Spending vs Investing

[jenk]

The article in general is worth reading - but I left un-cut a particularly telling piece.

Face It, You're Spending, Not Investing
September 18, 2005

I am a little cranky today. But then again, I'm almost always a little cranky.

This, I hastily add, is entirely justified. If you write about personal finance, you are exposed to a steady stream of irritating nonsense, as brokers tout the virtues of rotten investments, Wall Street strategists pretend they're clairvoyant and ordinary investors struggle to justify their financial foolishness.

Which brings me to today's complaint. Why do so many folks claim they are making an investment -- when all they're really doing is spending money?

Getting Real

Trust me, this happens all the time. A jewelry store near my home has shopping bags stamped with the words "Beautiful Investments!"

A few years ago, I got a flier for lawn fertilizer, which noted that "a survey of real-estate agents indicates that a well-maintained lawn adds an average of $3,600 to the resale value of a $90,000 home."

Meanwhile, during the Beanie Babies frenzy, my kids were advised that, if they removed the manufacturer's tags, their stuffed animals would no longer be considered "investment grade."

Come on, folks, let's be realistic. Jewelry, fertilizer and Beanie Babies are not investments. Yes, your lush green lawn may add slightly to your home's value and, yes, your jewelry may someday be worth more than you paid. But, in your heart of hearts, you know these aren't truly investments.

How do you know? It comes down to a simple litmus test: If you hand over a wad of money and get a lot of pleasure in return, you are probably spending money, not investing it.

That said, you can analyze any expenditure in the same way you analyze a stock. With a stock, your total return consists of a mix of capital gains and dividends.

Similarly, with jewelry, fertilizer and Beanie Babies, you also get a mix of capital gains and dividends. Problem is, the capital gain is usually a capital loss, and the dividend isn't of the cash variety.

Rather, the dividend consists of the pleasure you get from having a green lawn, cuddling up in bed with your stuffed animals and flashing your diamond ring at the neighborhood cocktail party.

In other words, if you spend your money wisely, you will collect huge dividends. But don't kid yourself: These aren't the sort of dividends that will pay for your retirement.

Collecting Rent

When it comes to confusing spending with investing, nothing can match the muddled thinking that surrounds real estate. In fairness, however, this isn't entirely surprising.

To understand why, imagine you bought two homes, one for your own use and one that you rented out. The rental property, I would argue, can be considered a pure investment.

Like a stock, you will get both capital gains, thanks to the home's price appreciation, and dividends, in the form of monthly rent checks. If you added up your rent and price appreciation and then subtracted homeowner's insurance, maintenance expenses, mortgage payments, taxes and other costs, you would have your profit. Often, this profit can be pretty darn impressive.

By contrast, there's no way the house you bought for your own use can be considered purely an investment. True, you should enjoy some home-price appreciation. But despite today's infatuation with home prices, this probably won't make you wildly rich.

According to home-finance corporation Freddie Mac, U.S. home prices have climbed an average 6% a year over the past 30 years, compared with a 4.4% inflation rate. Moreover, home-price appreciation is often largely or entirely wiped out by the hefty costs of homeownership.

Meanwhile, because you are using the place yourself, you won't collect any rent. That's a big deal. The reason: If you are a landlord, rental income is typically your biggest source of profit, dwarfing the gain from price appreciation.

On the other hand, you do have to live somewhere. Shelter is a necessity. Buying a home and effectively renting it to yourself hardly seems like frivolous, discretionary spending.

So if you live in your own home, are you investing or are you spending? I would argue it's a little bit of both. Most of us own homes that provide more than just basic shelter, so there is indeed a large element of consumption.

The implication: If you trade up to a bigger home or buy a vacation property for your own use, these purchases probably won't turn out to be great investments, because you're buying extra space -- and then consuming all of the potential rental income yourself.

Taking a Break

The costs of homeownership don't end with mortgage payments and maintenance expenses. Homeowners will often remodel the bathroom or put in a new kitchen, and then claim these expenditures are investments.

Sure enough, the projects pay impressive dividends, by bringing immense pleasure to the homeowners involved. But if these folks are hoping for hard cash, they will probably be disappointed.

The reality is, when homeowners go to sell, they rarely recover the full cost of their home improvements. In fact, the longer they wait to sell, the shabbier their home improvements will look -- and the less they are likely to recoup.

Today's confidence that buying homes and fixing them up is a great investment has fed the current mortgage-borrowing binge. We feel a whole lot better about spending borrowed money if the spending can somehow be considered an investment.

Some families take this financial self-deception even further, figuring there's nothing wrong with borrowing against the value of their home, so long as their increased borrowing doesn't exceed their home's price appreciation.

Mortgage lenders are apparently more than happy to play along. Indeed, at the end of July, I got a statement for my home-equity line of credit from PNC Bank. I don't owe any money on the credit line. But PNC clearly thinks that I should.

On my July statement, under the heading "Important Information," I got the following message: "Need a break this summer? Let your house treat you to a vacation. Simply use your line of credit to pay for your dream get-away."

And with that, I got just a little bit crankier.

Write to Jonathan Clements at jonathan.clements@wsj.com1
- from: http://online.wsj.com/article/0,,SB112700679404844168,00.html

I know people who argue that the mortgage (or the PITI) is equivalent to the rent they'd pay, and so they shouldn't count deduct it from the appreciation in determining how much they made on a house sale. Personally, I go back and forth. One advantage to a fixed-rate mortgage is that the the payment IS fixed. Rent is SOO not fixed! OTOH, I don't think that upgrades or remodels are automatically 'investments' because you really don't know if other people will want to "reimburse" you for, oh, Corian countertops.

Judgment call, judgment call, judgment call...

I do like that Clements includes pleasure and satisfaction as dividends, tho. Warms my little non-ascetic Taurus heart.