The board game Monopoly, first marketed by Parker Brothers in 1935, has been enjoyed by billions of people. If you're reading this, you've probably played the game at least a few times and have memories (or nightmares) of dealing properties, building houses, and feeling the effects of Chance. A major goal in this game is to own houses/hotels on your properties as they generate greater income (via rent) and will be worth the most when it's time to cash out. The winner is the one with the most wealth at the end of the game (let's call that retirement) - which is usually determined by sunrise, starvation, or when your parents come to pick you up.
We play a similar game when it comes to investing and saving for retirement. Last week, a study by the Ontario Securities Commission, "Investing As We Age", revealed some interesting facts about the financial situation and outlook of those over the age of 45.
Some highlights of the study:
- Retirement issues are the top concern for 25% of those over 45.
- 76% of those over 45 in Ontario own a home
- 37% of Ontario homeowners over 45 years old are relying on the value growth of their home to fund retirement.
- That means that 28% of those over 45 in Ontario are relying on their house increasing in value to fund retirement!!
BUT there are significant risks in relying on a one-asset strategy to fund retirement. Just like a Monopoly board, owning only one property (even if its Boardwalk), is not going to win you the game. Plus, pouring in all your assets to acquire & maintain that property may land you in trouble down the road.
1) Diversification - invest all over the board
The age old term "Don't put all your Eggs in One Basket" holds true for your Net Worth and future retirement needs. Don't let Canadian Real Estate dominate your Net Worth. Hold various asset classes like stocks, ETFs, bonds, mutual funds so that if there is a correction in the real estate market, (which is already happening in the GTA), any impact on your finances can be buffered. If you are solely reliant on a house or property to fund your retirement, a real estate correction at the wrong time could leave you ...without a roof?
2) Over Estimating the Future ReturnS - Boardwalk is worth a lot, but not that much.
Yes the housing market has been up significantly, especially over the last decade. However, this does not mean that the market can sustain such an accelerated growth. In fact, history has shown that there have been prolonged periods of time where real estate did not rise. For example, if you bought a house before the 1989 housing pullback in Toronto, you didn't break even until 2005 in real dollars! If you are reliant on house growth to fund your retirement, be careful not to overestimate the future value and risk. You may find yourself actually not having enough for retirement. Yes the last few years have seen certain markets grow wildly but keep realistic expectations on how much your house will be worth in the future.
3) "Cashing in" your House is not always easy, or worth it.
Even in Monopoly, selling a house only gets you 50% the original price (I assume the agent fees, closing costs & market corrections are significant here). Housing is a highly illiquid asset dependent on the demand of buyers. You don't want to be forced to sell at less than you planned for to fund your retirement, especially if there is a correction. In addition, there are significant emotional attachments to one's house. Maybe you love living in your neighbourhood and home, and wish to stay there. But if you need the money for retirement, the decision won't be yours. Plus, you still have to find another place to live. There are other ways to cash out your house like borrowing against it or reverse mortgage, but keep in mind these options generally have much higher interest rates than your standard mortgage rate. (The Monopoly mortgage rate of 10% is not far from reality!)
Special Note to Young Professionals/Young Families Looking to Buy a House
1) COUNT AGAIN WHAT THE BANKER GIVES YOU
Word of advice: Don't blindly accept what the Banks say you can afford. They only really look at your mortgage and other associated housing costs in relation to your income. Banks don't care if you're eating KD everyday, or your other lifestyle expenses (maybe you like to eat out, or take a vacation once in a while, or drive a car). Even if your cash flow works out presently, consider the Monopoly Chance deck. How could marriage, kids, aging parents, or a career change affect your cash flow?
In addition, by committing to a mortgage, there will be less money available to invest for retirement. Carefully consider if you will be able to save enough for retirement. Check out my How to Reverse Engineer your Retirement article.
2) taking on too big of a mortgage IS A MAJOR RISK
In today's near all-time low interest rate climate, it's easy to take on a very large mortgage. You can almost be certain that interest rates will rise over the next 20-25 years. At the time of writing this, the Bank of Canada has raised rates twice in the last 3 months with many experts saying that they forecast another 3 to 4 more increases before the end of 2018.
If there is a market correction, your equity can easily be wiped out due to the amplifying effect of leverage. For example, if you have a $25,000 down payment on a $500,000 house and the market price goes down to $475,000 you have actually lost your entire down payment. You still owe $475,000 but living in a $475,000 house......this equates to zero equity.....ouch.
3) Consider future mobility (pass go, don't go to jail)
Don't create a prison for yourself. If you are young, one of your greatest assets is the ability to move around to find jobs or pursue opportunities. If you get a job offer in New York, or Hong Kong, or Timbuktu you can take those opportunities without worrying about being tied down by a house. Due to the highly illiquid nature of Real Estate (closing costs, reliance on the market), you may be locking yourself down if you are set on Buying rather than Renting.
4) Carefully do the math (Rent vs. Buy)
To blindly assume that by renting, you are paying someone else's mortgage, is a mistake. Do the math properly! Add up your sunk costs for buying a house: property tax & fees, maintenance fees, repairs, opportunity cost investing (i.e. cost of down-payment in your TFSA), and of course mortgage interest. Compare that to how much it costs you to rent the identical place. Even if the sunk costs are equal to rent, you are banking on appreciation of your house. As mentioned above, don't assume that since prices have gone up recently, that this growth rate will continue.
Don't get me wrong. I understand the pride of ownership, and how good it feels to finally put that red hotel on Pacific Avenue. It's hard to put a price on these intangibles. However, it's easy to get caught up in the hysteria of recent housing gains, and you may find yourself stuck in the future. As I write this post, many in the GTA are already seeing a once thriving market suffer some serious issues in the last 6 months. The One-Asset strategy that many Canadians are, perhaps unknowingly, implementing right now is full of risks that may be a source of future retirement problems. Don't make this mistake! The game of Monopoly (and Life) is a long one. Seek balance, diversification and reduce your risk.