Should I buy a home or invest in the stock market?
If a 25 year old has about $50K saved up in the bank- what is the best framework / method to make a decision on allocating that capital? (there seem to be two main options – real estate and S&P 500 index fund). If you could share a framework that can help with such decisions that would be great.
Answer
There are many reasons for wanting to own the place where you live. Many of these reasons are personal and are above and beyond the logic of financial analysis. However, it would be constructive to at least understand the financial implications of using (for example) $50K as a down payment to purchase a home vs. renting and buying a different financial asset to fund your freedom.
Using a 11% CAGR (Compound Annual Growth Rate) over a 30-year time horizon (by investing in a low-cost S&P500 index ETF), $50K in 2019 will grow to $1.1 Million by 2049 (you may choose to use different projected CAGRs, just use this investment calculator. You can consider $1.1M in 2049 as the opportunity cost of using the $50K as a down payment on a home today.
Assuming all other costs are equal (i.e., rent vs. mortgage interest+taxes+maintenance – They’re not equal by the way. In major cities in Canada, the latter is likely to be much higher), the property you purchase would have to increase in value by $1.05 Million ($1.1M less your initial $50K) by 2049 in order for you to break even by purchasing a property vs. investing in the S&P500. Of course, if your home ownership costs exceed rent payments, you would have to also consider the opportunity cost of investing this monthly excess as well.
The above is an overly simplified and likely unsatisfying analysis. Its purpose is only to highlight the issues for consideration and to form the beginnings of a framework for decision making.
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