Is Your House a Good Place to Park Your Wealth?

family-in-front-of-house 2The most basic purpose of a house is to provide a place to meet our physical needs for safety and shelter and our social needs of family and community. We believe most people would agree that the house serves each of these purposes quite well. However, many people use the house in a way that it was not intended or designed for. I am referring specifically to using the house as a place to park their money. They may not even realize that is what they are doing or that the house may not serve that purpose well at all, and it may be costing them a fortune.

The best example of parking one’s money in their house is paying cash for a house. To pay cash for a house one must relocate money from their investment account to the house. Money was simply moved from one asset to another. The question we are positing is whether the house is a good place to park your money. Since money you park in your house is part of your overall financial wealth, we will refer to this money as “wealth in the house.”

Any time you have money available, you face an investment decision. Whether you save $100 each month, receive $2,000 from a tax refund, gain $50,000 from the sale of a house, or earn $500,000 from the sale of a business, you need to decide where to locate your money.

The real question here is when you have “extra” money, what is the highest and best use of that money? To answer that question there are many things to consider, but let me break it down into four primary considerations:

  • Safety – Is the investment safe?
  • Liquidity – Is the investment liquid?
  • Return – Is the investment generating a return?
  • Tax Treatment – What tax treatment does the investment receive?

We’ll define safety as minimizing or eliminating the potential loss of the investment. We’ll define liquidity as the speed and ease with which you may convert your wealth to cash. We’ll define return as the interest or growth you receive on the investment. We’ll define tax treatment as the method of taxation the principal and/or growth could potentially be subject to.

When investing in assets (or liabilities), you typically want the highest possible Safety (lowest risk of losing money), the highest Liquidity (highest access, use, and control of your money), the highest Return (highest earnings on your money), and the most favorable Tax Treatment (lowest tax liability on your earnings). As you invest over time, you learn that there are gives and takes required to balance your ideal mix of Safety, Liquidity, Return, and Tax Treatment based on your current specific goals and long-term financial needs.

So, how does wealth in the house grow? Wealth in the house, more commonly known as house equity, can only grow in two ways: 1) Market Appreciation and 2) Wealth Transfers, such as a down payment and principal reduction. Wealth in the house (house equity) is the difference between the value of your house at any given time and the balance of any outstanding liabilities attached to the house at that same time. For example, if your house is worth $350,000 and the current mortgage balance is $300,000, you have $50,000 of your wealth in the house.

Money in HouseThere is little a homeowner can do to affect the market appreciation of their house, but the growth of wealth in the house via wealth transfers (principal reduction) is entirely under each homeowner’s control. If you own a house, your wealth in the house is constantly changing in accordance with the amount of principal you pay monthly against your outstanding mortgage balance and fluctuations in the value of the house.

The decision to locate your wealth inside the house is a unique investment product consideration and to gain a greater understanding of what criteria goes into that decision and the ultimate impact of such a decision, it is necessary to consider the four primary considerations of Safety, Liquidity, Return, and Tax Treatment individually.

In the next post in this series we will ponder the question “Is Your Wealth in the House (Equity) Safe?

If you’re interested in learning more about the house as an investment and how owning a house can help you grow your wealth contact us to schedule a time to talk about your specific circumstances.

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