Home ownership vs investing

Make of thy dwelling a profitable investment.

— George S Clason’s The Richest Man in Babylon

The title of this article should be, “Why I’d always buy my own home over investing in the stock market”, but it was too long.

I invest in the stock market. On a monthly basis I purchase units from a low cost index fund via Vanguard, which by the way, are a superb company. I also have a workplace pension, which I invest in, again, using a low cost index fund.

I know that the stock market is a prime place to make money over the long term. The two other avenues to make money over the long term is buying rental properties and starting/owning your own business.

There’s often a debate of what is better financially, invest in the stock market or pay off your mortgage. At the moment with interest rates so low and mortgages as cheap as they may ever be, the financial return you receive by paying off your mortgage is nowhere near as good as investing the money in the stock market.

But, for once, I just don’t care.

Why? Because my house is my home. It’s where I live. It’s where my family live. It’s the place I come home to at night and the place I wake up in every morning. It’s where I sleep when I’m ill, and where I invite family and friends to visit.

I feel a home is so personal that no roaring bull market returns can equal what a home offers.

A home that is mortgage free, and all yours, is more part of your life than hundreds of thousands of pounds in a Vanguard index fund can ever be.

So at this moment, if I discovered I had a spare £100 a month, would I put it into my index fund and contribute more, or would I overpay my mortgage? The head says index fund, but the heart… of course says, I’d increase my over payment on my mortgage.

There are several financial benefits to this.

  • The first is by overpaying, you pay less interest in the long run.
  • The second is you pay the debt off early, so you stop making mortgage payments earlier, which reduces your expenses considerably.
  • The last and most important is the peace of mind you receive from knowing the home is all yours and you no longer have to pay for it.

Conclusion

Sure, you’ll get better returns in the stock market, but the inner peace a paid off home offers is priceless.

Your emergency fund is losing money

Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.

— Ronald Reagan

An emergency fund is a pot of money, at least 6 months’ worth of expenses, that you use to end a financial emergency. It stops you going into debt and keeps your financial life healthy.

Once people squirrel away their minimum of 6 months’ worth of expenses, people tend to forget about the emergency fund and move onto other parts of their financial life, such as saving for a house deposit, saving into a pension, saving into a stocks and shares ISA to invest in the stock market via Vanguard.

This “build and forget” approach to an emergency fund is, on one hand, a good thing as you don’t keep dipping into the fund when you want to buy some consumer crack such as a new TV, or new car, or holiday to hot, dusty Spain. You only reach for that fund in a real emergency, like losing your job.

But the problem with the “build and forget” approach is that inflation is attacking your emergency fund every day.

Inflation is the killer of cash. Inflation is the cost of products and services increasing over time. An example is in 1980 my dad purchased a three bedroom house in the south east of England for £18,000. In 2009 when we sold, it was worth £157,500. If he had saved the £18,000 in an emergency fund expecting to buy a house with it in 2009 he would have been shocked, and out of luck. That £18,000 in 2020, 11 years later, would be worth even less. It wouldn’t buy a bottom of the range VW Tiguan. Why? Inflation.

Over time, the cost of goods and services, usually, go up. Some things might go down. Such as a computer in 1980 would have cost a small fortune. In 2020 a computer is vastly cheaper, and more powerful. That’s because the producers of the computer and all its components have improved their processes to make computers cheaper, which allows them to lower the price, and instead of selling to thousands, they sell to billions of people.

Yet with most products and services, inflation drives the price up. When I was a child a Mars bar cost 10p. Nowadays, I’m lucky if I get a one for less that £1. That’s inflation. Same with services, I used to get my car cleaned for £5 in the late nineties, today, if I take it to the car wash, it’s £20+. Of course, at that price, I do it myself and bank the £20.

How to keep inflation from killing your emergency fund?

There are three options to stop your emergency fund getting eroded by inflation. I recommend doing all three:

  • Decrease your expenses – If your monthly expenses are £1,000, that would mean you have a minimum of £6,000 in your emergency fund. You can reduce your expenses, such as cancelling the gym subscription, as you haven’t entered the gym since it was refurnished… four year ago. The lower your expenses, the further your emergency fund spreads. In our example, reducing your expenses to £900 would mean that you only needed £5,400, so you’d actually have £600 surplus. This is a bit of a cheat really, as your £6,000 is still getting eaten by inflation, but it definitely helps. Plus, reducing your expenses should be a lifelong practice. Any money you pay out on expenses is not being saved and not earning interest, which compounds and earns more money.
  • High interest ISA/savings account – Putting your emergency fund into a savings vehicle such as a cash ISA or savings account is wise, as it allows you to access it immediately. You should shop around for an account this gives you immediate access to all the money, which offers the highest interest. At the moment interest rates are lower than a limbo dancer’s balls, so finding a rate that equals or beats inflation is almost impossible. People use between 2% and 3% to measure inflation. If you get an interest rate in your savings account of 1% then if the inflation rate is 3% your emergency fund is only losing 2% rather than 3%.
  • Contribute more cash – Once you hit your financial goal of at least 6 months’ worth of expenses for your emergency fund, it’s time for you to move on and tackle another financial goal, such as investing or saving for a house deposit, but what you should do each year it top up your emergency fund by a certain percentage amount. If we use 3% as the inflation rate, then your emergency fund needs to increase from £6,000 + 3% (£180) = £6,180. If you have a good interest rate on the ISA of say, 1%, then you only need to top it up with 2% (£120). For my piece of mind, I’ll always top it up by 3% myself and let the interest the emergency fund is earning do its thing. I usually add this additional 3% right at the beginning of the tax year 06/04/20XX just so I can cross that financial goal off my list, forget about it, and then concentrate pushing all my money into my workplace pension and my Vanguard index fund. Plus the earlier I do it, the longer the interest has to build up until the end of the next tax year.

Conclusion

So there are just three simply ways to stop your emergency fund getting chewed up by inflation, with minimal contributions. The emergency fund is a beautiful thing. We work so hard to build it that we don’t want anything to happen to it. By contribution 3% a year you’ll help keep it in tip top shape.

Hold!

There’s a major market crash coming!!  And there’ll be another after that!!  What wonderful buying opportunities they’ll be.

— JL Collins’s The Simple Path to Wealth

Today I entertained myself by reading the 1 star reviews of a popular finance app that allows you to save money by rounding up your purchases to the next pound. So if you buy a cup of tea for £2.25 then it rounds it up to £3 and banks the 75p, adding it to one of their savings products. I don’t use, and have never used, this app, so I can’t disclose if it is a good product or not for building wealth.

What I want to talk about is this app has many 1 star reviews because the customers lost money. They are not complaining about the app functionality, which I would expect to see on a review website. From what I can gather these 1 star reviewers used the app and invested their surplus money into a stocks and shares ISA. Meaning they put their money into the stock market. It is apparent that these reviewers have not been educated on how the stock market works or how to invest. I assume that they invested their money in good faith and expected it to go up, like they see in Hollywood films or read in the newspapers about a postman who invested in Google on the day they floated on the stock market and is now doing his post round in a gold Bentley.

Unfortunately the stock market doesn’t only go up. It also goes down.

So what happened is these people invested their money for a couple of days/weeks/months and only saw it go down. They panicked and sold up taking a nice tidy loss. This is what a lot of people do when investing. This is wrong.

If you are thinking of investing or investing at the moment, before you do anything, read J L Collins’s book The Simple Path to Wealth. This is all you need to know, and if you follow the simple path you’ll be rich. If you can’t be bother to spend 8 odd quid on a book and read 200 odd pages then you should not be investing in the stock market.

Three great takeaways from this book are:

  • You should invest in low cost index funds. I invest in the S&P 500 via Vanguard. I like Vanguard. JL Collins loves Vanguard.
  • You should invest for the long term, 10,20,40,60 years. Don’t think you’ll be rich within 6 months. Investing is like cricket, a long game.
  • When the stock market has temporary drops… HOLD! Do not sell. This is the worst possible time to sell. Hold, hold, hold. If you were on a ship and a huge storm happened you wouldn’t jump overboard into an inflatable dingy and think you’ll be alright. Stay on the ship, ride out the storm and another day will come where the sea is calm and the weather is beautiful.

Additionally, what you should do when the stock market has a temporary decline is buy more more more. Everything is on sale. If your job was to buy TVs and they sold for £500 each, then one day when you went to the TV warehouse and you found they were selling the exact same TVs for £250 would you stop buying them? No, you’d buy twice as much as the sale will soon be over. That’s the same with stocks. If they drop to a lower price, buy more! If you’re not retired, and still investing for the future, a stock market temporary decline is like your Christmas and birthday all rolled into one. Buy as much cheap stock as you can get your hands on.

Everything must go!