Dear Rick:
I am in my mid-20s, a college graduate and have just gotten my first real job. Currently, I am living with my parents and thus, my cost of living is very little because I don’t have to pay for room and board. The company that I am working for has a 401(k) plan, and my father, who is a big fan of yours, said I should put in the maximum I can and to use the Roth option. I, on the other hand, would like to take the money that I’m putting into my 401(k) plan and use it for a down payment on a home. I figure that with the tax breaks and how houses appreciate, I would be much further ahead. My question to you is what should I do; put the money in the 401(k) plan or buy a home? You should know that I am looking at condominiums, and the one I saw that I would like would cost a little over $100,000.
Thank you.
George
Dear George:
First of all, congratulations on getting your first real job. I remember when I graduated from college and got my first job how exciting it was. I also want to congratulate you on thinking about your finances. Unfortunately, all too often people don’t think about their finances until it’s too late. That being said, I agree with your father that you should maximize your 401(k) contribution and use the Roth option. I believe from a pure investment standpoint your Roth IRA would significantly outperform the appreciation that you may or may not see in a home. I cannot stress enough how important it is for someone in your situation to start saving for their retirement ASAP. I always tell people that retirement is a brand new concept in the history of mankind and you cannot have too much money in retirement. When I first got involved in this business, when it came to retirement, at most you were talking about a 10-year retirement period. Fast forward to today, and I tell people who are retiring that they have to plan for a 25 or 30-year retirement. Fast forward 30 or 40 years from now when you retire, you probably will have to plan for a 40 plus year retirement. Therefore, the sooner you start saving for your retirement, the easier it will be to achieve your goals.
I am certainly not discouraging you from saving money to eventually buy a home. Not because I believe homes are good investments but rather, I believe homes, for many people, add to a great quality of life. All too often, people think they’ve made money on a house because they buy it for $100,000 and 20 years later they sell it for $150,000. They think that they made $50,000; however, that is not the case. After all, there is no home in America that is not a money pit. You always have to put money in your home to maintain it. When people look at how much they made on the sale of their home, they very rarely take into consideration the cost of maintaining it. In addition, what people also forget about is to factor in the time value of money. $100,000 20 years ago is worth a lot more than $100,000 today. Therefore, when people factor the cost of maintaining a house, improvements and the time value of money, they find that they didn’t make nearly as much as they thought.
My recommendation for everyone just starting their career is to fully fund their retirement account before they buy a house. Only after you fully fund your retirement account should you then start thinking about saving money for a home. Yes, it may delay buying a home for a few years; however, the benefits down the road will be substantial.
Whether it is buying a house or saving for a child’s college education, as far as I’m concerned, the number one priority has to be to save for your retirement. To be able to enjoy a long and comfortable retirement, you must have resources. The easiest way to get the resources is to start saving as soon as you can.
Good luck!
Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com