Homes are the single most valuable asset many people own, yet homes cost money to buy and maintain. Living in a highly desirable home is alluring since it has a huge effect on lifestyle. As a result, a large percentage of net worth can get tied up in a home without considering overall financial goals.
How much net worth should be in your home? The standard rule of thumb is to have is 20-30% of net worth allocated to your home. The key, however, is to balance overall financial goals with desired lifestyle. Factors to consider are the time frame for building wealth, the amount needed for major expenses and retirement funding, estimated future investment returns, and lifestyle priorities and expenses.
The best percentage of net worth in your home goes way beyond a standard rule of thumb for those proactively wealth building.
In this post, I’ll address why the percentage of net worth to have in your home is so important in building wealth with examples to demonstrate this point.
Formula for Home to Net Worth Percentage
As with most financial questions, again, the percentage of net worth that should be in your home is simply not a one size fits all formula. While we can use financial planning standards, such as 20% to 30% as a guide, both homes and financial goals are very unique and intertwined.
Several millennials have become known for living happily in tiny houses while cutting expenses to the bone to create financial independence, for example.
These frugal individuals clarified their financial and lifestyle priorities, then thought and lived outside the box to achieve their own definition of financial independence.
Like me, you may not want to go to that extreme. But as always, I do go a little outside of the box because doing so makes it easier to reach financial goals based on what has worked well for us.
Still, the percentage of net worth to have in your home is a factor of several big picture factors as you’ll see below.
Then check out the 3 examples given below of couples considering reallocating their home to net worth percentage.
Factors Affecting The Percentage of Net Worth to Have in Your Home
The percentage of net worth in your home is based on an overall wealth plan that includes the following factors below.
The amount you need to retire is a reflection of how much it cost you to live comfortably. This is a function of both your lifestyle and where you live.
Here are some examples:
- Higher home prices are usually in neighborhoods with higher property taxes.
- The going rate for handymen and contractors who work in more expensive areas are often more expensive.
The more expensive your home is, the more it costs to maintain, as a general rule.
More square footage means more space to heat and cool, and more space that will need repairs and maintenance, for example.
Next, let’s look at factors related to financial goals.
Importance of Home Value to Net Worth
It’s simple: The more net worth that’s allocated to your home, the less net worth available to invest.
When You Want to Retire
From a practical perspective, the amount of time remaining for your wealth to compound before retirement affects the percent of net worth you’ll need to allocate toward investing vs a home.
If you have two decades before retiring, you have more time for your investments to grow, and thus need to a smaller amount invested to reach your goals. This means you can have a higher percentage of net worth in your home if you choose.
Alternatively, if you have only a few years for wealth to compound before retiring, you’ll need more money to compound, so you should probably choose to have less of your net worth tied up in your home.
Economic and Market Cycles
Believe it or not, real estate, economic, and stock market cycles are one of the biggest influences on how much of your net worth should be in your home. This is important for two reasons.
- The economy affects the value of real estate which affects the value of your home. The last thing you want is a huge percentage of your net worth tied up in a depleting (and often expensive) asset, especially during broad real estate market corrections.
- The economy affects stock market cycles which affect the amount your money will grow (or shrink) over extended time frames.
- Most investment portfolios have assets that increase in value during bad financial times to offset assets that decline in value during such times. With homes, there is no such offsetting asset so net worth can take it a big hit.
How to Capitalize on Real Estate Cycles
While it’s counter intuitive, following a decade of rising stock prices, you can plan on having lower investment returns over the decade or so as a general rule. This is because assets become overvalued near the end of extended rising stock markets.
On the other hand, following a decade of lower than usual stock returns, you can often plan on higher returns over the next decade assuming there are no fundamental economic changes.
When you consider cycles in your projections, you can estimate better how much your money will grow. Doing so will help you know about how much net worth you’ll want in investments vs in your home.
In other words, if you’re looking to sell your home to reduce the amount of net worth tied up in it, look for seller’s markets.
And if you’re looking to buy a home, it may make sense to allocate a little more net worth to a home during a buyer’s market following a real estate correction.
This is because there is a greater chance your net worth will increase if you buy an asset below market value.
Is Your Home an Asset?
Many people argue that their home is personal, and such market factors shouldn’t be considered when making decisions to buy or sell a home. I’ve seen too many people get into serious financial trouble during major real estate corrections related to economic cycles over the past few decades to agree with that.
Again, homes are often where people have much of their net worth tied up in an expense asset.
Finally, how much you enjoy living in your home vs how much you want to use your net worth for wealth building opportunities is really the bottom line.
The goal of investing and wealth accumulation is to allow us to live how we want. Your home is so much a part of your life.
Beyond the actual dwelling, there is the convenience and time element of being near work, family or activities.
There is the connection you have with your home.
But all this must be weighed against financial peace.
And the reality is that financial peace is a function of the numbers reflected in your investment returns and savings needed to fund a comfortable lifestyle, for life.
Next, let’s look at some examples of couples evaluating how much of their net worth should be in their home.
Retiring at 60 with High Percent of Net Worth in Home
Let’s look at the net worth of Sara and Joe, a couple, both 50, with a net worth of $1,000,000.
They have $500,000 invested in a portfolio in stocks, bonds, and money market funds based on a standard asset allocation for their age and desired risk.
They feel comfortable planning for a realistic 4% annual return over the next decade before they retire.
(Read my post How to Understand Your Investments for more explanation about this.)
To dig in a little more, this estimated 4% return is before considering inflation, so their real return will be roughly 2% if inflation stays near recent averages.
Sara and Joe would really like to retire at 60 since they want to spend some time traveling before getting older.
Fortunately, their home has increased in value over the years. They think they could sell it for $500,000 after all costs, so they have 50 percent of net worth in their home.
Yet is this the best percentage of net worth to have in a home for Sara and Joe? Let’s do some math.
To retire comfortably in their current lifestyle, they have decided they want investments of $1,500,000 for traditional retirement withdrawals.
They are saving $1,000 a month and putting it into their investment portfolio.
By entering this information into the Retire Certain Early Retirement Calculator we see their investments will grow to about $941,000 by the time they wanted to retire at age 60.
Keep in mind retirement calculators are based on best guesstimates, as all future projection calculators are.
Their investments could grow by 8% a year or -2% a year but based on history and the current market environment as of this writing, 4% seems like an optimistic but reasonable projection.
Click here to go to my post How Much Money Do You Need to Retire with Vanguard founder Jack Bogle’s prediction on future returns.
By simply questioning the percentage of net worth that should be in their home, Sara and Joe have opened a world of possibilities to reach their retirement savings goals which they are not otherwise going to reach unless they make some changes as evidenced above.
Let’s explore the options for Sara and Joe to reach BOTH their lifestyle and financial goals.
Downsizing Their Home
Sara and Joe could downsize their home and invest the proceeds from the sale of their home, for starters. This could have several effects on their net worth:
- This would provide more investment capital to compound.
- They could increase their investing skills to increase investment returns.
- They could lower investment costs to increase the amount they get to keep to compound.
- They could add one or more alternative income streams to reduce the amount they’ll need to save to retire comfortably
Let’s say Sara and Joe don’t want to downsize because family visits frequently or they love their neighborhood. But they’re open minded and committed, so, let’s think outside the box.
(Read my related post Businesses to Start Later in Life with 115 cool ideas.
Income Streams from Their Home
Rather than downsizing, Sara and Joe could explore the possibility of short term leasing. Factors to consider are:
- If they have a separate dwelling or an area where a separate entrance could be added.
- Whether they live in an area desirable for short term leasing
This would turn their net worth consuming home into an income producing asset instead of only a house with many expenses and no income as millions of people have done.
Low Percentage of Net Worth in Home
In this example let’s look at Ted and Alice. They are also 50 years old and want to retire at 60 with $1,500,000 in investments to use for the standard retirement withdrawal method.
Their net worth is $1,300,000. After some research, they see they could get about $300,000 net from selling their home.
Their percentage of home value to net worth is 23% and they are evaluating if they should lower it.
They have $1,000,000 invested in stocks, bonds, and a money market account. They are comfortable with a 4% estimated projected return.
Plus, like the couple above, they add $1,000 a month to their retirement savings account.
Entering this information into the Retire Certain Early Retirement Calculator, we see that they will have about $1,717,000 in their investment portfolio when they want to retire at age 60.
Ted and Alice are reaching their goals to retire at age 60 with $1,500,000 in savings. This is a simple and traditional model that will work IF their investment account has a 4% return after fees and taxes.
They choose to keep their current home based on this potential outcome.
40 Percent of Net Worth in Home with Alternative Plan
Be forewarned. This example is outside of traditional financial planning, but there are even some financial advisors and thousands of investors who use this approach.
Let’s look at Bob and Carol in this next example. They have a net worth of $1,000,000. In their net worth statement, they have valued their home at $400,000.
They have $600,000 in their investment portfolio which is heavily invested in stocks and cash with minimal bonds.
This means that 40% of their net worth is in their home. Bob and Carol were upset when they looked at the numbers because they really want to keep their home so they take the following steps after some serious research and education.
Bob and Carol spend a few hours a month managing their income focused portfolio.
They sell covered calls when they see a good opportunity for out of the money covered calls on dividend stocks. (Here is my post on covered calls.)
This allows them to earn about 12% a year in income alone from their stock investments, about 6% from dividends (stocks, MLPs and REITs), and another 6% from out of the money covered calls.
They plan to continue this covered call strategy after retiring while realizing that it may not work during the occasional bear market every few years. Plus, they have some of their investments in cash and bonds.
For this reason, they want to conservatively plan for 9% instead of 12% income from dividends and selling covered calls.
While they also get some increase in value from their stocks, they won’t take that into consideration since some years that probably won’t happen.
Plus, they will have to pay taxes on the covered call income that is outside of their IRA.
Since they plan to have the 12% income from their dividend and covered call strategy in the stock portion of their portfolio, they feel confident they can retire on retirement savings of $800,000 since investment income will pay for much of their lifestyle expenses.
They also add $1,000 a month to their investment account from job income.
By entering Bob and Carol’s data into the Retire Certain Early Retirement Calculator using the lower 10% return (from income alone which is reinvested), we see their retirement savings should grow to almost $1,833,000 by the time they retire at 60.
How to value your home in your net worth statement is explained in my post entitled Does Net Worth Include Your Home here.
Summary – Net Worth Percentage for Home
We all love hard and fast rules and formulas. They require less work on our part.
But as you can see, there is no neat little formula that tells you how much of your net worth should be in your home.
There are only priorities, financial goals, and math. Only you can set your priorities and create your financial goals if you want to live life on your own terms.
Decide how much of your net worth should be in your home based on what you want in your life.