How to Make Your Home a Good Investment

Wait. Don’t people say, “Your home is your best investment?

For many people, their home may be their only major investment. For them, that old conventional wisdom might be true. But that is unfortunate.

It is easy to find better investments with dramatically higher long-term returns.

Despite the lower returns, homeowners on average are wealthier for 2 non-investment reasons.

In my latest video, podcast episode, and blog post you’ll learn:

• How do homes compare to other growth investments for rate of return?
• Why is it unfortunate if your home is your largest investment?
• What are the 2 non-investment reasons homeowners tend to be wealthier?
• Why does your home start being a great investment but then stop?
• Can your home be your retirement plan?
• Is home equity the key to wealth or is it “dead equity”?
• How can you make your home a good investment?
• What are the 2 best strategies to make your home a great investment?

How do homes compare to other growth investments for rate of return?

For many people, their home may be their only major investment. For them, that old conventional wisdom might be true. But that is unfortunate.

The average home in Toronto has grown in value by 6.3%/year the last 50 years. This is more than most other cities in Canada.

The central growth investment for long-term investing and retirement investing is the stock market, where returns have been dramatically higher. In fact, Toronto homes have grown in value only slightly more than GICs.

The average home in Toronto on January 1, 1975 was worth $52,806. Investing that amount until the end of 2024 in different investments, here is how much you would have:

We value our homes for many emotional and non-investment reasons. A home provides stability, personal satisfaction, and pride of ownership. However, as a pure growth investment, our homes are not high growth.

Remember this stat. The Toronto stock market has had nearly 7 times the growth of Toronto real estate. Global and US stock market returns are much higher.

Why is it unfortunate if your home is your largest investment?

If your home is your largest investment, you probably can’t retire comfortably.

Retirement planning has good and bad news. The bad news is that you probably need much more than you think to retire comfortably. The good news is that it can be much easier to get there than you think.

We have written Financial Plans for thousands of Canadians. Everyone is unique. The total investments most need to retire with the lifestyle they want is between $2 million to 5 million. Some with very frugal retirements are less. Some with very comfortable retirements are far more.

You can use the “4% Rule” as a general estimate. A portfolio of $2 million sounds like a lot, but it supports a retirement of $80,000/year before tax. Think of a couple with each earning $40,000/year. That’s decent, but not comfortable. I know – it’s odd thinking that $2 million is not a lot!

If you are planning to retire in 20 or 30 years, the cost of living doubles about every 25 years. To retire on $80,000/year in 25 years, you will need twice as much, or about $4 million at that time.

Other than some in the FIRE community, financial independence means you become a multi-millionaire.

A multi-millionaire is not rich today!

In short, the average home in Toronto is a bit over $1 million, while most people need $2-5 million in investments to retire comfortably with the lifestyle they want.

What are the 2 non-investment reasons homeowners tend to be wealthier?

Despite the lower returns than other investments, homeowners tend to be wealthier. There are 2 main non-investment reasons for this:

1.   Forced savings: Homeowners are forced to make their mortgage payments, which means they slowly pay down their mortgage. They are forced to grow their equity. Tenants typically have significantly lower monthly payments, but they are not forced to save.

2.   Leverage: Homeowners typically start with a down payment of 20% and borrow the other 80%. This means that for a $1 million home, they invested $200,000 but have an asset worth $1 million. They are leveraging 4:1! Their home is worth 5 times the money they invested so their returns start 5 times higher.

Leverage with a 20% down payment means that if your $1 million home grows in value by a moderate 6% or $60,000, you made a return of 30% on the $200,000 you invested.

A 30%/year return is awesome!

Why does your home start being a great investment but then stop?

Here is the ironic (and funny part). Most homeowners spend their working lives focused on paying off their mortgage. They start with a 20% down payment and are making a return of about 30%/year. As they pay down their mortgage, their rate of return on the money they have invested goes down dramatically. Once they pay off their mortgage, their home value is growing only 6%/year.

Mortgage Size             Your Rate of Return

80% of home value                  30%

60% of home value                  15%

50% of home value                  12%

25% of home value                    8%

Mortgage paid off                      6%

In short, your home starts as a great investment when you have a large mortgage. Then the return drops dramatically as you pay down your mortgage. Once it is paid off, your return is just moderate.

Can your home be your retirement plan?

I often hear people say that when they retire, they will downsize their home and use the savings for their retirement.

There are 2 problems with this thinking.

First, if you downsize in Toronto from a 2,500 sq. ft. 4-bedroom home to a 1,250 sq. ft. bungalow or a condo (half the size), the prices may hardly be any lower. You likely won’t clear very much. Remember that most people we see need $2-5 million to retire with the lifestyle they want.

Second, the people that talk about downsizing are usually young. When you reach retirement, will you still want to downsize? The vast majority of people we meet want to stay in their home when they retire. They are comfortable there. They have so much history. It is full of all their stuff. What do they do with all their stuff if they downsize? And downsizing usually would not get them much money.

There is logic in selling your home to buy or rent, especially a condo. Freedom. If you want to travel a lot, having a house is a problem. Who will maintain it, mow the lawn & shovel the snow? With a condo, you just lock the door and then travel as long as you want.

The investment logic of selling is that if your mortgage is paid off, your home is not making a great return – plus it is giving you no monthly cash flow. If you have significant home equity, how can you use that to support your retirement cash flow?

The easiest way is to sell your home and rent. You clear $1 million or more, invest it for more growth and then withdraw a bit each month for cash flow. Selling a bit of your investments each month is called “self-made dividends”.

This can help your retirement, but your home is likely not your retirement. Even if you sell it, rent, and invest all the proceeds, it is likely not enough. The amount you invest is probably less than $2-5 million most people want to retire with the lifestyle they want.

Is home equity the key to wealth or is it “dead equity”?

I hear both sides. For many people, the equity in their home is the bulk of their net worth. (Unfortunately.) But many people call it “dead equity”.

What do they mean by “dead equity”? It can mean 2 things:

1.   That part of their net worth is not getting stock market returns.

2.   When they retire, your home equity generally does not give you any monthly cash flow.

The term “dead equity” is certainly exaggerated. It’s not dead. It is still making a modest return, even if you have no mortgage.

However, the main point is generally true. Your home equity:

1.   Does not support your financial freedom and retirement goal nearly as much as it could if you invested it more effectively.

2.   Does not normally give you a regular monthly cash flow once you retire.

How can you make your home a good investment?

To keep your home as a good investment, you should keep a large mortgage on it as long as you can. There are other considerations such as payments, but remember how your rate of return drops dramatically as you pay down your mortgage?

There are 2 main ways to do this:

1.   Pay off your mortgage as slowly as possible. Start with a 30-year amortization. If you refinance, try to revert back to a 30-year amortization. Keep your payment as low as possible – and then invest the difference.

With a minimum payment, your mortgage is likely to remain above 60% of your home value for many years. This means you can keep getting a return of 15% of more on the amount you have invested.

Most people that don’t have a Financial Plan save far too little to become financially independent with the lifestyle they want. It is important to stay disciplined and invest all the savings from your lower payment.

Remember, it is the discipline of a forced mortgage payment that helps homeowners be wealthier. A lower mortgage payment only helps you if you invest all the savings.

 2.   Smith Manoeuvre: This is an elegant strategy to keep reborrowing the principal portion of your mortgage payment from a linked credit line to invest. It converts your mortgage over time into a tax-deductible credit line. It can allow you to keep your total amount borrowed at 80% of the value of your home (or whatever level you are comfortable with).

Keeping your total amount borrowed near 80% of your home value means you can keep getting the 30%/year return on the amount you have invested in your home.

In short, a home with a large mortgage is usually a great investment. A paid-off home is usually only a moderate return.

Ed