A house is a home, not a way to fund a comfortable retirement
The best strategy for wealth accumulation is a diversified portfolio
Buying your own home is important. It provides a place to live and a form of security. But you cannot rely on appreciation in house prices to fund a comfortable retirement. Data on household wealth accumulation over the past eight years shows that the best strategy for growing wealth is to hold a diversified portfolio with a weighting towards financial assets like shares or bonds, rather than property.
Household wealth is influenced by three factors. The first, is that a surge in debt can quickly undermine the net worth of any household, especially if the debt is being used to fund consumer spending rather than buying an asset such as a vehicle or residential property.
The second component is growth in the value of financial assets such as unit trusts, direct holding of shares, pension funds, retirement annuities or a bank deposit. Their appreciation is largely determined by the level of interest rates or the performance of the stock market. Stock markets can be volatile over short periods, but they mostly perform exceptionally well over the longer term.
The final component is growth in non-financial assets. These include mainly residential properties, but also vehicles and other durable goods. Over time this category has been expanded to include a wider range of assets, such as art and other collectable items.
In 2017 SA’s householders were richer than ever before, with a net worth (after debt) of more than R10tn. That is partly because, after the financial crisis of 2008, household debt, particularly mortgages, rose slower than in the borrowing spree of 2005/06. Now it is quite manageable.
Household mortgage debt, measured in rands, increased by an annual average of only 3.7% over the past 10 years, which is well below the rate of housing inflation.
Apart from lower debt, South African householders also gained from the appreciation in their financial assets, which has far outstripped growth in physical assets. Over the past eight years growth in financial assets, including equities, money market and income funds, has averaged 9.7% a year. By comparison, physical property has appreciated by an average of 6.8% a year and inflation was 5.6%.
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True, property prices exceeded inflation. But 83% of the growth in householders’ wealth in the past eight years has come from financial assets.
The same holds true for many developed countries, such as the US, Europe and the UK, with some minor differences. Owning property in parts of the UK has delivered handsome returns but even that strategy delivered less than financial markets. In the US, growth in financial assets was key to growing wealth as US stock markets performed well.
In the past 15 years, global household wealth rose by 125% in US dollars to reach a record $280.3tn in 2017. This equates to an average annual growth rate of 5.6%, including the impact of the global financial market crisis that cut household wealth by 12.6% in 2008. The rate of increase in global wealth has easily outstripped population growth over the past 15 years, as well as inflation.
The global household sector’s net wealth has fully recovered from the impact of the global financial market crisis. As in SA, this recovery has been helped by a more prudent approach to the accumulation of debt, while at the same time the value of residential properties outside SA has tended to move higher, helped by growth in employment and lower interest rates.
The first lesson from this research is that it is important for households to accumulate a diversified set of assets and not simply focus on home ownership. The second is that, as far as possible, debt should be mostly used to acquire an asset, such as a home, vehicle or education, rather than fund consumption of non-essential items. The third is that having long-term financial assets in the form of retirement savings or a unit trust is critical to ensuring a more rapid increase in net wealth over the longer term.
This article was paid for by Stanlib.