The largest liability that you will typically have on your personal balance-sheet is your home loan. And because most of us tend to stretch our home budget, the home loan repayment consumes more than 40 per cent of total monthly income. This leaves limited room to pursue other investment objectives. So, if you believe that you can pursue only one objective during the initial years of your career, which will you prefer to do first—buy a house or save for your retirement? In this article, we show why the decision is not always easy!
Residential asset
There are several reasons why your first investment objective should be to buy a house. For one, a house provides you shelter. You may also argue that your home generates return because you save on rent! But such an argument may not always hold water for reasons mentioned in the next section. Your house can, however, be an attractive investment during your retired years. How? You can reverse-mortgage your house to generate cash flows that can supplement your pension during your retired years. Of course, this would be possible only if the value of your residential property is significant and your children do not quarrel on your decision to reverse-mortgage the house.
For another, buying residential property provides more satisfaction than investing in a financial asset because of the touch-and-feel factor attributed to physical assets. Besides, the urge to own a house comes early in your working life because of family and peer pressure—if your friends have already invested in a residential property, it is highly likely that you will want to do so too! This factor is driven more by our culture than by risk-return benefits; it is typical for individuals to buy real estate and gold without much consideration about the return on such investments. So, why then should you consider saving for retirement if there are compelling reasons to buy a house first?
Retirement savings
There are two reasons why buying a house should not be your default choice. One, your job requires you to continually transfer your work location. If you do not live in your own house, you will typically rent it. Now, given the low rental income relative to the high initial outlay, it is moot if your investment in a house will be attractive. And if you believe that you can increase your returns through low down payment and higher borrowing, remember that the monthly installment on your mortgage can be otherwise used to accumulate wealth in your retirement account.
Now, a portfolio consisting of stocks and bonds in your retirement account typically outperforms investment in real estate. And if you believe otherwise, do not be carried away by the returns that real estate has generated in the last 10 years! And even then, how can you consider any increase in value of your residential property as part of returns, considering that your intention to buy a house is to occupy it, not to sell it at a higher price and profit from the transaction?
Two, you should consider saving for your retirement first when renting is cheaper. This would apply to you if you live in a smaller city or in the outskirts of the metros where rentals are lower but land prices are higher, making initial investment in a house unattractive.
Conclusion
Your decision to choose a house first can be attributed to the present bias—our tendency to typically prefer near-term rewards to future rewards. Buying a house gives us happiness now whereas saving for retirement generates happiness only at retirement. But beware. Buying a house first need not be an obvious choice.
(The author is the founder of Navera Consulting. Feedback may be sent to >knowledge@thehindu.co.in )