Both of these goals are, of course, very important. In order to have a comfortable retirement, you should start saving for retirement as early as possible, so that compound interest works in your favor.
On the other hand, owning a home is an emotional goal for a lot of people, who want to own their own place before they have kids.
The issue is that, especially early on in your career, it can seem like you have to choose one or the other. And that’s a hard choice to make.
In this article, we’ll guide you through the relevant calculations, and then show you a couple of ways of planning your financial future so that you can have a comfortable retirement and buy a home.
So let’s jump straight in with an answer to the question we started with. For the majority of people, in the majority of cases:
“it’s better to save for retirement before you save to buy a home”
That might seem counter-intuitive, because you will need a home before you retire. It can also be emotionally difficult to deal with, because buying a home gives you a nice place to live, whereas a Roth IRA doesn’t provide you with anything tangible (yet). However, when you look at the numbers it becomes obvious that retirement savings should come first.
This is due to a simple fact – in the long-term, the stock market out performs the property market. Over the course of 20 to 25 years, the gains you can make on the stock market far outpace those that can be made investing in property.
And since most retirement plans are invested in the stock market, even with a low-risk stock investment you are likely to be better off at the end of 25 years if you put money into a retirement investment fund.
This is just the general trend, however, and it does not apply in every circumstance. If you are clever, or you know the property market of a particular city or country particularly well, you can make gains investing in real estate.
However, you will need to be clever, lucky, or very dedicated in order to beat the long-term growth of the stock market.
Investing in this way also reduces your stress, because you don’t have a physical asset – your home – which needs continual maintenance in order to hold its value. Using a platform like Wealthface, you can set up an investment for your retirement, and just let it run without having to constantly monitor the value of your asset.
Renting vs. Buying
For a lot of people, the answer above will be a disappointing one. That’s for two main reasons – one is that many people have a lot of “emotional capital” invested in the idea of buying their own home, and the second is that renting can seem like a huge waste of money.
Let’s deal with the second of these points first. Despite many people believing otherwise, rent is not wasted money.
The idea that it is comes from a previous generation – Baby Boomers – who could buy property relatively cheaply, and who enjoyed that property rapidly increasing in value over many years. The property market is different today, and it’s difficult to realize the same gains.
In addition, for most people of younger generations, renting makes a lot of sense. Renting means that you are not responsible for maintaining a property, and you can move city (or country) with little notice.
Ultimately, this freedom to get a higher-paying job across the country may end up being more lucrative then investing your current salary in a house that may fall in value.
Second, in the answer above we’ve just looked at the monetary arguments for and against buying a home – not the emotional ones. Money isn’t everything, and if buying a home will make you much happier than not doing so, that’s an important realization.
And, as many people have pointed out, it’s probably not a great idea to see your house as an investment vehicle anyway – the property market is simply too complex and unreliable to be a good basis for a long-term investment, and houses are inherently unreliable assets.
There is, however, a way of both saving for retirement and a down payment on a house, at least if you live in the US. Or at least there is in principle.
This is because the IRS allows you to withdraw money from an IRA to buy a house, and if you take advantage of this you won’t have to pay the normal 10% early withdrawal penalty.
There are some rules which govern this – the IRS treats a withdrawal from a traditional IRA as income and you must pay taxes. Withdrawals from a Roth IRA for a home purchase are both tax- and penalty-free as long as the Roth is at least five years old.
This means that, in principle, you can take $10,000 that you’ve saved into your retirement account, and use it as part of a down payment on a house.
The downside is that this doesn’t make much sense financially, because this is $10,000 that won’t be earning compound interest for the next 30 or 40 years.
The Bottom Line
The bottom line here is that, looked at from a purely financial perspective, most people should save for retirement before they save to buy a house.
The stock market significantly outperforms the housing market, and it makes more sense for your money to be where it is working hardest for you.