Pay Down Debt vs. Investing

[Eager]

I should add though, as far as guaranteeing mediocrity goes, what is a more obvious example of that than the following:

A couple work hard, buy a house, still work hard, upgrade, have a family, work even harder, upgrade again, family grow and leave, upgrade but downsize, become debt free, grow old, cark it. Massive inheritance to the offspring. Which they knew was coming ever since they were young adults....

I fully intend to be a S.K.I. er.

 

[kid hustlr]

One more example. Say we have a mortage costing 8% and we just won the lotto for 100k.

A couple of quick assumptions:

there is no CGT in this world.
there is no set up costs to buying an investment property.
we have the opportunity to buy a 400k property that is exactly neutrally geared.

After 10 years time:
If we pay the mortgage:
we save 100,000(1.08)^10 = $215,892 or $115,892 in interest.

If we invest:

If that property is worth more than $515,892 (which equates to roughly 2.7% compounded) then the better decision was to invest.

Is this correct? Obviously there are loads of if and buts and assumptions and investment risk etc etc. I'm just trying to get my head around the concept of opportunity cost in regards to investing.

 

[Julia]

I fully intend to be a S.K.I. er.

Given that by the time you're old and in need of some level of care, how are you going to time your spending to ensure that you don't end up in the lowest and most squalid level of care as opposed to retaining sufficient funding to pay for quality care.

Don't be under any illusions: aged care by the time you need it will be absolutely user pays.

If you're so determined to leave nothing to your offspring I hope you're not depending on them to look after you when you're old and feeble.

 

[Tysonboss1]

Is this correct? Obviously there are loads of if and buts and assumptions and investment risk etc etc. I'm just trying to get my head around the concept of opportunity cost in regards to investing.

Yes,

But in reality, all those things you excluded do exist and would have a negative impact.

and as I stated earlier, the higher return is based on leverage which works both ways,

Try doing the math on what would happen to you $100K in capital if the investment property which down by 2.7% per year and you still owed $300K to the back.

Almost complete 100% loss,..

thats the risk of your high risk stratergy.

Is it worth it.

you decide.

 

[Beej]

Like this...

If you plot that chart on a log scale - as you should for something with the sort of time period you are looking at there, you would notice that the current situation has occurred at least 2-3 times in the past to a similar magnitude and for a similar period of time ( look at the 70s and the late 80s for example). By that I mean look at the magnitude in % terms by which one line has "over-shot" another etc. The linear scale just makes things look worse now than they have been in the past - in fact this is the leading "confidence trick" of much of the analysis of the housing market / debt situation that is floating around at the moment.

The other point I would make is that looking at the price of anything and adjusting it to CPI doesn't really tell you much - it is quite possible that the price of assets may rise at a rate well above the price change of a selected "basket of goods" indefinitely, or certainly for very long periods of time. Ie, there is no guarantee of a relationship between the value of land < 10kms from a city CBD and the weighted price index of banana's, bread, milk, TVs and so on.

Finally to address the OP question, I'm with the "it is better to pay down your debt ASAP and take the 10-13% risk free return" crowd on this point. The only exception would be if you are really hell bent on taking the "high risk / fast track" road to wealth creation - as long as you really understand the risk that entails - ie you could end with nothing, or be far worse off than the alternative.

 

[McLovin]

If you plot that chart on a log scale - as you should for something with the sort of time period you are looking at there, you would notice that the current situation has occurred at least 2-3 times in the past to a similar magnitude and for a similar period of time ( look at the 70s and the late 80s for example).

And then prices went nowhere for many years...

 

[Beej]

And then prices went nowhere for many years...

Well, they went nowhere only relative to CPI growth. For example, in the 70s, house prices increased by a huge amount, even though they grew at a rate less than CPI for that period on your chart. The thing is, you have to buy assets in nominal $, not some imaginary "CPI adjusted real $". So during that period in the 70s for example, owning a house was one of the best things you could have done - high inflation "inflated away" your debt, meanwhile your wages were growing rapidly. Of course no-one was getting ahead in real terms, that's the problem with a high inflation environment, but those who deliberately delayed asset purchases in such periods were punished even more for their decision.

 

[McLovin]

Well, they went nowhere only relative to CPI growth. For example, in the 70s, house prices increased by a huge amount, even though they grew at a rate less than CPI for that period on your chart. The thing is, you have to buy assets in nominal $, not some imaginary "CPI adjusted real $". So during that period in the 70s for example, owning a house was one of the best things you could have done - high inflation "inflated away" your debt, meanwhile your wages were growing rapidly. Of course no-one was getting ahead in real terms, that's the problem with a high inflation environment, but those who deliberately delayed asset purchases in such periods were punished even more for their decision.

Look, the point was to show the link between wages and house prices. I don't think prices will collapse American style (unless something severe happens to the economy) but I do think that over the long run house price growth is linked to wage growth more than any other asset class.

Anyway, I've said all I need to in this thread.

 

[Beej]

Look, the point was to show the link between wages and house prices. I don't think prices will collapse American style (unless something severe happens to the economy) but I do think that over the long run house price growth is linked to wage growth more than any other asset class.

Anyway, I've said all I need to in this thread.

Fair enough - I don't disagree with your general outlook by the way. Just wanted to show that some of those charts floating around are designed to make things look worse now than they actually are relative to past periods and market cycles.

 

[odds-on]

Look, the point was to show the link between wages and house prices. I don't think prices will collapse American style (unless something severe happens to the economy) but I do think that over the long run house price growth is linked to wage growth more than any other asset class.

Anyway, I've said all I need to in this thread.

McLovin,

I agree with you. House price to income is the key.

Interesting website below.

http://www.interest.co.nz/property/house-price-income-multiples

Key point being:-

"The house-price-to-income multiple is a simplified, yet internationally recognised measure of housing affordability. It is covered in Agenda 21, Chapter 7 of the United Nations Framework and it is defined as the ratio between median house price and median annual household income, otherwise known as the median multiple. The World Bank also says this ratio is "possibly the most important summary measure of housing market performance, indicating not only the degree to which housing is affordable by the population, but also the presence of market distortions"."

Cheers

Oddson

 

[Tysonboss1]

McLovin,

I agree with you. House price to income is the key.

Interesting website below.

http://www.interest.co.nz/property/house-price-income-multiples

Key point being:-

"The house-price-to-income multiple is a simplified, yet internationally recognised measure of housing affordability. It is covered in Agenda 21, Chapter 7 of the United Nations Framework and it is defined as the ratio between median house price and median annual household income, otherwise known as the median multiple. The World Bank also says this ratio is "possibly the most important summary measure of housing market performance, indicating not only the degree to which housing is affordable by the population, but also the presence of market distortions"."

Cheers

Oddson

Agreed,

As long as the "House price" part of the calculation includes the entire spectrum of dwelling ie. apartments.

As I said earlier, Actuall houses on land will increase faster than wages generally in a growing city, due to population growing while the number of houses on land is decreasing.

 

[odds-on]

Agreed,

As long as the "House price" part of the calculation includes the entire spectrum of dwelling ie. apartments.

As I said earlier, Actuall houses on land will increase faster than wages generally in a growing city, due to population growing while the number of houses on land is decreasing.

I agree it is crude but it is a useful tool for anybody interested in property investment. It is equivalent to using the percentage of total market cap relative to the GNP as a stock market valuation tool. If the property market is overvalued then to make decent returns one has to allocate serious capital to buy the right house in the right street in the right suburb – similar to picking the right stock in an overvalued stockmarket. I personally feel way more comfortable sticking $100k in a microcaps than taking out a $400k loan (assume $100k equity) to buy a $500k property in an overvalued property market.

Cheers

Oddson

 

[Tysonboss1]

I agree it is crude but it is a useful tool for anybody interested in property investment. It is equivalent to using the percentage of total market cap relative to the GNP as a stock market valuation tool. If the property market is overvalued then to make decent returns one has to allocate serious capital to buy the right house in the right street in the right suburb – similar to picking the right stock in an overvalued stockmarket. I personally feel way more comfortable sticking $100k in a microcaps than taking out a $400k loan (assume $100k equity) to buy a $500k property in an overvalued property market.

Cheers

Oddson

I prefer to use a P/E ratio of various property options, Making a comparison of the earning power of the rental return over time to justify a price i am willing to pay for a property, As well as making various judgements as to what a property has in the way of options for the future, eg development.

Just like the equity security investments I make, I pay much closer attention to each indiviual situation of each opprtunity than I do to macro economics.