Here's a not-so-uncommon scenario these days: You bought your lovely home, be it a castle, bungalow or yurt, for $200,000 five years ago. Today, it's worth about $300,000. That's a tidy 50% total gain, or 8.5% on a compound annual basis. Right?
Not so fast -- you've probably oversimplified matters. For example, think about what you've put into the home over the years. Some of those purported profits probably went to businesses like Home Depot (NYSE: HD), Lowe's (NYSE: LOW), or home-building supplier USG (NYSE: USG). Let's say that you spent the following amounts:
Those items total $25,000. Subtract them from your initial "gain," and you're left with an increase of $75,000, or 37.5%, which is still significant. Annually, though, it amounts to 6.7%. Factor in expenses such as insurance and property taxes, and your gain (at least compared to options such as renting) shrinks even further.
Your expectations should be realistic, too. Don't expect your "investment" in a home to make you rich. It can help many people become wealthy, but it's not a surefire ticket to Easy Street. As Knight Kiplinger recently noted in Kiplinger magazine, whereas the average annual gain of the S&P 500 over the past 30 years has been 12%, the average annual gain for home values has been 6.2%. That's respectable, and has beaten inflation -- but not by much.
For most of us, our homes should be valuable because they give us shelter and comfort, and help us build valuable equity. But to make the most of your dollars for your future, it's hard to beat the stock market. Investing in a broad S&P 500-based index fund is easy and immediately plunks you in 500 of America's biggest companies. Over many decades, the S&P 500 has averaged annual gains of about 10%.