Im reading a draft manuscript of Professor Moshe Milevskys soon-to-be-released new book, Your Money Milestones: A Guide to Making the 9 Most Important Financial Decisions of Your Life . Its been an enjoyable read so far and I plan to post a book review shortly.
One of the refreshing things is the originality of thought; the way rules of thumb and conventional wisdom are challenged with reasoned arguments and the backing of scholarly research. Dont expect to hear the same old prescriptions for what to do with your personal finances.
Take, for example, his position on homeownership. In Chapter 6, he writes: I think that a large proportion of individuals within the population should not own a home, or should push the purchase off as long as possible, and instead rent.
This statement has its roots in Milevskys notion of holistic balance sheets, which depict personal wealth as the sum of financial assets and human capital. When we are young, our personal wealth will be mostly in our human capital; when we are older, it will increasingly be in financial assets.
When Milevsky says a large proportion of people should not own a house, he is thinking mainly of people under 40. When we are young, most of our wealth is locked up in our human capital, which is illiquid, non-diversified, and definitely non-tradable. In this context, buying a house doesnt make sense since it adds to the balance sheet another asset that is illiquid and non-diversifiable.
Buying a house for an investment has strong similarities to someone being convinced stocks are a good investment for the long run but they decide to buy only one stock for their portfolio. I dont care how reliable that one stock is, or how large are the dividends, that stock portfolio is not diversified. The same goes for housing.
From another perspective, there is a lack of diversification on your personal balance sheet since your human capital (stream of wages) and housing asset are both sensitive to economic fluctuations. In other words, there is a good chance that if your job wages take a hit, so will your real estate. If your wages are sensitive to the economy, it makes little sense to expose a large portion of your financial capital to the same factors by allocating a significant portion of your balance sheet assets to a house.
Another consideration is the increasing mobility of the labor force. There is a much higher probability that you might need to relocate for a job, a career, or employment opportunities. This would be another incentive to rent for as long as possible.
Its only when you are older and much of your human capital has been converted into financial assets that you could consider buying a house. With a large component of your wealth in financial assets, the sensitivity of your human capital to the economy is no longer an overriding concern. Adding a housing asset to your wealth doesnt result in having all your eggs in the same basket, Milevsky claims.