Choosing The Right Home, Part II: How Expensive A House Do You Need?
How much of your net worth should be invested in your home? That depends. When you are starting out, your home may represent most of your wealth. It may be all of it. But as you start saving and investing, you’ll want to gradually decrease that percentage from most of your wealth to half of it, then a quarter of it, and eventually (if you get really rich — and I hope you do) to a mere 5% or 10% of it.
Why? Because your home isn’t meant to be an investment. It’s meant to be a sanctuary. Home-spending decisions are not — or should not be — primarily about return on investment. In buying and fixing up and furnishing your home, you will spend a good deal of money on things that will have a lot of emotional value but very little financial worth. If you want to put a new set of windows in the living room, repaint a bedroom, or buy a bookshelf for your beer-can collection, you don’t want to have to do a financial analysis first.
To the contrary, the investments you make for financial gain can and should be decided upon based on such rational, bottom-line thinking. I bought my first house 20 years ago for $175,000. I put down about $15,000 — which was the sum total of my net worth. Ten years later, I was living in an $800,000 house, which represented about 25% of my net worth. Today, I live in a more expensive home but one that counts for only about 10% of my wealth. That feels good. Eventually, you’ll want your bond portfolio to be equal to or greater than the equity you have in your home.
The same will be true for your stocks and your other investments. What about taxes? It’s true that a more expensive home will give you larger mortgage payments that will contain larger interest payments that will reduce your net taxable income. But, at most, that will be taking away 40 cents for every dollar you are spending. So don’t let tax considerations dictate what you do.
Bottom line: Buy the smallest house you can to accommodate all of your needs comfortably and then invest time and care — more than money — into making it a home. Take the money you could spend on a showcase house and invest it in quality real estate, an area where you can maximize your returns without compromising your lifestyle.