer also assumes a mortgage. As an example, Bob has $2mm in the market & a house worth $500K; the ratio would be 20% ($500k / $2.5mm). Now if Bob takes out a $400k mortgage the ratio becomes 4% ($100k net non-income / $2.5mm)because Bob put the proceeds of the mortgage into the market.

As a result, I never said it but I mentally excluded this whole issue. Instead my whole focus was trying to devine a ratio that represented the implicit costs associated with maintenance & replacement of personal property; particularly toys. We can all envision Bob's four car garage full of things that are expensive most with motors in them.

TheBadger


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Author: hocus Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3284 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 2:07 PM
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Actually, when I started this whole thread on the ratio of non-income producing assets vs. total assets, I was not thinking about rent v. buy.

Well, you know, TheBadger, they say Keynes wasn't a Keynesian and Darwin wasn't a Darwinian. Once you start the ball rolling, you're responsible for any damage done. ;)


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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3285 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 2:10 PM
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My most humble apologies. Let's all head for the commune.

TheBadger


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Author: 4gonefool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3287 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 2:42 PM
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Okay, I've resisted jumping into the Rent vs. Buy issue for a while, but Hocus' post brought out the need to add my $.02 FWIW.

Two things caused me to make the buy decision.

One, I was living in an area where the rent was being raised twice per year for more than 10% annually. Call it "rentflation". There was no end in site and any improvement in rate by moving meant a longer commute or a higher local crime rate. This created a helpless "I can't get ahead" feeling. I calculated that if this continued for several years, I would have no choice but to move into a low rent high crime area.

Secondly, I got married (well hooked up anyway). When you're single, where you live isn't necessarily as important, because for all kinds of reasons, you are not there as often. When I was single, I would leave my apt. to seek human companionship. It was a case of staring at the walls until it felt as if they were closing in on me. I knew that no matter where I moved this would happen, so my choice was to endure the hassles of roommates or live in a pricier one-bedroom apt. and spend little time there. I took the one-bedroom apt., because I could afford it at the time, but then the aforementioned rent raises started to eat my lunch.

Then I met my future wife and we began living together. This was great for the expenses, but we would spend so much time in the apt., that the combination of rentflation plus the need for more space drove us to look into buying a house. A larger apt. triggered the rentflation again. So we bought a fixer upper with 5% down and we built a master suite onto it. We bailed when a job transfer was offered and LA had became just too depressing to live in. Unfortunately this occurred during the recession in '95, so we netted less than a 4% gain on a house we owned for 10 years. We moved back to an apt. for a brief time during the job transfer and couldn't stand the crowded feeling it produced. We had our second house custom built and I can't say it was a bad investment, because we've been very happy in it.

So both economic issues (rentflation) and lifestyle issues (cohabitation) were involved in our Rent vs. Buy decisions. If I were single now, I would probably move back into a city and seek other human company, but for now, our big roomy house with a mountain view is a reward for the commute I endure and an investment that might pay off pretty well because the area I live in is now going through "houseflation". We plan to retire and build our new home in an economically depressed rural area where rental housing is almost non-existent and therefore not an option. We will probably do much of the construction work ourselves because we enjoy the sense of creativity and accomplishment that DIY can bring. Thus we will turn our voluntary sweat equity into our down payment. We will probably more than pay the cost of the new house from the proceeds of selling our current house and then mortgage it at 80% LTV for leverage to add even more to our portfolio. By doing this, we'll get a great deal on just what we want. We'll have a fixed rent payment, inflation-adjusted maintenance costs and all the other joys and problems of owning a new custom home.

This has been kind of rambling, but hopefully I've conveyed that Rent vs. Buy sometimes has factors that make one choice or the other the only viable option for making the best from what you have. I can't imagine living in a house as a single guy. I can't imagine living in an apartment as half of a couple. I can't imagine renting a house in a place I don't enjoy living in. I have no doubt that I could have retired earlier if our second house had not been so big, but this particular missed opportunity protected my sanity and wasn't nearly as bad as the losses I've suffered at the hands of the Wise.

4goneFool


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Author: 4gonefool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3289 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 2:57 PM
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my whole focus was trying to devine a ratio that represented the implicit costs associated with maintenance & replacement of personal property; particularly toys. We can all envision Bob's four car garage full of things that are expensive most with motors in them.

So now we get back to my earlier point about a warehouse full of classic cars that are never driven. Your ratio is meaningless if the collector will not continue to add to the collection without subtracting. If the "toys" don't require or receive significant additional expense or equity, then their value and their effect on the ratio is irrelevant. Granted, this is a special case, because most toys are played with and eventually broken (at least if you're a normal overgrown kid). I can see value in the ratio if this link to future expense is present, but not if it is absent.

It's a very enjoyable thread.

4goneFool


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Author: TheBadger Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3294 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 3:49 PM
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Let me see if I understand this correctly; I can tell the wife that my motorcycles don't cost anything because everytime I sell one, I sell it for more than I paid for it???

Wow, this gives me a whole new lease on life; I thought maintaining them, insuring them, etc. cost me money. I can now go get a few more.

On a more serious note; you are right to the extent that Bob's toys (or mine) are relatively static, are not replaced, take little to maintain; however, even though I tend to sell scooters for more than I pay for them; I intuitively know (and I don't dare add it up) that they are costing me a pretty penny.

TheBadger (with at least one weakness)





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Author: BluesH One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3314 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/7/2000 10:20 PM
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4gonefool wrote:
I'll be moving to a place that's cold in the winter, because that's the only way to live in a place that isn't too hot for too long in the summer.

Untrue. Try almost anywhere on the west coast, for example. Our favorite summertime sport over here is watching tourists in Bermuda shorts turning blue. Remember Mark Twain's quote: "The coldest winter I ever spent was a summer in San Francisco."

Bob H, aka Blues,
who grew up in Chicago. Love the people and culture, but will never live there again because of the weather.


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Author: baanista One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3325 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/8/2000 7:30 AM
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rjstandford took exception to my saying that buy versus rent is an investment decision. He said Buying a house becomes an investment decision only to the extent that you are spending more money that you would otherwise spend to rent a place to live. For the purposes of this discussion, you should assume 0-down 0-cost mortgages too (not the best rates, but available and competitive).

I don't look at this from a "What's the payment?" perspective. If you buy a $100,000 house, you have added an asset worth $100,000 to your collection of assets. If you take out an $80,000 mortgage to buy the house, you have added $80,000 to your liabilities.

If you rent, you have no new assets and no new liablilities. A person who rents, is NOT investing in an asset called a house. The renter's asset allocation is therefore different from the home owners.

Remember, someone with enough assets to retire early DOES NOT need a mortgage to buy a house. Example: If you have a $1,000,000 in stocks, you could sell $100,000 and pay cash for a $100,000 house. Or you could use take on margin debt to pay cash for the house. Or you could get a mortgage to pay for the house. Each option changes your asset allocation.

rjstandford had this to say about mortgage debt: its not subject to margin calls, its tax deductible, and that your portfolio value has also risen by $100,000 when you incur the loan. I wish my margin terms were this generous :-)

Your NET WORTH doesn't change, it stays the same. Your Portfolio only increases by the amount of the increase in liabilities (Debt), and that is the same whether you used a mortgage or margin.

On tax deductibility, mortgage interest is a useful deduction only to the extent that it exceeds your standard deduction. Margin interest is deductible against investment income (dividends, interest income, short term gains?). Which is better tax wise depends on your situation.

To compare mortgages to margin, mortgages are foreclosed when you can't meet the payments, even though the asset hasn't decreased in value; Margin calls happen when the value of the asset decreases, even though you could still meet the payments. <grin>

Regards,
Baanista

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Author: 4gonefool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3326 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/8/2000 8:07 AM
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<<I'll be moving to a place that's cold in the winter, because that's the only way to live in a place that isn't too hot for too long in the summer.>>


Untrue. Try almost anywhere on the west coast, for example. Our favorite summertime sport over here is watching tourists in Bermuda shorts turning blue. Remember Mark Twain's quote: "The coldest winter I ever spent was a summer in San Francisco."

Well yes, I guess I should have qualified that. I should have said, "that's the only way ... on my budget. I've been all over the west coast and loved visiting it. It's a good place to build a career, but I don't think a good place to retire to. I spent 13 years within 6 miles of the beach in the South Bay (LA) area. California has an ideal climate with the cold coastal water coming down from Alaska making the lower lattitudes quite tolerable. OTOH, the cost of living and the political climate is IMO intolerable.

Oregon and Washington aren't much better west of Interstate 5 (the temperate zone) and east of Interstate 5, the winters are considerably cooler and the summers considerably hotter.

4goneFool




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Author: rjstanford Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 3339 of 734857
Subject: Re: Relationship Of Non-Income Producing Assets Date: 2/8/2000 10:57 AM
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bannista commented (about buying a house):

I don't look at this from a "What's the payment?" perspective. If you buy a $100,000 house, you have added an asset worth $100,000 to your collection of assets. If you take out an $80,000 mortgage to buy the house, you have added $80,000 to your liabilities.

I guess that's where we differ. I've seen a lot of posts on this board from people claiming that houses are good investments, terrible investments, the key to retiring early, the bane of the early retiree, et cetera.

From my perspective, you can make the decision as to whether or not to buy a house (assuming a stable situation and decent credit) purely from the perspective of the payment (don't forget taxes and insurance). While your financial situation changes on paper, your daily life (writing a monthly housing expense check) is not impacted financially. This once again moves it toward a lifestyle decision and away from a financial one.

It also helps point out that some of the 'fixed' ratios are no more useful than the 'save 15%' ratio that intercst so nicely debunked a little earlier. While buying a house can drastically change your asset allocations, it need not affect on the rest of your savings plan in the slightest.

I may not have expressed myself clearly, however. Certainly once the decision to buy a house has been made, you should select a propery with an eye both for a good current value and good future prospects as an investment property. With no money down, any house appreciation is a free bonus in a sense :-)

As an aside, I did some quick calculations in Excel. Most of my comments have reflected someone who finds a house to purchase with a net monthly payment equalling their rent check (not all that hard to do) with no down payment. However, I ran some numbers to see what would happen with a down payment.

Assume a $100,000 house with $20,000 down. The house appreciates at 5% (I think that's a little low historically but close enough) and the market at 11% (likewise).

House value:

0 years $100,000
15 years 207,892
30 years 432,194

Down payment in market:

0 years $20,000
15 years 95,691
30 years 457,845

So after 30 years you'd pretty much break even (barring special events, and taking into account the roughness of these numbers). However, if you had found a 15 year mortgage that totaled the same as your rent payment, even with 20% down, you'd come out ahead financially. This is ignoring any potential rent hikes, of course.

It also intentionally ignores mortgage interest -- remember, we've posited that your final monthly payments are the same with renting or buying. If this isn't the case in your neighborhood, obviously these calculations are not for you!

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