Some of you who read the headline above are wondering what revelation Monevator will bring you next.

Magic beans aren’t legal tender? Money doesn’t grow on trees?

Of course your house is an investment. Of course it’s an asset.

But from experience I know other people are up in arms:

“My house is not an investment! I will not consider it part of my net worth. My house is my home. It is not for sale. I have to live somewhere!”

The best that can be said for their viewpoint is that unlike much wrongheaded financial thinking, this particular form of fiscal foolishness doesn’t do much harm (aside from raising my blood pressure).

It’s not like thinking you borrow money from a bank (no, you borrow from your future self) or ignoring the impact of compound interest (clue: it’s enormous) or ignoring the time value of money.

In fact it’s likely a beneficial delusion.

Treating your home as a long-term commitment rather than a token to trade is a big reason why people usually do much better owning their own property than they do investing in shares.

But that doesn’t make them right.

Your house is an investment, an asset, and a big part of your financial net worth, regardless of what imaginary friends you had as a child or whether you avoid walking under ladders or whether you Feng Shui your home, or any other irrational thoughts you have about money.

The things they say

It’s so blatantly obvious to me that your own house is an investment, I’ve put off writing this post for years because I’m afraid I’ll sound like a patronising nursery school teacher asking if everyone is happy.

“Yes miss, I’m very happy today as I haven’t yet fully integrated my prefrontal cortex. Also, I think I’ve wet my trousers.”

Instead I’ve decided to just sound angry.

Twice in the past month alone, two financially astute people who I have a lot of time for declared to me that their house was not an investment.

And something snapped.

This madness has to stop!

Since by any normal measure it’s abundantly clear that your house is an investment – you go and buy a house, it increases in value, one day you likely sell it – normal weapons clearly don’t work on this form of muddy thinking.

Instead, we’re going to turn their own puny but persistent arsenal back on itself, by tackling each of their feeble defences in turn.

So let’s run through the things they tend to say, and why they’re wrong.

Incidentally, I’ll use the words investment and asset interchangeably, because they both apply.

You can also insert “part of my net worth” because they also claim a house that’s worth many multiples of their annual salary is not part of their net worth, too (I know! And these are sane people!) but it’s very clumsy to write that out.

“My house is not an investment because I don’t intend to sell it.”

Just because you don’t have plans to sell your house, that doesn’t mean it’s not an investment.

It’s an investment that you’re not selling right now. Simple.

Many of Warren Buffett’s friends and family never sold all their Berkshire Hathaway shares, and they became mega-rich because of that. They’d maybe borrow against shares to buy homes or similar, but they never sold out completely.

And you’ll notice that financial journalists don’t tend to write:

“What a shame Warren Buffett’s early friends and family didn’t make an investment in Berkshire Hathaway, because it looks suspiciously like they’re very wealthy on the back of those shares they didn’t sell. I guess it’s some sort of money illusion. Nice sports car, mind.”

Most people move houses several times. Strangely enough, when they come to buy a new house, they usually sell the current one.

When they do sell, they expect not to see change from a twenty. And the rest.

They want paying! From the sale of their house that isn’t an asset or part of their net worth. (Right…)

Young people renting houses up and down the country are not priced out of the market because estate agents will only sell to people who’ve painted their own walls and visited a Dunelm.

They are priced out of the property market because people bought houses, and those houses have gone up in value – like good investments do – and sure enough those homeowners want paying if somebody else would like to own their house.

If it walks like a duck…

Your house is an investment.

“My house is not an investment because I need it to live.”

No, your house is a very valuable investment because you need it to live.

It’s funny how people don’t consider their homes an investment, and yet they’ve no such confusion about pensions.

One day you’ll need to live on your pension, too. It’ll prove a good investment. Like buying your own home.

“My house is not an asset because I need to live somewhere.”

I know this will shock the smugger homeowners out there, but everybody needs to live somewhere. Those of us who haven’t bought our own homes don’t retreat to the woods at night to forage for snails and sleep upside down with the bats.

The fact that you need to live somewhere is one of the very good reasons to buy your own home. It can be the cheapest way to pay for living somewhere, in the long-term, not least because you end up owning a valuable asset. (Oh the irony).

If you chose to you could sell your house tomorrow, bank the cash, and start renting. You wouldn’t die like a clownfish flapping about on the High Street pavement, gasping for air.

You’d have traded one investment (a house) for another (cash in the bank).

“My house is not an investment because it doesn’t generate a return.”

Yes, people really do say this. Push them and they might say:

“Well I don’t even know how much prices have gone up, I don’t even look in the estate agent’s window. I don’t even check on Rightmove three times a week. Not usually. Not before lunchtime! My house is not an investment”.

Well, good for you, but even if that’s true, your ignorance about the value of your investment doesn’t mean it’s not an investment.

Warren Buffett says he wouldn’t care if the stock market didn’t open for a decade. He doesn’t care about day-to-day prices either. But every one of his shares is an investment.

It’s one of the biggest divisions in this country that those who’ve owned property for more than 20 years can utter this sort of nonsense with a straight face, having bought their homes for the equivalent of couple of iPhones and a pint of fancy cider.

But there you go. Their house has been an outstanding investment – likely multiplying their initial deposits five to 30-fold or more – but, I know, it’s a home!

That long-term tax-free capital gain is only one part of the return that you get from owning your own house, by the way.

You can also rent out rooms in a house. You happen to rent out rooms to yourself and your family. Economists call it imputed rent.

As we all agree, you have to live somewhere, and generally you have to pay rent for that somewhere, too. (Don’t tell your parents, generation boomerang…)

If you own your own home, it’s imputed rent all the way for you. Which means you’re a money-grabbing landlord (to yourself) as well as a moony-eyed homeowner.

The truth is you’re killing it in this investment game by owning your own home!

“I have to spend money doing up my house.”

This doesn’t mean it’s not an investment.

It means you have to spend money maintaining (or increasing) its value.

It means it’s not as lucrative as it might seem. It means it’s a less convenient asset than a fund held in an online broking account.

It’s still an investment.

“A house is illiquid.”

I agree. It’s an illiquid investment.

I have small cap shares that I bought in batches of a few hundred at a time to avoid moving the price. They’re still investments, too.

In the midst of the credit crisis, the Qataris and other sovereign wealth funds bought half-finished skyscrapers across London that nobody else wanted. They got them cheap, and it’ll be years before they sell. They’re investments.

I could go on for hours.

“My house is not an asset – I have a huge mortgage!”

Aha! At least here we have an appreciation of assets and liabilities. However it’s still wrong.

The fact that you have a £200,000 mortgage, say, on your £300,000 house does not mean you don’t have an investment in property worth £300,000.

You do. It’s just you also have a debt secured against that property to the tune of £200,000. The net asset value of your investment in property is £100,000.

This is true even if you’re in negative equity, incidentally. In this case you have a negative net asset value. Not good, though a lot better than if you had no house at all to net against the £200,000 of debt.

By the way, your bank won’t make the mistake of not counting your house as an asset if push comes to shove.

Despite the fact you live in it, that you have to live somewhere, that you have pictures of your kids on the walls and you painted those walls yourself – ah the memories! – your bank sees your repository of dreams as an entry on a spreadsheet that enables it to lend you the money to buy a house in the first place.

Just ask somebody who’s had their house repossessed.

Alternatively, go to the bank tomorrow and explain to them that you don’t want to buy a house at all. You’ve read on some different blog that a house is NOT an asset and NOT part of your net worth – I know, bizarre – so you really can’t see the point of owning one.

But you would like to borrow £200,000 to spend on a fancy tent and a lot of camping fees.

Oddly enough, your bank won’t lend money against your vagabond dreams.

“I don’t pay tax if I sell my house, so even the government knows it’s not an investment.”

Someone actually said this to me once. I didn’t know whether to laugh or commandeer a bus to run him over, and then reverse to make sure.

I know I’m inclined to take this one personally, given I juggle capital gains tax on a few puny thousands of pounds worth of shares while countless friends have made six-figure sums on their homes tax-free over the past two decades – and then I even take stick on this blog for trying to minimise my CGT bill – but anyway, for the love of all that’s Holy, just because you have an almighty tax break on your house doesn’t mean it’s not an investment.

It’s just another way in which it’s potentially a great investment.

“There’s no point me considering my house an investment, because it would make up most of my net worth!”

This doesn’t mean it’s not an investment.

If you actually totted up your own personal balance sheet properly, you might better appreciate that you’re very exposed to one asset class – property – and very light in most of the others – cash, bonds, and equities.

“House prices don’t go up so much once you take into account costs and inflation.”

An interesting point. But while I’d take a lot of persuading that houses are a bad investment, presuming you don’t buy in the middle of a bubble – I’m not actually arguing in this article that houses are a good investment.

I’m arguing that houses are an investment, good or bad. Which they are.

“It’s only worth something when you sell it. Otherwise it’s all paper.”

An ex-girlfriend used to say this all the time. She was smart but had some funny views about money.

By this measure only people who keep all their money in cash are rich, and the rest of the world’s wealthy are phonies.

This means Forbes will have to rewrite its rich list to focus on drug dealers, prostitutes, tin can millionaires, and Scrooge McDuck.

While it’d make for an interesting read, it’d also be wrong.

As rich people everywhere know, you don’t have to sell something for it to be worth something.

Another brick in the wall

It’s very simple. You invest in a property, you probably bought it with a mortgage that you pay off over the years. Eventually you own the house and you can live in it or roll the money into a new one.

While owning it you live seemingly rent-free (or more accurately enjoying that imputed rent, and please note I didn’t say ‘cost-free’) until the day you die or achieve immortality by cryogenically freezing your brain and encamping yourself in your living room amongst all those lovely things you own and those nails you hammered into the walls (“my house is not an investment, I just don’t want to ask a landlord for permission to bang in a nail!”) for all eternity.

And you can sell or downsize or trade-up your investment along the way, too.

If a 70-year old woman sells her rectory to buy a smaller and more manageable two-bed flat, she is not obligated to pretend she hasn’t got a six-figure sum in the bank that doesn’t really exist because her house was a home not an investment.

She’s allowed to spend the money she gets from selling her investment, including the capital gain she made it.

Somebody else might end up renting all their lives (foolishly, in my opinion, but it’s what I’ve done so far so there you go), investing in shares or other assets, and eventually have a portfolio that pays their rent when they retire.

Their share portfolio is an investment, too, even though it pays for them to live somewhere, which we agree is essential.

The fact that your house’s gains roll-up capital gains tax free, or that it’s illiquid, or that you bought it using leverage (a mortgage) does not mean it’s not an investment or an asset – it just tells you more about what kind of an asset it is.

The last time I tried to convince a good blogging buddy of mine that his house was an asset, he retorted that his house had:

“… absorbed capital that I cannot liquidate without exposing us to hazardous renting and the UK housing market that appreciates above the rate of inflation – that’s a dangerous thing for a retiree to do financially.”

Talk about making my case for me!

Yes, a house is not some useless consumable item – it’s a damn useful asset/investment to have when you’re retired for exactly the reasons he states.

Just ask the old boy who rents next door.

Things that aren’t assets:

• dishcloths
• mistresses and toy-boys
• budgerigars
• leftover pizza

Something that is an asset:

• a house

Our property-disowning, home owning democracy

The worst thing about this whole nonsense is it infects social policy, too.

We live in a crowded country where we’re invited to feel sorry for wealthy pensioners living alone in four-bedroom houses whose Council Tax has risen because their home, well, it’s not like a big house is an asset they could sell, is it?1

We also have situations where old person A doesn’t have to sell his house to pay for care, but old person B who saved the money in cash instead is judged as having the means to pay for it. (I paraphrase, but that’s the gist – and it applies to all sorts of means-tested benefits).

The incredible thing is that even after getting through these 2,541 words (count ’em!) someone, somewhere, is thinking:

“Yeah, but that’s rubbish, because my house is not an investment”.

Look, I get it. You like the security of owning your own home. You don’t intend to sell. You dealt with the dry rot. You love the wisteria. You haven’t considered what you’d get for the house if you put it on the market since the day you bought it and carried an IKEA bag over the threshold.

Fine, that all makes sense.

Just don’t tell me that your house is not an investment or an asset. Because that’s exactly what it is.

1. Seriously, why do we feel sorry for a homeowner who has to sell up, but not for a renter who is already renting? It’s muddled. [↩]

Good reads from around the Web.

It’s a truth universally acknowledged that anyone in possession – or pursuit – of a fortune will run up against a financial services industry determined to make life more complicated for them, in order to extract their portion of silver.

So passive investors should be concerned that the fast-complicating ETF sector is set to become more convoluted still.

The profusion of ETF types – synthetic, leveraged, short, sector-focussed, actively managed, and more – has already moved ETFs far from their origins as simple stock market-listed index funds.

And now Rick Ferri warns that rule changes by the SEC to make it easier for companies to launch ‘self-indexing’ ETFs will make things murkier still.

Ferri writes:

Soon there will be self-indexed ETFs that don’t follow any published index.

They’re secret.

Only the fund providers themselves will know how the index is constructed – and what’s in it – even though the ETFs will be marketed as passive indexing.

That authority behind the change, the SEC, is a US body, so initially this is a concern for US investors (and those who buy US-listed ETFs).

But where the US leads in ‘innovation’, the UK eagerly scampers behind.

As a result we will also need to be doubly alert to what we’re investing in.

That’s probably okay for Monevator readers. We’re all well aware of the need to check out which index our fund follows, how it is invested, where it is domiciled, and what it costs to run.

But the ordinary and clueless man or woman in the street hasn’t the foggiest.

Ferri notes:

If self-indexing sounds a lot like active management, it should, because that’s essentially what it is.

The requirements for self-index ETF holdings are identical to the website disclosure requirements applicable to actively-managed ETFs. So, why not just call this active management?

I suppose some ETF providers may conceivably use self-indexing to create real-but-cheaper ETFs that offer broad market exposure while saving some money paid to index companies.

But others will produce exotic ETFs that cost more to run and that are benchmarked – and marketed – using their own made-up indexes. These will be designed to either sell investors an exciting active ‘story’, or to provide a more flattering benchmark for performance than a vanilla index would.

Ho hum. As I said last week, the so-called ‘lazy portfolios’ will meet the needs of the vast majority of people who want to save and invest for their future.

[continue reading…]

I’m pleased to introduce another post by Pete Comley, author of Monkey With A Pin and a much-debated Monevator article last year extolling the virtues of cash. This time it’s inflation that Pete has in his sights…

Most people think inflation is just one of those things that happens. That like the rain, it is a fact of life and almost appears like a random act of God. We have always had inflation and ever will. It is meant to be around 2%, but sometimes it goes higher and (much less often) a bit lower.

End of discussion.

But if you look back into history, it was not always like that.

The following graph shows the UK inflation index – including the best attempts to historically replicate it where applicable – since 1750.

What this graph of inflation shows us is that for nearly 200 years, prices in the UK went up and down in a zigzag, largely influenced by good and bad harvests.

The graph also shows the impact of war. During conflicts, resource shortages and massive increases in money supply led to sharp price rises. However the graph shows that after the Napoleonic Wars and World War I, there followed a period during which prices to a certain extent came back down again.

But inflation did not come down after World War II. Since that time, UK prices have taken a very different direction. They have moved continually upwards.

To understand why – and what it means for us today – we need to understand the economic situation back then.

Britain’s Financial Dunkirk

After the war in 1945, Britain’s finances were in a mess.

We had won the war, but in the process government debt had soared to 237% of GDP. The Americans had given us billions and then, after VJ day, demanded we pay it back. To make matters worse from this perspective, the UK had just elected a new Labour government that had promised to spend even more cash to nationalize everything.

The famous John Maynard Keynes, then working for the Treasury, said Britain faced a ‘Financial Dunkirk’.

But roll on just 25 years and Britain’s debt to GDP ratio had reduced to around 50%. A remarkable achievement!

How was this economic miracle pulled off by a country that was often described in the 1960s and 1970s as the sick man of Europe?

According to some detailed analysis of deleveraging by Ray Dalio of Bridgewater Associates, virtually all of the debt was just inflated away.

The UK’s ever increasing tab behind the bar

If you look at the government debt statistics, you’ll find that over that period, the UK did not net pay off any of that debt. Instead it actually increased debt, from £2.6bn in 1947 to £3.3bn in 1970.

Moreover, if you start pouring over the debt numbers – as I did for my latest book – you’ll notice that no UK government has had a written plan to pay down its debts since Sir Robert Warpole in the 1720s! The government debt tab behind the Treasury bar has been rising for hundreds of years. You are still paying for the Battle of Waterloo today.

There are basically three ways governments can deal with their debts, if they don’t plan to pay off the capital.

• Firstly they can make the payments easier to afford. For example, following the Napoleonic Wars, productivity increased massively in Victorian times, as did the population, and so UK debts became a much smaller proportion of our tax take.

• The second option is default. The UK likes to pride itself that it has not formally defaulted on government debt – although it has rewritten its debt contracts like War Loans, which some might class as a default.

• The third option is to just inflate the value of the debts away.

Given the lack of much real productivity growth, the third route was the one that the UK (and other countries) decided to follow after 1945.

An inflation whodunnit

So how did this change in UK government attitude towards inflation come about? Who or what was responsible?

Culprit #1: Hugh Dalton

Clement Attlee’s post-war Chancellor must bear some of the blame for instilling an inflation policy into UK governments and the Treasury.

Hugh Dalton was one of the few Chancellors that the UK has ever had who really understood economics and public finance . He wrote some the first textbooks on the subject in 1923.

‘Comrade Hugh’ as he was known passionately strived against passive rentiers. Ideally he would have got the rich to directly pay off the debts after the war.

Instead he decided on way of making cash and bond holders pay by ensuring he kept interest rates low whilst fostering inflation – a policy that today we call financial repression.

Culprit #2: John Maynard Keynes

Some of the responsibility also lies with John Maynard Keynes, although it was probably not intentional on his part.

Many aspects of Keynes’ economic thinking as expressed in his General Theory came to be adopted by postwar governments, both here and in the US. In particular, politicians somewhat simplistically interpreted Keynes’ writings as saying that if you wanted full employment you had to have a certain level of positive inflation.

Therefore policy makers started adopting a positive inflation attitude.

A good example of this was in 1952 when the Federal Reserve in the US was granted greater independence, and specifically tasked to maintain “low inflation”.

Culprit #3: Bretton Woods

What the US decided about inflation had a positive impact on the UK because of the Bretton Woods monetary system.

This in effect pegged the pound to the dollar, so inflation being created in the US was then exported to the UK. Both countries then benefited from the reduced burden of their debts in real terms.

Inflation today

We have inherited that system where having positive inflation is built into the very structure of our economy. And the Bank of England is tasked with ensuring we always have it, targeting a rate of around 2%.

The government has allowed contracts to be created that also stoke inflation – think rail fares that go up every year by above RPI, and the recent rises in tuition fees. They are but two examples. Indeed recently Merryn King was bemoaning the fact that nearly half of our inflation was caused by these government regulated prices.

As a result of the UK government’s bias to inflation, prices in the UK have gone up over a half since 2000.

The need for inflation in the economy is arguably more important now than ever, due to the escalating nature of UK government debts. Our budget deficit of £120bn a year is adding very quickly to our total public debt.

Indeed if you look at our projected debts for the next few years in inflation-adjusted terms (as opposed to a ratio of GDP) you can see the reason why inflation must continue in the UK, and why it will almost certainly will be helped higher by Mark Carney in some way.

[Many will see the Bank of England’s new linking of the inflation target with a 7% unemployment threshold as a move in this direction – The Investor].

Why inflation is a real danger to you now

The impact of inflation – and how you might avoid the consequences of inflation – has been well-covered on Monevator in the last few years.

What I think few people have fully appreciated though is that inflation now – even at 2-3% a year – has suddenly become a problem for us in a way it was not, even just five years ago.

As I discussed on Monevator last year, cash deposits for decades kept up with inflation. Even after subtracting basic rate tax, savings accounts were usually able to preserve wealth.

That all changed with quantitative easing, and more recently with the government’s Funding for Lending scheme. Interest rates are now a long way below inflation and I think they are likely to remain there for many years to come, ensuring anyone with cash will see its real value eroded.

An even larger concern in my mind is what is happening to wage inflation. Because of the recession, many workers have effectively struck an unwritten deal with their employers that they’ll take little or no inflationary rises in return for keeping their jobs. Average wage inflation is 0.9% vs RPI at 3.3%.

Moreover if you look at the latest four years of data for average gross income for all UK households, it has not grown a penny. Against that RPI is up 12.5%. We are all becoming poorer because of inflation.

Why income matters is that it also affects how effective inflation can be in helping reduce the burden of household debts, such as mortgages. It is all very well inflation being above 3%, but if you’ve not had a pay increase, inflation is not going to erode the real value of your debt.

In my view before we all rush to load up on ultra-cheap mortgages, we need to check we’re in a job that is certain to be awarded inflation-linked pay rises.

What history teaches us

Inflation is not a random act of god, like the rain. It is also not a mere by-product of a set of economic variables.

Inflation serves a specific purpose and has been effectively government policy since World War II.

Pete Comley’s book, Inflation Tax: The Plan to Deal with the Debts, is now available from Amazon and other retailers.

1. Data source: http://www.ukpublicspending.co.uk for 1750–2011; Public Sector Finances Databank for 2012 onwards; data for 2013–2018 are government estimates; data adjusted by RPI. RPI is assumed to be 3% pa for 2013–2018 [↩]