As humans, we are effectively short food and shelter for the rest of our lives, and you could probably add in insurance/medical care. (I think Mike at Rortybomb made this point a while ago, but I couldn’t easily google it.) That means that we need to somehow structure our earnings, consumption, and investment to satisfy those expected needs (future payments), bearing in mind that in our later years we’ll be doing very little earning and investing, and lots of consumption.
However, we have a choice on how we satisfy those needs. One way is to prepay them while we are working, which is what one commenter suggests for our housing needs:
My view of the housing market, and why I think a lot of this anti-housing as an investment is silly, is that it’s a consumption good you will always need to consume. You’re not going to suddenly decide in 2027 that you might do without housing for a while. On that basis alone then it’s quite sensible to store it up for when you have no income, ie in retirement. It’s an almost perfect hedge of a large chunk of your consumption needs.
The commenter is right in one regard – we certainly do need to store up for our future consumption, when we’ll have no income. However, the choice is not whether to save for the future, but in what vehicle. Specifically, the above comment seems to argue that we should be prepaying for our housing needs. Paraphrasing: “Buy a house now so that you’ll have one when you’re not employed.”
While I certainly agree with the need to save for future consumption, I don't see any reason that we should prepay our housing needs in the form of a single, non-diversified asset with large transactions costs. Similarly, I think we can effectively save for our future food needs without filling our basements with cans of vegetables, soup, and spam. (And beer! Don’t forget the beer. Some, especially stouts and barleywines age very well.)
So the choice isn’t save or don’t save for future housing consumption. But rather, in what form. Putting aside some very important factors (differences of housing types available for rent or sale, other payments like property taxes, maintenance, possible rent increases), it's an economic tradeoff between two different-looking cash flow streams. In the same way that annuities can be easily converted into lump sums (and vice versa), it's straightforward to compare renting (effectively a negative annuity) with buying (a one-time lump sum). It's inappropriate (in my opinion) to imply that buying is somehow different (and better) than renting because of the timing of the payments.
My impression of this debate is that most people arguing for housing as an investment view the purchase of a home as qualitatively better than renting a home (for reasons that are often poorly articulated), while the other side views it as more of a straightforward evaluation of the timing and magnitude of the cash flows.
Thank you for taking the time to reply to my comment. Funding one's retirement can, as you suggest, take place in three ways - either you buy up the goods and services you will want over your working life and then run them down, or rely on other people to provide you with those goods and services, whether through the sale of paper claims such as stocks and bonds or through government intervention.
ReplyDeleteYou can't really do much of the former - you can't store most goods and any services, and also your tastes are hard to predict in advance - so most of your retirement consumption will come from the hope that the financial claims you built up on other people are honoured, and preferably for more than you paid for them (a real return). I'm quite optimistic about investments providing a useful return but think you might as well pre-fund what you can, to be on the safe side, and housing is the only one you can do so, and you know you will want to consume.
Matthew,
ReplyDeleteI think we understand each other's position, and I appreciate your comment. My last two comments:
1. When you say "might as well pre-fund what you can", I completely agree with you because in my view pre-funding something means setting aside the funds for it, not placing those funds in a particular asset.
2. For many people, housing needs vary greatly over time, so that it's quite inefficient to try to satisfy housing needs in the (for example) DINK, family with young kids, family with older kids, kids move out, retirement stages with a single house. If you instead, like many people, satisfy those needs in different houses, you're incurring a lot of transactions costs if you're being at each one of those stages.