Is Homeownership Making You Poor?
Spoiler alert: it’s not buying your freedom from BigLaw
This post comes with a trigger warning. Few topics in finance are as emotionally charged as homeownership. It is, quite literally, the very definition of the American Dream. To doubt the wisdom of homeownership is an affront to American values, and it is an affront that many take personally. The financial wisdom of homeownership is deemed to be so obvious that it doesn't even warrant discussion. Renters are presumed to be throwing their money away, while homeowners are presumed to be setting themselves up for financial success. Neither of these statements is true, but that hardly matters.
That said, we believe that what is most important in life is, first, to determine what it is you really want from it and then, second, to try your hardest to achieve exactly that. For many people, homeownership is a critically important part of that calculus. We would never dissuade anyone from doing what, after honest reflection and sober analysis, they have determined is important for them to do. Just the opposite in fact. So this post is not in any way meant to discourage the determined home buyers from buying a home. Rather, this post is intended to present a different point of view for those who are looking to attain freedom from BigLaw.
Our path to non-homeownership
By the time we paid off our student loans in our early BigLaw days, we had already determined that we don’t need more than a single first-year salary to live a fulfilling life. So, when Zero Net Worth Day arrived, with a large chunk of our income no longer being allocated towards debt repayment or spending, we found ourselves with excess cash. Neither of us had a particularly strong interest in buying a house (we were perfectly happy renters), but we didn’t really know what else to do with our money, and so we thought the responsible, adult thing to do was to start saving for a downpayment. What else is there to save for, after all?
We went at it aggressively and, not long after, had $100,000 saved. At that precise moment—cash in one hand and Zillow listings in the other—online research led us to the FIRE movement whose simple but compelling message would change our lives. That $100,000, we learned, if invested in the S&P 500, would double every 7 years (based on historical returns of around 10%), meaning that if we invested it while we were very young, it could double 5 times by the time we reach retirement age.
In other words, our $100,000 downpayment, if invested, could be worth $3.2 million at retirement.
This realization presented us with no other option but to immediately divert our downpayment to low-cost index funds. At that point we could’ve been pretty much done with retirement savings, but we thought to ourselves: BigLaw is the gift that keeps on giving—why not take full advantage of the salary scale and save for an even bigger nest egg? And while we’re at it, why not really supercharge our savings so our investment portfolio allows us to stop working not when we’re 65, but decades earlier?
Back when we had our initial $100,000, we considered the option of buying a home first and then saving for retirement. But the longer you wait to save for retirement, the less time your money has to grow. For example, if you set aside your first $100,000 towards retirement at age 37 rather than 30, it only has time to double 4 times, leaving you with $1.6 million rather than $3.2 million at age 65. And if you wait until you’re 44, then your money will only have time to double 3 times, leaving you with $0.8 million at age 65. 3 doublings is obviously still fantastic, but 5 or more doublings is how you get to truly extraordinary wealth with minimal effort. Now imagine saving $1 million by the time you’re a senior associate or, say, 35 (we explained how many BigLaw associates should be able to do this here): that $1 million could be worth $16 million by the time you’re 63. Have two BigLaw incomes and can set aside $2 million by the time you’re 35? That’s a staggering $32 million by the time you’re 63. This is where things begin to get really absurd. Why are more BigLaw people not onto this? We have absolutely no clue.
Bottomline: invest while you’re young, and the market will do most of the work for you. When popular wisdom tells you that buying a home is the only responsible thing you can do with your money at age 25-30, we’re here to tell you that there are many excellent uses for your money that go far beyond homeownership.
‘But home equity is an investment too, isn' it?’
Home equity is a valuable asset. As an asset class, home equity has historically returned around 3-4% per year, which edges inflation, although not by much. In the hierarchy of assets, 4% is significantly more than what you can expect from cash under a mattress, but significantly less than what you can expect from stocks. Since being a homeowner means that you are required to pay your mortgage each month or else lose the asset, home ownership also has the added benefit of being a kind of forced savings account. A portion of your monthly mortgage payment (typically whatever is left over after interest, taxes and insurance are taken out) becomes home equity, which you can use later in life: for example, as a downpayment on a new home, as collateral for a loan or as an inheritance to pass to your children. When you take $100,000 that you have diligently saved and use it as a downpayment, there is no doubt that you have purchased a valuable asset.
From our perspective, however, home equity has major drawbacks.
1. Home equity is not income-replacement wealth and, in and of itself, does not allow you to achieve financial independence from BigLaw
Home equity does not work well as a source of income unless you rent or Airbnb part of the space, which is rare for a primary residence. And if you want to be financially independent in the sense of one day being free from mandatory work, then you are going to need sources of income. Think of it this way: if you have a portfolio of stocks and bonds worth $1 million, then you could withdraw and spend around $40,000 per year without ever running out of money (based on a 4% safe withdrawal rate for retirees (whether they’re 35 or 65)). Maybe your family spends more than $40,000 a year (ours does), but with $1 million in the stock market, you are well on your way to being financially independent. Whereas if you have $1 million in home equity, then that is still obviously great, but you can’t really spend any of that money (without taking out a loan or selling and downsizing) as it is locked up in the home. A primary residence is primarily a place to reside.
The point is, financial independence can’t be achieved with just home equity. And for many BigLaw professionals both young and old, home equity is far and away the primary asset class into which most of their investment money is going. This is all to say that many BigLaw professionals—including many partners—are not on a path to financial independence.
2. Focusing solely on building your home equity can substantially delay your entry into the stock market, thus making it more difficult to accumulate multi-million-dollar wealth
A second drawback of homeownership is that, based on our observations, it often delays by years, and sometimes even decades, the time by which you are able to make serious, downpayment-sized investments into the stock market. When we look around at our BigLaw peers, what we usually observe is that most tend to buy their first home right around the time they expect to start a family and, for the few years that follow, a large chunk of their income is applied towards raising children, along with various home projects and improvements. We have also observed that, after buying a home, many BigLaw lawyers will choose to aggressively pay off their mortgage rather than to aggressively invest in stocks, which further ensures that much of their excess cashflow is allocated to lower-performing assets while they are young.
Common wisdom will have you believe that homeownership, home improvements and aggressive mortgage repayment is not just reasonable, but financially prudent. And that will be true under some circumstances, but without careful attention it can also be catastrophic to your ability to build wealth, since delaying significant stock purchases by just 14 years could mean that you lose out on 2 stock market doublings, and are thus left with only 25% as much as you otherwise might have had had you started investing earlier in life. After buying a home, many BigLaw homeowners are content to build home equity and contribute to their 401(k), which is a very slow path to wealth. It is a viable path and the one that most middle-class and wealthier Americans are on, but it is a path likely to keep you in the workforce until you are 65 or older.
An alternative to allocating the entirety of your savings to a house
Research has shown that the prevailing wisdom that ‘renting is the equivalent of flushing money down the toilet’ does not hold up at all in most high-cost-of-living areas where BigLaw attorneys are concentrated. But our goal is not to dissuade anyone in BigLaw who’s intent on buying a house from doing so: everyone can and should do their own research and reach their own independent conclusions on what makes the most sense for them. Besides, there are many psychological, family and other reasons why buying a house—even if it doesn’t necessarily lead to the most optimal outcome from a financial standpoint—could still be the right thing to do for someone. Indeed, we too might one day buy a patch of wilderness to build a cabin or yurt on, but that’s not on our immediate agenda.
Instead, the point we hope to leave you with is that starting to invest as early as possible in your BigLaw career makes accumulating massive wealth very easy because you’re letting the stock market do the majority of the work for you.
The time-value-of-money principle is so powerful that many people who delay their entry into the stock market will never catch up, even if you coast through the rest of your BigLaw career (or leave BigLaw altogether) while they decide to go the partner route and earn substantial paychecks in the future. There’s simply no substitute for growing your portfolio while you’re young!
In light of this, consider the following alternative to allocating your first-ever savings to a downpayment: invest in the stock market first, grow your portfolio to $1 million (or less/more, depending on your goals), and then buy a home. Or, if it’s important to you to purchase a home as soon as possible, then be cognizant of psychological and other factors that may further delay you from investing substantial amounts in higher-performing, income-generating assets.