Why large investment in property at young age could be risky
Posted by: Uma Shashikant on Jun 27, 2017, 05.00 AM IST
By Uma Shashikant
Last week was celebration time. A young couple in the family were moving into their newly-minted home. As working professionals they have decided to live in the city they grew up in, and a house was the “base” they wanted to create for themselves. The primary personal finance question they had in mind was: Do we own too much in one asset? How does this affect us?
It is a good idea to pause and consider whether it makes sense to own a house at all. The temptation is high. The lure of the bank loan, the attractive EMI, the constantly rising price of property, and the psychological satisfaction of having invested in an asset, are all reasons why young investors choose property over most other assets.
The primary objective of owning a house is the protection it offers when all else goes wrong. To own a house is to buy oneself an expensive insurance should there be a setback. One can begin something new when there is no pressure of a fixed rent to pay, or no fear of being ‘on the street’ should adversity hit. The safety, security and satisfaction that most associate with owning a home comes from this comfort that one’s own home provides.
However, young buyers run the risk of overdoing this. A large investment in property too early in life comes with three key risks. First, relocation in the interest of career is hampered if one is tied down to a location too early. IT professionals with locked flats that are tough to rent out will testify to this risk. Second, social pressures lead to overshooting of budgets, resulting in steep EMIs that leave too little for other needs of a young couple. Many credit card defaulters have pushed themselves into such misery. Third, unexpected twists and turns in career, family and health needs a fall-back option. A single, solid asset offers little help. More so if it is a house one is living in.
Prioritising their psychological and financial needs is a task young investors should master. Buying a house so that one feels secure should wait until their careers have stabilised. Our young couple gave themselves 10 solid years to build on their professions, living in rented accommodation along the way. They did not see paying rent as ‘foolish’, but as breathing space they gave themselves to build their careers. It was only when they knew firmly about how they will live and work, that they decided to buy property.
A common mistake young earners make is to buy property too soon. Then they find themselves being posted to another city; or they end up with an educational loan to fund higher education; or their spouses do not like the property enough to move in; or they kill themselves commuting from the distant property they managed to buy. In early years of life and career, a lot is still flexible and uncertain. Locking oneself into a large investment too early can be severely constraining.
Setting money aside from the time one begins to earn is a good practice. This money when invested sensibly, can grow into a decent sum that can be available for emergencies of the early years. Young savers are able to draw from and replenish a corpus of money, and learn the merits of financial discipline and emotional intelligence of building a corpus. Desist the temptation to invest too much, too early, in a house funded with a borrowing, to get into the habit of ‘compulsory’ saving in the form of an home loan EMI.
Our couple found that their love for travel was the toughest to resist. As hardworking professionals they could not deny themselves a break when they felt they needed it. Soon enough, elders in the family and friends began to tell them that they needed the ‘discipline’ imposed by the EMI and that they would own a house if only they did not spend so much on holidays.
So our couple bought into a tiny one-bedroom flat. This decision was well thought out. They did not see the flat as their “home”, but only as an investment. They therefore did not incur high costs in furnishing it. They also did not overdo the location and other facilities, except for ensuring that the flat could be rented. They also did not overshoot the budget. Removing emotion from the buying decision ensured that it was sensible.
The EMI for this flat was partly funded by the rent it earned, and partly by diverting some of their savings. Our couple knew that they would sell this flat off if needed. That helped in keeping it small and basic. Needless to add, selling this flat off helped immensely when they bought their dream house a few years later.
Now to the question of what happens in the future. Our couple now has a house, a bigger EMI, but a bigger income that supports it all. They will not have to pay more than 20% of the household income towards the home loan. Buying a house when incomes have grown and stabilised offers this singular advantage. The house does not constrain normal spending or saving. That also means that they can continue to build other assets, which should be their focus going forward.
The imbalance that our couple sees is a short-term phenomenon. It is easy to be taken in by the size of a current event. Their house is over 80% of their assets now. But in 10 to 15 years’ time, they will find that it has evened out to a more normal 30%. Three things will work in their favour to make this happen.
First, careers peak and flourish when one hits the 40s. For many of the illustrious youngsters of the modern times, it is even earlier. For those who have the ability to make the most of the opportunities around them, the first five to 10 years are the learning ground for a steep take off thereafter. When earnings run ahead, so should savings and investments, leading to a healthy net worth in the future.
Second, one large physical asset in the form of the house they live in typically satiates many household’s need for security and a sense of wellbeing. Incremental lifestyle and discretionary expenses typically fall when a household focuses on building upon what it currently holds. Our couple should not fritter away the benefits of the afterglow that house ownership brings, where responsible spending is the key benefit.
Third, stable incomes and a secure lifestyle enables investments in risky growth assets such as equity. If the household is already enjoying a good income and a healthy saving rate, it is ripe for growth assets. The higher return from such assets will enable a better appreciation in net worth, given time.
Our couple should therefore focus on their career and profession and shoot for emerging at the top in the next 10 years. If they manage to not expand their lifestyle expenses too much as they move up, and if they save diligently and invest in financial growth assets such as equity, they are likely to find themselves sitting on a neat net worth that is a multiple of what they now have.
Many young investors think that they should master the art of timing the entry and exit into equity markets to become rich. Timing your asset acquisitions in line with your professional growth, just as our young couple managed, is a much more useful skill to acquire.
The author is Chairperson, Centre for Investment Education and Learning.
(Disclaimer: The facts and opinions written in this column are those of the author and do not reflect the views of economictimes.com.) This article appeared in Economic Times dated Jun 27, 2017, 05.00 AM IST