We’re often told, “Your home is your biggest investment.” That’s why, as the logic goes, it’s okay to buy a big ol’ McMansion in a sprawling suburban development even if it’s too large for your needs.
As the owner of several rental properties and one home in which I actually lived, I can definitively say that this advice is terrible. It even cost me the equivalent of owning a Ferrari. Let me explain.
You see, your home is not simply your biggest investment. It is also the biggest consumer purchase you make.
Consider this pair of scenarios:
Scenario 1: Alice and Andrew buy a $700k McMansion shortly after getting married. It’s much bigger than they need, but they figure, hey, someday we’ll have kids and we’ll grow into this house. The house goes up 1% in value per year, after inflation.
Scenario 2: Bella and Brian buy a $400k townhome shortly after getting married. It’s perfect for their needs as a couple without kids, but would also suffice for raising one or two young kids down the line. They then purchase a $300k investment property and rent it out starting at $1500/month. Both properties increase in value 1% per year, after inflation.
After 10 years, their oldest child is now 7 years old, and they decide to move into a larger home. In those 10 years, they collected $240k in rent (rent had increased and the average ended up being $2000/month over the 10 year period), and invested consistently into conservative ETFs, and now have $320k liquid. They sell their starter townhome and use the additional $320k towards the purchase of the McMansion of their dreams. And yes, they still have the rental property generating cash flow like the money printing machine it is.
It doesn’t take a Math PhD to realize that Scenario 2 is way better than Scenario 1. Why? Alice and Andrew’s $700k McMansion appreciated a bit in value, but that’s it. Meanwhile, Bella and Brian’s $700k worth of properties appreciated in value while $300k of that was also serving as a rental income machine. In other words, Bella and Brian invested in $700k worth of properties, but only treated $400k of that as a consumption item. The remaining $300k was pure investment.
In other words, if your home is excessively large or expensive compared to your needs, it can easily become a crazy-expensive consumption item because it represents a foregoing of rental income.
My Real Life Experience, aka Giving Up a Ferrari
I first realized this truth when I was splitting my time between my East Palo Alto, CA house and a Sacramento, CA apartment. My house had a fair market rent of $3300/month, and I slept in it only 3–4 nights a week.
One day, I realized I was foregoing $3300/month of rent to live in a house half the time. Then, since I’m a car nut who thinks about all financial decisions in terms of the cars I could get for the same money, I realized $3300/month was Ferrari lease money. Or, if you prefer, two Porsche 911s. Or five BMWs. Holy smokes. I’d been giving up the equivalent of a Ferrari for many months without realizing it — all to have access to more “house” than I really needed.
The math was so obvious, yet so astounding. After realizing this mistake, I quickly moved out and rented out my house, living full-time in the Sacramento apartment. It was, bar none, one of the best financial decisions of my life.
So, be clear in your thinking when it comes to enormous purchases like buying a home:
- Investment and consumption do not have to coexist in the same exact property or properties.
- Ownership is required for investment, but it is not required for consumption.
Separate out these concepts, and you will be able to make far better financial decisions.
