Sunday, April 18, 2010

Buy a house or invest first?

I have posted that I did not want to buy a fancy car because of its value will depreciate very rapidly, halved in 5 years. Today posting is to look at things that will appreciate over time. One of the basic securities for us to fulfill is having a roof over our head. I have heard many argued that it is better to invest and grow money and pay in a lump sum for a house or vice versa. I have created three scenarios(Mr. A, Mr. B and Mr. C) to determine their net worth in the first 10 years of their working life.

Some key assumptions

Starting pay RM 2,000 straight from school and having annual salary increase about 10% and occasionally get 20% increment due to promotion.

All three persons are equally good and confident to generate annual compounding return of 10%.

Mr. A.
He decided that he wants to save 10%-20% of his income and spend the rest to upgrade his lifestyle as his salary gets bigger.

At the end of 10 years, his net worth is about RM 105 k but without a house.

Mr. B

Mr. B is an interesting person. He is a strong disciple of delayed gratifications. He figured that if he can survive with RM 21,600 a year expense after his graduation. He should not upgrade his lifestyle as his salary rises. He pinched every penny he has, drove the damn second hand Kancil for 10 years. He loves having cash in hand and do not feel like buying a house yet. Occasionally his girl friend will get angry with him due to his frugal lifestyle and his future mother-in law puts pressure on Mr. B as her daughter is getting older. Mr. B seems cannot be bothered because of his obsession to grow wealth. Despite of occasionally having unhappy moments, at the end of 10 years, his net worth grew to RM 272 k. He is in much better position compared to Mr. A. He paid 272 k for the house and only need to take 18 k loan.

Mr. C

Mr. C is the most interesting lot among three of them. He is aware of future inflation of big ticket item especially house. He is aware that he needs to buy a house ASAP due to rising house price. Why housing price rises over time? Simple, rising labor and commodities like cement, steel, aluminum and etc. House prices have been rising between 7-10%. Let’s settle for 7% for the purpose of this exercise.

At the time he graduated, an apartment cost about RM 150 k. He fears his salary cannot catch up fast enough with house prices. He quickly invested the first for 4 year savings that he accumulated, about RM 30 k. He was right, at 7% inflation, the house already gone up to RM 190 k. So the poor chap have to take a loan of about RM 160 k for 30 years with interest rate of 4%(BLR – 1.8%).

His net worth is RM 283 k, 11 k better than Mr. B despite of him serving 36 k interest to bank.

Wrapping things up.

First of all, we all need to be aware that not many people can generate 10% annual compounding growth consistently over a long period of time. May be only 3 out of 100 people. In case of people lose money or generating return below the housing inflation rate, you know the end result.

If one is as good as Mr. B, invest first and buy later is not so bad.

Mr. C early action protected himself from doing stupid things with his cash and hedged against inflation naturally. A good choice for those do not have strong discipline or ability to invest.

Mr. A probably scores highest marks in enjoying life. After all, you can't bring it with you when you are gone.

Last few words, in case that you need to quote me for any debate, please use it gently and wisely. It's an emotional issue for a lot people.

1 comment:

da sOuL said...

it is nice that you have put the scenario into different shoes. well, that's how financial mgmt is related to human. but personally i like strategy on Person B more. hahaha...