Primary Home vs. Diversified Portfolio

After the last commentary, one reader asked a great question:

"The market portfolio may be more diversified, but is it truly less risky, on average, than the value of a home over time in the Boston area?"

Since "risk" means different things to different people, and since there are various types of risks, we'll try to provide some general perspective and a historical analysis to help you think about it.

When it comes to "risk" in this case, two questions to think about are:

  • I might need X dollars in the next year, how should I invest it?
  • I don't need Y dollars for the next 20 to 30 years, how should I invest it?

The first question leads us to liquidity and price stability. So, what's more liquid (can be sold quickly and generally holds its value): a house, stocks and bonds, or cash? Clearly cash, but let's review some reasons why:

  • Selling a house or getting a home equity line of credit requires a lot of time (days to months) and may have high transaction costs (up to 6% of the home's value).
  • Stocks and bonds are typically much easier to sell than a house, usually with just the click of a button, but their prices can be volatile1.
  • Alternatively, cash requires no sale and generally provides stable value2. With some set aside, you can avoid selling your house and/or ride out market volatility — meaning you're not forced to sell more risky assets at a loss to meet any short term or unexpected expenses.

Regardless of how you allocate your money, cash is critical to help manage unexpected expenses over the short-term. Having cash equivalent to 3-6 months living expenses is the often quoted rule of thumb; however this can vary significantly for different people3.

The second question requires thinking about the opportunity cost of long-term returns. According to Investopedia, opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action4. When you choose to put money in your house, you are choosing to invest in your home instead of other assets like stocks, bonds or rental properties. There is no right or wrong decision, but it helps to analyze options to best meet your goals.

So, how has a diversified portfolio of stocks, bonds and cash performed versus a home in Boston over the long-term?

In Figure 1, we show the total return of a hypothetical conservative portfolio (50% US Stocks, 30% US Bonds, and 20% Cash) versus a Boston Home Price Index (the S&P Case-Shiller Boston Home Price Index), starting with a $100 in each investment in 1987 and holding until June 30, 2017.

Figure 1

Source: Boston Home Price Index = S&P Case-Shiller MA-Boston Home Price Index (1987-2017); US Stock Market = S&P 500 Index (1987-2017), US Bonds = Barclays US Aggregate Bond Index (1987-2017), Cash = 3-month Treasury Bills (1987-2017); Returns are not adjusted for inflation, taxes, maintenance costs of transaction fees.


The 50/30/20 Portfolio has significantly outperformed. Why? One major reason is compounding – the interest and dividends from the portfolio are re-invested and compound. Since the homes we live in do not pay interest or dividends, their returns have lagged a portfolio of assets that do, such as stocks, bonds, or even investment properties with rental income (which can act like a dividend). As we mentioned in the first commentary, compound interest is powerful.

We are not saying that the future will look like Figure 1, where market conditions were mostly favorable. But the historical data can help us understand our options, assess probabilities, measure risk and make informed decisions. Of course, we must also take into consideration our specific objective, risk tolerance and time horizon when using this information to decide what suits us best.

We should think of the hypothetical diversified portfolio as a toolbox with each tool serving a different purpose. Historically, cash has been the best tool to manage short-term expenses, while investments that tend to benefit from price appreciation, reinvestment of dividends/interest, and compounding have generally been optimal tools for long-term returns.

Please note that the above example is simply a total return comparison of a hypothetical diversified portfolio versus the potential appreciation from a primary home. Also, for simplicity, the one example does not consider tax consequences or transaction fees for either investment or the total costs associated with owning a home.A more in depth analysis is required when deciding whether to pay cash for a home versus takeout a mortgage, or when deciding to pay off an existing mortgage versus investing in the market. A thorough analysis would consider a variety of factors that are beyond the scope of this commentary and should be applied to your unique situation along with the help of a professional.

Lastly, as noted in the opening line, this commentary was inspired by a reader?s feedback. We appreciate and strongly encourage continued feedback. Knowing what the readers are wondering about allows us to give you more applicable information.

*For your consideration, a Q&A about ?risk? may not resonate with the broader reader as it would with a specific person. The content of the article may be confusing to the broader reader, although the content was simplified.

1Security prices, at time of sale may be worth less than its original value, can be volatile depending on market conditions among other contributing factors

2Cash generally provides stable value over the short term. Over time, the value of cash may be worth less than its original value due to inflation.

3What is the right amount of cash to have? An often quoted rule of thumb is a minimum of 3 -6 months of living expenses. But this number is different for different people, depending on factors such as income type, job security, short-term plans, and other unique factors. It’s also important that the cash reserve in your overall portfolio is held in ?liquid? accounts and not ?restrictive? accounts such as a retirement account that would be subject to tax consequences and early withdrawal penalties if under age 59.5.

4http://www.investopedia.com/terms/o/opportunitycost.asp

The information provided is general and intended to inform and educate. It is not intended as an offering of any specific products or services, nor to be construed as specific investment, legal or tax advice. Past performance is not indicative of future results. Individual situations can vary, as such; this information should only be relied upon along with an individual assessment in light of your own specific situation.

The S&P 500 Index is a broad-based unmanaged benchmark generally representative of the US stock market. The index does not reflect investment fees and expenses, and investors cannot invest directly in the index.

Barclays Capital U.S. Aggregate Index (formerly the Lehman Brothers U.S. Aggregate Index) is an index of the US investment -grade fixed-rate bond market, including both government and corporate bonds. The unmanaged index does not reflect investment fees and expenses, and investors cannot invest directly in the index.

S&P Case Shiller Home Index is an index that tracks changes in home prices throughout the United States. The index is unmanaged and does not reflect investment fees and expenses. Investors cannot invest directly in the index.