This is part five of a five-part series on Retirement Planning.
Part 1: Years to Retirement
Part 2: Savings Rate
Part 3: Inflation
Part 4: Social Security
Part 5: Large Asset Ownership
I have been surprised recently by the amount of advice from financial experts against purchasing homes and other large assets.
They refer to things such as market collapses, uncertainty, frustrations associated with maintenance, transaction costs, and ownership as a barrier to lifestyle flexibility, as the main reasons to consider renting over owning.
Truthfully, their reasoning is sound. The numbers do make sense when you look at them from a certain point of view. However, I personally don’t subscribe to this type of philosophy generally.
Instead, I view homeownership as a matter of security, providing one of the needs to sustain particular lifestyles (and it does so mostly in perpetuity).
As a financial asset, it is subject to risk, just like anything else. But it can also be a very beneficial financial asset (with a great return), and it can even be considered an inexpensive source of funding for short term needs. The key is to be responsible, realistic and pragmatic when buying a home.
Understand the (potential) risks, study the market, and make sure you over-leverage yourself. Let your home serve you, and don’t get yourself into a situation where you have to serve it. In other words, it’s important not to be house rich but cash poor.
Large Asset Ownership
Large assets like homes, rentals, businesses, real estate, and other non-depreciable assets are useful for retirement and important to take into consideration. With that being said, they can also be very tricky when it comes to knowing exactly how to account for them.
As a general rule of thumb, other non-depreciable assets like collections, memorabilia, art, licensing agreements, or intellectual property should not be depended on for retirement income or as an asset. Don’t rely on them to be a source of retirement income, rather think of them as an added bonus if, and when they pay out.
Speaking of that, I once met a couple who purchased internet domains decades ago as a strategy to fund their retirement. Internet domains are a non-depreciable asset, however, that doesn’t make them a high-value asset, let alone a “sure thing” when it comes to any amount of income. This couple is unwilling to sell any of their domains for less than $1 million each, which is quite the stretch. So far, the highest offer they’ve received for any of their domains is $5,000 and they’re 5 years away from retirement.
This is an example of really poor retirement planning.
On the other hand, when it comes to homes and businesses however, I have heard several philosophies when it comes to these. In the end, they actually all have some truth to them. These general principles can be generalized to all real property type non-depreciable assets, but we’ll focus on homes and businesses specifically.
Homes As Retirement Assets
“You can expect your costs to decrease in retirement because you will pay off your home. Therefore you can expect your living expenses to decrease at least the amount of your mortgage payments and to use your home as an asset you can borrow or sell against.”
“You can expect your costs in retirement to stay about the same. Even though you have lower home costs, you will have more medical and lifestyle costs. Medical costs will occupy more than twenty percent of your budget, and that is about the same as your current home payments.”
“Your home will not be able to fund or even compensate for living expenses. You will eventually need to sell your home because you won’t be able to take care of it and you will likely end up in assisted living, which costs considerably more than owning a home. You can expect this expense to consume both the mortgage amount and home value. Therefore, you can’t count on your home as an asset after retirement.”
These are the three general philosophies I have heard and I believe that each one of them has truth in it. Assuming you will need a higher income in your retirement years than you currently have now is a good assumption to make because it will help you be more conservative in your financial plan and give you more wiggle room. However, I personally don’t believe that retirement costs will spike. Changes to your cost of living are very difficult to accurately predict.
For this reason, I always suggest using interest adjusted buying power method of predicting the standard of living..
I also don’t believe it is financially responsible to rely on money spent on your home in the same way that you would view a bank account: whatever you put in you will get out.
On average, home values go up, but not all home values go up. Especially if it is a home you plan on living in for a long time. Neighborhood dynamics, construction projects, or city planning can have a very big impact on the value of your home. The longer you have to retirement, the less you can rely on your home as a guaranteed retirement asset.
Alright, so what should you do with your home? Well, it certainly isn’t valueless. Quite the opposite of that. I suggest taking the approach of look at your home as a large asset that has the potential to either increase or decrease in value.
This is much the same as a stock, bond, or any portfolio. The main difference, however, is the transaction cost. It costs way more to sell a home than a stock or bond, but the principle is the same. Living in a home is a continuous benefit afforded by the investment (eliminates living expenses like rent in perpetuity). If the value of the asset shifts such that the dividend is no longer worth it, make a change.
And if it makes sense, you may want to consider selling your home, putting the money in an investment fund, and using the proceeds to rent in perpetuity. If your health is concerning, downsizing or going into assisted living may also be a necessary option.
My opinion on this is simply to make as good financial decisions as you can as far as living arrangements go, and kick the can down the road to make the rest of your decisions at retirement. Your home is an unpredictable, but not wildly variable, asset.
If you’re currently considered purchasing a new home or refinancing your mortgage, you’ll want to read our recent review of Box Home Loans.
Businesses As A Retirement Asset
“Businesses are a source of passive income that can generate long term income over the course of your retirement. With proper management they will grow with, or even faster than.”
“Businesses can be a good source of income, but by taking a passive role, the business will likely not make as much as it did with you driving it and the returns will degrade over time. It may be wiser to sell your business and put the proceeds into your income accounts to provide a lower, but guaranteed return.”
“Businesses are wildly unpredictable. With so much disruptive innovation and fierce competition that they simply cannot be counted on as retirement income. Selling while you can is the only responsible thing to do in retirement planning.”
Although businesses share many of the same properties as homes, they are significantly trickier and more complex. Owning all, or even part of a business is an asset that you can sell or borrow against, but unlike a home a business can pay cash dividends, and not living space dividends.
Just like homes and real estate, the transaction cost is high. In fact, it’s often even higher than the transaction cost of homes because finding potential business buyers is more difficult than finding a home buyer. Unlike homes, the value of the business can fluctuate wildly. Between entering new markets, or finding cost savings with new innovations, potentially increasing sales or decreasing costs and consumer behaviors, as well as disruptive products and services, the value of your business can vanish in what seems to be overnight.
So what is the strategy when it comes to businesses as an asset for your retirement? Well, it is pretty much identical to the home strategy, just much harder. You have a large asset that has illiquid value, but real tangible benefits (dividends). The best approach is to be careful.
If the business takes a certain level of expertise to manage, perhaps selling it off, or parts of it, to competitors may be the best alternative. If it takes a pretty standard set of skills that can be found easily or trained easily, consider hiring a general manager and taking on a passive role while still maintaining control and ownership.
You don’t need to decide now. You will be in a much better position at retirement to know exactly what you should be doing then. View it as a large asset that will likely retain a large amount of its value, but don’t depend on it as far as getting every dollar out of it for a clear path to fund your retirement. Losses happen, and risk is considerably higher in business.
How Large Assets Impact Your Plan
Go ahead and include your home, business, and other non-depreciable assets in your retirement plan. It’s likely that they are going to increase or maintain their value, but plan on them funding your entire plan.
In other words, hope for the best and plan for the worst. Assume they will be worth a percentage of their current market value (percentage will depend based on market risk and time to retirement) in order to hedge against potential future losses. In the meantime, it’s important to keep your financial plan up to date and update your retirement asset projections as your current asset holdings change from year to year.
*”non-depreciable asset” refers to an asset whose original value isn’t consumed through use and ownership. For instance, a home can maintain its value, or even increase in value even after it has been lived in for many years. The value of the property will not decrease with use. Thus it is a non-depreciable asset. Although there are costs associated with repairs and maintenance, these costs don’t affect the overall value. On the other hand, if you buy a car, you will never sell it for the same price you bought it. By using the car you are decreasing its value. This is depreciation, therefore the car is a depreciable asset. This section is talking exclusively about non-depreciable assets. Don’t confuse non-depreciable assets with large purchases. They aren’t the same. Sorry boat and RV owners.
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