Home Value as % of Net Worth at Retirement?

[jIM_Ohio]

I disagree. I understand it doesn't change your retirement planning or your ability to fund your retirement. But from a gross portfolio perspective it is not desirable.

I hold that any one asset that grows to be a large fraction of your net worth is not diversified. If you had a large run up in one of your asset classes of your retirement accounts you would want to rebalance, right? It is not really practical to do that with your house, but I think it is important to know that you are overweighted in real estate. So in that case maybe you wouldn't want to go buy a rental property, but rather increase other investments. Or if you owned REITs in your investments you might reduce your exposure to compensate.

REITs return and the value of my house will not correllate. For starters REITs would probably be owned because of a dividend stream, and I don't see my house paying me dividends any time soon. I would not lower REIT exposure because my house was 20-30-50% of my portfolio.

Consider that REITs can be diversified into commercial real estate, foreign real estate, vacation real estate etc... all those sectors would not correllate to the value of my house in Ohio.

If my wife owned a $1M diamond necklace, that would not stop me from investing in diamonds or commodities.

[jIM_Ohio]

I do think it is relevant. Having a large portion of your net worth represented by the equity in your house is not diversified IMO. Look at boomers who planned to use the equity in their house to retire on. Say you only had $250K in retirement savings with $750K in home equity, planning to downsize or borrow against that equity to finance a large portion of your retirement. If you lost 20% of that equity in the housing bubble you are going to be cash strapped in retirement.

Would I use 20% as a planning target? Not really, because I think it will be the natural result of good savings habits and not saddling yourself with a large house payment.

This is how I would answer the question. Regardless of house value, a person needs good savings habits to retire with proper risk assessment.

A person's net worth does not determine if they can retire.
A person's financial independance does. In the 250k/750k case, I would argue the person is not financially independant and could not retire.

[disneysteve]

A person's net worth does not determine if they can retire.

And the percentage of net worth represented by the home doesn't matter either. If my home was 50% of my net worth, but that net worth was $5 million, I could retire just fine. If the home was 20% of net worth and the net worth was $3.125 million, I could also retire just fine. In both examples, the investment portfolio is $2.5 million.

[tripods68]

Since scfr asked the question, it is obviously relevant to him.

I'll try to be specific. The home equity does add value to your retirement nests eggs, if for instance, paid off your home and decide to cash out. It wouldn't be prudent to expect home value to go up year-after-year since it increases uncertainty in retirement planning. But it adds certainty if you have paid off your home outright. Anything that adds value to the home would simply be "icing on the cake". Downsizing is very common; kids are all grown and hopefully moved out after college. So you decide to rent or buy a condo instead. Those gains eventually becomes part of your estate. It is true, millions of Americans uses their equity gains from selling their homes as part their nest eggs. So we can't discount this fact. However, no one else is better of knowing what you will need to fund retirements better than yourself. That percentage will change year-after-year as you climb up in corporate ladder (i.e salary increases, bigger stock options awards, and bonuses) as you get closer to your retirement age. Your decision to retire will also be based on build asset mixtures and returns over the years (i.e., 401K or ROTH). Have you achieved the kinds of returns you expected with your asset allocation mixtures? If so, is that enough to retire on with your expected Social Security benefit less expenses? How aggressive can you be on your asset allocations to reach your goal?

I still go back to the traditional way to best gauge what you need upon retirement. How much do you make now, and how much of that you will need to live on comfortably upon retirement? Can you and your wife retire on one income at a lower percentage? Keep in mind, you won't be paying anymore social security, no defer comp, no SDI, union dues etc, house paid for. You will also be saving gas and the wear and tear of your car. Whatever that percentage is (50%, 60% or 80%) that should be the goal you should aim for. I guess, you need to be consistent saver no matter what life throws at you. Easy to talk a lot harder to execute.

[feh]

I'm not sure why you would want to have a target percentage. In general, I want to have as much saved/invested as possible.

The size/value of your house should be determined by what you need, rather than a percentage of your net worth.

If I were to retire tomorrow with a net worth of $5 million, I wouldn't be looking for a $1 million home. Such a home is simply not necessary. (Note: I live in the Midwest, not California).

[disneysteve]

Downsizing is very common; kids are all grown and hopefully moved out after college. So you decide to rent or buy a condo instead.

I know a number of people, including my mother, who have downsized in retirement, but none of them did it for financial reasons. They did it because they no longer needed the big house and multiple rooms, they weren't able to take care of the house anymore, they weren't physically able to get around as well with stairs and all, or they wanted to move to a warm climate to escape wintertime. In fact, a couple of people who moved to warmer climates actually spent more on their "downsized" homes than they got by selling their existing homes. They pulled money out of savings to make up the difference.

So downsizing isn't always a financial matter.

[noppenbd]

REITs return and the value of my house will not correllate. For starters REITs would probably be owned because of a dividend stream, and I don't see my house paying me dividends any time soon. I would not lower REIT exposure because my house was 20-30-50% of my portfolio.

Consider that REITs can be diversified into commercial real estate, foreign real estate, vacation real estate etc... all those sectors would not correllate to the value of my house in Ohio.

The Vanguard REIT index returned 35%, 30%, 11% and 35% in the years 2003-2006 respectively. I think that is pretty well correlated with the rise of the housing bubble in the US, although not necessarily with every housing market.

[disneysteve]

The Vanguard REIT index returned 35%, 30%, 11% and 35% in the years 2003-2006 respectively. I think that is pretty well correlated with the rise of the housing bubble in the US, although not necessarily with every housing market.

Exactly. We bought our home in 1994 for $142,000. Today it is worth about twice that. That works out to an annual appreciation rate of about 5%. We didn't see anywhere near the returns of that REIT index. Only 15% of the fund's holdings are residential real estate. The rest are industrial, offices, retail, hotels, storage units, etc. So probably not much correlation with the value of my home and the value of those holdings.

[tripods68]

I know a number of people, including my mother, who have downsized in retirement, but none of them did it for financial reasons. They did it because they no longer needed the big house and multiple rooms, they weren't able to take care of the house anymore, they weren't physically able to get around as well with stairs and all, or they wanted to move to a warm climate to escape wintertime. In fact, a couple of people who moved to warmer climates actually spent more on their "downsized" homes than they got by selling their existing homes. They pulled money out of savings to make up the difference.

So downsizing isn't always a financial matter.

I agree completey with you Steve.

I didn't mean to exclude other reasons as to why people "downsized". I was simply referring to whatever root caused people arrives at the decision to "downsized" (i.e., financial or non financial reasons) that capital gains will be part of your estate whether you like or not.

[scfr]

I hold that any one asset that grows to be a large fraction of your net worth is not diversified.

Thank you for stating my fuzzy thoughts so clearly!

And thanks to all of you for the thoughtful replies.

Some additional thoughts:

- I understand that we cannot dictate the appreciation or depreciation of our home's value, but that does not mean we can't make intelligent assumptions. We do it all the time when we do retirement calculators: Investment return, rate of inflation, life expectancy. None of us can possibly know any of those figures for certain, but we assign numbers based on reason anyway. Historically, home values have kept pace with inflation. Assuming you are buying at a price that reflects the historical trend (and not at the top of a bubble), the figure you use for expected inflation and the figure you use for the expected appreciation of your home could be the same (for example 3%), couldn't it?

- Monkey Mama is correct that I am thinking a lot about this right now because I am trying to decide how much to spend on a house. I think this is a good time to think about it. But I also think it is something people might want to monitor, especially as they approach middle age ... (see next thought)

- Regarding downsizing: I think if more people monitored their home equity as a percentage of their net worth, especially as they start to get "older" (and I'm in my mid-40's and include myself in that category so I hope no one takes offense at the use of that word), it might prompt more people to downsize earlier on. For example, if someone is 55 and realizes their home equity is too large a fraction of their net worth, and they go ahead and put their home up for sale, they are in an infinitely better position than someone who comes to the same realization at 65 and who is forced to have a "fire sale" on their home.

Well ... I've heard percentages of 10-20% and they sound reasonable to me. If anyone else thinks this calculation is (or even possibly could be) important and cares to throw out a number, that would be great!

[scfr]

And the percentage of net worth represented by the home doesn't matter either. If my home was 50% of my net worth, but that net worth was $5 million, I could retire just fine. If the home was 20% of net worth and the net worth was $3.125 million, I could also retire just fine. In both examples, the investment portfolio is $2.5 million.

Not necessarily.

If your property tax plus the upkeep on your home totals 2% of the home's value annually, on a $2.5 mill home you will need to spend $50,000 per year just to maintain it.

If you have only $2.5 mill in financial assets and you follow the 4% withdrawal rule, maintaining your home will suck up 50% of the money you have to spend annually. Surely that is not acceptable, is it?

So the value (and therefore the cost) of your home at retirement relative to your financial assets will really affect your lifestyle.

[jIM_Ohio]

Thank you for stating my fuzzy thoughts so clearly!

And thanks to all of you for the thoughtful replies.

Some additional thoughts:

- I understand that we cannot dictate the appreciation or depreciation of our home's value, but that does not mean we can't make intelligent assumptions. We do it all the time when we do retirement calculators: Investment return, rate of inflation, life expectancy. None of us know can possibly know any of those figures for certain, but we assign numbers based on reason anyway. Historically, home values have kept pace with inflation. Assuming you are buying at a price that reflects the historical trend (and not at the top of a bubble), the figure you use for expected inflation and the figure you use for the expected appreciation of your home could be the same (for example 3%), couldn't it?

- Monkey Mama is correct that I am thinking a lot about this right now because I am trying to decide how much to spend on a house. I think this is a good time to think about it. But I also think it is something people might want to monitor, especially as they approach middle age ... (see next thought)

- Regarding downsizing: I think if more people monitored their home equity as a percentage of their net worth, especially as they start to get "older" (and I'm in my mid-40's and include myself in that category so I hope no one takes offense at the use of that word), it might prompt more people to downsize earlier on. For example, if someone is 55 and realizes their home equity is too large a fraction of their net worth, and they go ahead and put their home up for sale, they are in an infinitely better position than someone who comes to the same realization at 65 and who is forced to have a "fire sale" on their home.

Well ... I've heard percentages of 10-20% and they sound reasonable to me. If anyone else thinks this calculation is (or even possibly could be) important and cares to throw out a number, that would be great!

I appreciate the research you are doing. I think you are doing a "top down" approach when a bottom up approach makes more sense.

top down- using some high level guideline such as income, debt, and net worth ratios.

bottom up- how much house do you NEED. Not a cost based analysis when you start. Define your requirements based on functional need, then figure out how to pay for it later.

bottom up example:
1) are you married?
2) do you have kids?
2a) are any of them moving out anytime soon?
2b) are any kids entering the picture anytime soon?
3) are the kids the same gender?
4) are the kids similar ages?
5) does your family live far away?
6) do you have visitors/entertain?
7) do you work from home?
8) does the holiday season affect your lifestyle?
9) do you host business functions at home?
10) do you have a hobby which affects the house you get?

and ask similar questions like these. There is no mention of cost anywhere in those questions- define the functional requirements first. (I am an engineer, bear with me).

Once you define your requirements, you can then attach a price to them. For example, if you work from home, you need a home office. Plenty of houses can be purchased without a home office (and cheaper than with a home office), but the requirement dictates that you need to pay extra for the functional requirement.

In my case, my wife loves the holidays. She also loves entertaining. She lives in many ways for having company. therefore we "need" a formal living room and some space so when 30-50 people are in our house, we have enough room.

If you have two kids of same gender and within a year in age, they could share a room, yet if there was a 3 year age difference, or a boy and girl, sharing a room is out. This would define the requirement for how many bedrooms. Again it's possible you need 4 and can find cheaper houses with 2 or 3, but your requirement is 4 and you will need to attach a price to that requirement. For example, the house we built comes with 2 upstairs floor plans- 4 and 5 BR. We have the 4, the 5 BR costs more. We can find the price on that additional BR if needed.

You could ask questions about the kitchen (maybe wife likes to cook and needs a given amount of counter space, even if normal house comes with less counter space). There will be a cost to this requirement.

Define the requirements, then do the following:

1) go to at least 3 different competing builders and price out a new home which meets the minimum requirements (even if you do not plan on building, I think this is a good step with little pressure from a realtor).
2) go look at 3 different houses (which are for sale) which come close to meeting the requirements as well. Look at overall prices.
3) go back to budget and look at what it will take savings wise to get the house which meets the minimum requirements. You have 6 data points (3 new construction and 3 for sale) to be able to average a price and make a good guess what things cost.

I should not my wife and I shared a condo for 4-5 years before building our current house. We went to homerama (expensive houses) each year and also would walk through builder market homes 2-5X per year even when we weren't looking to buy. When we walked into the model we eventually built, we knew immediately it met our requirements (hers and mine). Had an office for me and a loft for her (and kids), plus a good open great room. Window shopping for houses is a great way to spend cheap time with a spouse.

There might be houses in your area which sell for 150k, but they may not meet your requirements (two car garage, 3 BR, 2.5 BA, kitchen with formal dining room, family room and home office maybe), so you are then stuck with "higher priced" houses because of your requirements.

If that higher price takes up more of your net worth now, that is a consequence, not a decision factor, IMO.

Once you get the house price, you work backwards.
a) 20% down is $X
b) the payment with 20% down is $Y
c) the budget you can afford is $Z
d1) if Y>Z then increase X (increase down payment to get mortgage into affordable territory)
d2) if Z>Y, then invest the difference (budget is greater than the cost).

in case of d1, it might drive the ratio (networth to home value) down. In case of d2 it will drive the ratio up up up exponentially.

Again in both cases the ratio is used to express the situation, not drive the decision.

[LivingAlmostLarge]

I like the bottom's up approach. But things and situations change realize. There is divorce, death, and well unexpected kids. So nothing is set in stone. Just cause you buy a house with plans to stay there or sell nothing is set in stone.

Tell that to my neighbor's they were on the 5 year plan to sell their monster home. But then they accidentally had a baby when she thought it was um menopause and so instead they are now staying put because they want to raise their child in the bigger home and better school district instead of downsizing. Oh well. too bad their older kids were all out of the house in the 5 years plan. Now they get to keep their bedrooms.

[jIM_Ohio]

Not necessarily.

If your property tax plus the upkeep on your home totals 2% of the home's value annually, on a $2.5 mill home you will need to spend $50,000 per year just to maintain it.

If you have only $2.5 mill in financial assets and you follow the 4% withdrawal rule, maintaining your home will suck up 50% of the money you have to spend annually. Surely that is not acceptable, is it?

So the value (and therefore the cost) of your home at retirement relative to your financial assets will really affect your lifestyle.

This is a misuse of the 4% rule, IMO. The 4% rule is based on expenses. If a person has 25X their annual expenses in liquid investments, they are financially independant (or real close to it) for 40 years.

The 4% rule is NOT based on net worth. it is based on liquid assets which can be withdrawn by selling them. The withdraw covers costs. I might spend 2% per year on travel, 1% on healthcare and 1% on living (food, taxes, utilities). You might spend 2% on crack cocaine, 1% on drug rehab and 1% on utilities, taxes, and living.

How the 4% gets chopped up does not matter. 4% is a guideline used to suggest when you have enough to retire. It is not withdrawing 4% of net worth, it is withdrawing 4% of liquid assets (investments). How the 4% get spent does not change the 4% rule. There are not guidelines for what percent of the withdraw should be used for taxes, health care, body hygiene, cars or travel- because that is unique to each individual.

If you established a guideline for 4%, then found out I was withdrawing 3% at age 45 and someone else was withdrawing 5% at age 45, the ratios you established based on 4% would be misguided at best.

I might plan on living a long time and need to use 3% to prevent me from running out of money. The 5% might be used by someone which is expecting to die younger, gets a pension at an older age, or has a higher SS benefit. Or maybe that person is taking more risk in the market and can afford the higher income now.

[safari]

I don't want my house to appreciate much because I am planning to buy a bigger house when I start a family. If all houses appreciate in value, I'd have to pay more to upgrade a house. For example, if my house costs $500K and I want to buy a house that costs $1 mil, the difference is $500K. If houses appreciate 20%, my house would cost $600K and the other house would cost $1.2 mil, which means I'd have to pay $600K difference to upgrade the house. That's why I am hoping that house prices continue to plummet.