Economists versus(?) financial planners, part 3: housing, and weirdos
Let's finish up our discussion on the Freakonomics podcast episode on economists and personal finance, shall we? In part 1 and part 2 , we covered a wide range of topics, from consumption smoothing to dividend investing to debt snowballs; now, let's wrap things up with a couple of thoughts on housing -- and personal finance in general!
(The podcast does spend some time talking about how people don't save enough, and also that they lock up too much of their cash flow in "consumption commitment", known to non-economists as "bills, especially debt". But Professor Choi is upfront in his agreement with the common wisdom -- people should save more, and target no more than around 50% of their income to go towards consumption commitment -- so there's not really much to talk about there.)
Should I pay off my house early?
If you haven't already heard of him, Morgan Housel is a personal finance author that this podcast episode frequently taps for the "psychological" counter-argument to the economists' viewpoint. This makes sense, as his book The Psychology of Money is extremely popular and full of excellent insights as to folks' default behavior around money!
And in his book -- and in the podcast -- Housel makes a very interesting statement: paying off his 3% interest mortgage early was the worst financial decision he and his wife ever made...and the best money decision they ever made. Now, if you're a Seaborn client (or a longtime reader), you already know why it might be a bad idea to pay off a 3% loan early, given that as of this writing, even your online savings account has a higher rate of return...but how could it be a bad financial decision, yet a good money decision?
The answer, as you might guess, is psychology: it gives them joy, a sense of freedom and stability. On paper it makes no sense, and Housel is fully aware of this...and it doesn't matter to him! In his view, he's trading optimization for the ability to sleep better at night.
And: in my view, that's okay. Effectively, what he's doing is paying extra for a sense of stability, equal to the spread between the mortgage interest and likely rate of return of his investment portfolio. Depending on the house, this might be extremely expensive...but on the flip side, how often do you have an opportunity to literally buy happiness? And depending on what you have to give up, might that not be worth it? (More on that at the end of this article, though...)
Of course, if you're renting, you don't have think about mortgages at all -- and Professor Choi's plan is to rent forever! Not because this gives him particular joy that he's willing to pay extra for...but because he asserts that, economically speaking, renting and buying should cost the same!
The argument makes sense on paper: in an efficient market, the only difference between renting and buying something is that when you buy something, you pay the entire cost of the useful lifetime of the thing up-front. But like his argument for using adjustable rate mortgages, I really wish he talked about this more, or referred to a research paper -- I've yet to hear of any financial planner who's run the numbers and said, "yep, the economists are right! When you take XYZ into account, renting and buying works out the same!"
And honestly, I don't have a good hypothesis as to what we might not be taking into account. Repair costs on rental properties being more because their occupants don't treat them as well? The ability of a homeowner to decide whether to splurge on a $100,000 renovation...or not? All I can say is this: in the vast majority of cases I've seen, the difference between a lifetime of homeownership versus renting is quite stark!
That said, I do have some clients who get unduly twisted up into knots about buying versus renting in the short term. "I was thinking of buying a home now, but the market is crazy -- should I wait a year?" "I'm moving to a new place -- is it OK if I rent for a year while I find a home?" "I'm really not sure if I'll still be in Austin three years from now -- should I buy anyway?" And while these are good questions to ask and important decisions to make, I always remind them: I've never seen any financial plan break because you spent a year or three renting instead of owning. In most cases (though admittedly not all), the best decision is to move slowly and carefully, so you don't end up in a house you hate!
On being a weirdo
When he talks about why he rents, Professor Choi mentions that neither he nor his wife are particularly attached to the idea of owning the home they live in: "I’m kind of a weirdo in that way, and my wife’s the same way." And while I'm not as convinced that it's as financially sound as he says it is, I'm rather in love with the idea: that because they're "weirdos", they're free to make better decisions.
I'm a weirdo. Nearly all of our clients are also weirdos, in some way. That's not to say that we're all socially inept, or don't like anything that "normal people" like, or anything like that. We're just...out towards the edges of the bell curve. And this can come with disadvantages: specifically, when interacting with others, it's often hard to feel like we belong. Either we're getting weird looks, or we're hiding our weirdness in order to blend in. Either way, folks often don't really get where we're coming from, and it's not a great feeling.
But here's the thing: at this point, we're used to it. By the time you're old enough to be reading this blog, if you're a fellow denizen of Bell Curve's Edge, you've grown accustomed to the fact that you don't necessarily think the same way as most people you interact with -- and that's okay. You've probably figured out that, for a lot of things, following the common wisdom isn't necessarily something that makes sense for you.
And with that realization comes freedom! You don't have to do things the way other people do them. You don't have to spend to keep up with the Joneses; you don't have to have a traditional saving plan or asset allocation; you don't have to rent or buy or pay off your mortgage or not simply because that's what Dave Ramsey says you should do. You're free to figure out what's optimal for you. Maybe it means just doing what makes you feel better, even if it's sub-optimal, or maybe it means addressing your underlying irrational fears directly so that you can choose the optimal path with confidence. Either way, the choice is yours.
Even better: in the Internet Age, it's easier than ever to find other folks who are weird like us! Seaborn's built for exactly that -- by saying "we do our best work with Gen-X/Gen-Y tech professionals", we're basically throwing open the door to nerds of all kinds, anywhere in the US. And we love it.
So: embrace your inner weirdo, and all the freedom -- and potential optimization! -- that entails. And if you'd like to talk to other weirdos about financial stuff, you know where to find us!
Britton is an engineer-turned-financial-planner in Austin, Texas. As such, he shies away from suits and commissions, and instead tends towards blue jeans, data-driven analysis, and a fee-only approach to financial planning.