There’s a common perception that buying a house is akin to investing. And if that were true, it would be one of the best deals you could snag, because unlike buying bonds or shares of stock, you can live in it.
However, the real reason why house prices rise inevitably over time is largely down to inflation.
Certainly, if you can find favorable home loan rates and secure a property at a reasonable cost in a location that becomes more attractive over the years, you’ll make a profit.
But for many homeowners, the factors affecting real estate prices, and fluctuations therein, balance out. What you’re left with is a property whose numerical value seems to indicate investment growth but in reality just about lets you break even if you’re lucky.
Adjusting for inflation
In the above example, a house at least provides considerable value as a place of residence. For other assets, the passage of time tends to be a one-way street towards depreciating value.
In any economy, the general price level of goods and services can increase or decrease. The latter trend, known as deflation, might seem to be a good thing as far as affordability is concerned, but it’s actually associated with periods of economic downturn.
Multiple factors, acting in concert, drive an economy towards inflation. Though it raises the floor of average prices, inflation is typically desirable. It either signifies high demand for the products of that economy or better compensation for producers facing rising costs.
Thus, because governments and financial institutions desire economic growth and stability, recent decades have seen far more inflation than the reverse. And when prices go up, the raw purchasing power of a monetary unit like the dollar goes down.
A visualization of this effect would be the comparison of what a dollar could buy in 2020 versus 1944: one small McDonald’s coffee versus 20 bottles of Coca-Cola.
Prices today might seem ludicrous by yesteryear’s standards. But in reality, those are just numbers driven up by inflation. If you want to get a better idea of the actual value of a purchase, you’ll need to adjust for inflation.
To do that, look up the relevant Consumer Price Index. This index tells you how much commodity prices have changed over time. Divide the purchase value by the index value, and multiply by 100 to get the inflation-adjusted value.
Beware lifestyle inflation
There’s a different type of inflation effect at work in our lives: lifestyle inflation. And unlike economic inflation, this is something we can actively control and avoid.
Lifestyle inflation refers to an increase in our spending behavior as we accrue more purchasing power. Different events can trigger this. Getting your first line of credit approved, graduating from school and landing your first job, or getting a promotion or bonus at work, can all lead to this change.
Most people who find themselves in possession of more discretionary income than they’re accustomed to will also find new ways to spend it. And these purchases might incur further maintenance in the long term.
For instance, you might have been fine taking the bus or subway daily. But with a bigger paycheck, you buy a car. And for years to come, you end up paying for gas, parking, insurance, cleaning, repairs, and other upkeep costs.
Mitigating the effects
People who aren’t aware or attentive to the effects of economic inflation will typically buy things with an eye towards the present. Even worse, they may pay for these purchases using credit cards or other nearly usurious forms of debt spending.
Most assets, even those with a hefty price tag, don’t gain in value over time. Cars are the prime example. Excluding vintage models, they are guaranteed to depreciate while costing you far more over the years than the sale price alone would indicate.
A house is relatively stable because the supply of land is finite, the population keeps growing, and people are always looking for a place to live. Thus, real estate values usually scale to match inflation.
Shares of stock, while sometimes volatile, also keep pace with rising prices. Intrepid investors may consider speculative purchases, such as art objects. In general, regardless of your risk tolerance, buying things that have the chance to appreciate over time is one way of making sure your money scales with the economy.
And while doing that, minimize the creep in your lifestyle spending. Often, these two goals can be aligned.
Instead of spending your excess money on immediate gratification, put it towards a 401(k) or other appreciable investments. Pay cash more often instead of deferring the costs into the future on high-interest forms of debt. You’ll be able to live more comfortably, even as the cost of living seems to grow ever higher.
