Today's plunging price of gold in the face of what appears to be the early stages of the next housing bubble reminds me of the extent to which various markets can be unpredictable if not idiotic. In just a few months, gold and gold-mining company stocks have dropped almost 25 percent while home prices are rising rapidly as a result of slim inventory and multiple all-cash offers.

While gold fanatics are now left having to pray for some international calamity to arrest their investment's plunging value, those of us with a more conventional approach to building financial security have the stock market and our homes to fall back on.

It's reassuring for those of us owning homes to note that the tide seems to be rising even if we have no plans to sell. Homes turn out to be great investments, generally, but not for the reason one might expect. As financial instruments, they don't increase in value much, if at all, beyond just the rate of inflation.

What makes them turn out to be "the best long-term investment we've ever made" is attributable to factors that have little connection with the commodity itself. Instead, we benefit from the forced savings or disciplinary aspect of paying down a mortgage. Then, there's the tax-deductible treatment (effectively a government subsidy) helping us pay interest and property taxes.


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We would have had to spend at least something for shelter, so the true marginal cost of ownership is the increased cost over what we would have paid for rent. Finally, there is leverage if we borrow money and the house increases in value at a greater rate than the net after-tax cost of our interest and taxes.

What gets in the way of this perfect picture of homes as great investments is the fact that they increase in value only at about the rate of inflation. Long-term, for about 100 years, this has averaged 3 percent per year. Along the way, we will have had to spend money to keep them up. New roofs, insulation, dry rot -- all this expense has to be subtracted from our perceived gain in value.

But again, spending some of our income to protect the investment is really just another form of forced savings. The slowly-deteriorating house, if left to its own devices, will be just a money pit -- either for us or the next owner.

What makes us feel good about owning a house is that in just 10 years, a three percent annual rate of inflation will raise the value of the house (if kept up) by more than 25 percent. So what we bought for $400,000 becomes $500,000 and we've just made $100,000 minus the cost of improvements. What we might think was the product of sweat equity and good timing was really just inflation.

The stock market, on paper at least, offers a much better opportunity for investors than homeownership. Robert Shiller, the housing analyst, writes in the New York Times that homeownership can't compete with stocks when it comes to creating real appreciation over and above inflation. He points out that public companies plow their earnings back into the business, which prompts a growth in value over time. Companies that pay dividends to shareholders are still retaining the bulk of their earnings in an effort to sustain their growth.

While large companies have historically grown at the rate of 10 percent per year (including reinvested dividends) many skeptics say that 7 percent for the foreseeable future would be a more realistic expectation. Nevertheless, that would still be 4 full percentage points higher than the average annual inflation rate of 3 percent. It leaves housing in the dust.

Homeowners contemplating retirement sources may be looking at a window of opportunity to sell or downsize in the next few years at what could be housing's next high water mark. Invest the proceeds in a cross section of large, dividend-paying stocks -- or mutual funds that hold those investments. Keep life simple. Avoid fads like gold, and stay one step ahead of inflation.

Stephen J. Butler is CEO of Pension Dynamics. Contact him at 925-956-0505 or sbutler@pensiondynamics.com.