Home or Index Fund? The Choice Is Emotional as Well as Financial

Q: I am wondering whether buying a house is a smarter investment than a stock market index fund over the long term. I have been told that houses appreciate 3% to 5% annually, but the recent stock market gains have been much higher. I have gone to bookstores and the library and looked at every book that tells me the pros and cons, and I get the feeling I may be better off renting. I know there are many factors to consider, but which is the better thing to do money-wise?

A: I suspect home buying is like child rearing. If you’re not absolutely sure you want to do it, you might be better off not.

Homes can be expensive, unpredictable, demanding, rewarding--much like kids. And there are no guarantees--much like there aren’t with kids. The best minds in real estate expect homes overall to appreciate at a rate slightly higher than inflation for the next decade or so. Then again, the best minds in real estate pretty much missed predicting the California recession, during which property values tumbled by 20% or more.

Stock market returns aren’t guaranteed, either. At least your index fund won’t need a new roof in a few years; then again, it’s hard to feel much pride of ownership in a mutual fund.

So the decision is at least as much emotional as it is financial. Either way, you’re taking a risk. If you do decide to buy, you can make a smart investment choice by buying in the best neighborhood you can afford (that includes good schools); buying a single-family home rather than a townhouse or condominium, which tend to get killed in recessions and to lag in recoveries; and buying a home without major structural flaws or incurable defects (such as being situated next to a freeway, schoolyard or cemetery). Pile up a good emergency fund and don’t blow every paycheck on home improvements. Finally, keep contributing to your stock funds. There’s a lot of wisdom in hedging your bets.

When It Pays to Not Listen

Q: I just read your Jan. 31 advice in which you told the conservative young couple with $40,000 in savings for a down payment and pre-approval for a $300,000 loan to wait until they have more saved before buying. Your ill-considered advice may very well wind up causing that young couple to never be able to afford a home in the future! I am a real estate agent who is watching prices rise. The likelihood of another real estate downturn is almost nonexistent in the reasonable future. As for people who got “trapped” in homes worth less than their mortgages, those who didn’t lose their jobs and who kept their homes are, with few exceptions, finding them once again worth what they paid for them.

A: Thank you for writing, and for providing readers with a perfect example of why they shouldn’t get their financial advice from a real estate agent.

No one can predict what the future will bring--for the economy, real estate prices, interest rates or anything else. Yet how often have you heard real estate agents urge you to buy because home prices or interest rates are only going to go up? The real estate agent’s job is to sell you a home. The lender’s job is to sell you as large a mortgage as possible. The potential buyers’ job is to make sure they can afford it all--and to make sure they’ll be happy if, after 10 years of mortgage payments, property taxes, insurance and home repairs, they barely break even on their investment.

Uniform Enforcement of Tax Rules

Q: Over the last few years, my co-workers in police work have insisted that meals bought on duty are deductible as business meals. They also claim that haircuts are deductible since there are policies that dictate the styles for those in public safety. They say that their respective accountants have thoroughly researched this, but my own accountant says those costs are not deductible.

A: Some pretty odd things have been successfully deducted as employee business expenses, including monster breast implants for an exotic dancer. Haircuts, however, have been specifically ruled out by the IRS--even for those whose employers require a specific length or style--and that ruling was upheld by the Tax Court.

Ditto with meals. You need a legitimate business purpose to deduct a meal. Just being “on duty” isn’t enough, whether you’re a cop or a bank teller.

If your co-workers’ accountants really are letting them deduct these expenses, then those accountants are doing their clients and other taxpayers a disservice. The clients are sitting ducks for any rookie IRS auditor. And meanwhile, the rest of us are picking up the tab for their underpayment.

Note to Readers

Several of you wanted me to point out that Social Security contributions are a tax that is, in effect, taxed--sometimes more than once.

As explained in an earlier column, the 6.2% of income that working people contribute to Social Security is a tax meant to support the benefit system. However, that 6.2% contribution is not first deducted from income before we calculate income taxes, so it is subject to income taxes along with the rest of our incomes. Furthermore, people whose incomes exceed certain limits pay income taxes again when they receive Social Security benefits.

Liz Pulliam is a personal finance writer for The Times. Questions for this column can be sent to her at [email protected] or mailed to her in care of Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. To see past Money Talk columns, visit http://ukobiw.net/moneytalk.