Young & Invested: Should you invest in shares or save for a house deposit?
With pressure on young people to enter the property market at sky-high prices, I explore whether they should invest in the sharemarket instead.
Welcome to my column, Young & Invested where I discuss personal finance and investing for Gen Z and Millennials. This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Over the past month, my personal column has taken a housing and affordability focus. Every article brings me closer to the conclusion that ‘the great Australian dream’ is largely a myth for many.
Edition 6
The evolving dilemma
There is no denying that house hunting is our national sport. Telling people you aren’t interested in buying property feels like announcing that you won’t be watching the Swans grand final.
I have a dilemma. And I don’t think I’m the only one in this predicament. I am currently 25 in the early stages of my career on a solid income. I recognise this is a privileged place to be and I’m lucky that I can consider the best way to build wealth. I also live and work in Sydney, a city notorious for exorbitant house prices and cost of living pressures.
For decades, Aussies have been sold the dream of property. "Get on the property ladder as soon as you can” is the classic piece of intergenerational advice. Conventional wisdom is that this is the only way to build wealth. But is this still true? With no end in sight to Australia’s housing crisis, young people are faced with committing to crushing levels of debt to climb on the property ladder or divert funds to the share market.
The double-edged sword
The more emotions involved the easier it is to make a poor financial decision. Housing decisions are difficult because it combines the emotional draw of a home with the underlying assumption it is a key step to building wealth. These two justifications play off each other as people are willing to pay more and more for the security of a home and the promise of getting rich.
In my view the assumption that any form of housing constitutes an investment is an overly presumptuous perspective. Your primary place of residence is a basic need. It is easy to understand why property is perceived as an investment due to its potential for generating returns, however this overlooks several critical aspects.
An investment needs to be converted to cash at some point to spend. Yet you always need a place to live which requires a move to a cheaper location or smaller house The caveat of trying to generate returns from a primary place of residence is that you buy and sell in the same market. It is irrational to assume you can sell at a peak and buy in a trough, as you need residence for the period between.
Unless you are reaching retirement or selling to downgrade in value or area, house price appreciation may not directly benefit your cash flow. While an increase in the value of your property is advantageous, it concurrently implies that the market has appreciated overall. Our houses can become ‘golden handcuffs’ as people are compelled to spend more to maintain and upgrade a home. This may involve more debt. The tangible cash flow benefits of homeownership only arise after paying off the entirety of a mortgage. However, the interim period between purchasing the property and paying it off can bey a prolonged cash drain from mortgage repayments, council fees, insurance and other maintenance costs renters don’t face. It is this interim period that I find problematic considering my other goals.
Difficulty of accumulating a deposit
The disparity between young Australians entering the property market now vs a few decades ago is undeniable. New South Wales for example, has seen a 99% growth in value from 2014 to 2024, whilst wage growth has risen 26% over the same period.
Further, a glance at historical house prices shows the average property in 1984 cost $64k. Despite interest rates being much higher in the 80s, the annual income to house price ratio of ~3.5x is modest compared to today’s figure of 10.2x. This begs the question, is committing to an asset valued over 10 years of pre-tax salary the logical thing to do? This decision will depend on a variety of factors like personal circumstances, financial goals and the level of conviction on future house price growth.
In Edition 4 of this column, I ran an exercise on what salary would be required to comfortably afford a house. I recognise NSW, specifically Sydney, as an outlier with an extreme case of unaffordability. That doesn’t mean it is easy to buy a house in another state, I used Western Australia as an example to exclude Sydney as an outlier.
I found that it would require approximately $160,800 per year to comfortably purchase a home in Western Australia. However, this exercise made one sweeping assumption – the deposit had already been accumulated.
The prospect of saving for a deposit is a major concern for young people whose wage growth simply hasn't matched house price appreciation. In short, requirements for a deposit are growing well beyond the rate at which wages and savings levels can keep up.
And what if you weren't earning the required $160k annually? The reality is, the majority of millennials on a single income don’t. This is where the problem arises.
I ran an exercise on how long it would take to save for a deposit on a $1m house in Australia. To avoid Lenders Mortgage Insurance, I set a deposit of 20% and accounted for additional expenses such as stamp duty, lenders fees and one-off buying costs. In an article about the real cost of buying a home, Shani explores the additional costs associated. I used the Qantas Money calculator to estimate the additional upfront costs that may be required.
This results in a total cash requirement of ~$241k on a $1m house. This gives us the basis for estimating how long it would take to accumulate this amount on two median salaries?
Let’s assume that a couple earns a combined post tax income of $160k a year ($80k each) and are currently renting. Financial advice recommends that rental payments should not exceed 30% of pre-tax income. Let us conservatively assume that their rent is currently at 25% of pre-tax income.
Data from Numbeo, the world’s largest cost of living database, found that the median monthly living expenses (excluding rent or mortgage) were approximately $1.6k per person reflecting a combined annual expense of ~$40k. The remaining funds leftover for a deposit would be $49k.
This would result in accumulation of a deposit in just under five years. This is an extremely conservative estimate. It doesn’t account for other savings or discretionary spending.
Given the five-year time horizon inflation will play a role. I’ve assumed 2.5% annually. To replicate the purchasing power of $241k today in five years, you would require $272.7k. This results in an additional $31.7k in cash. At an annual savings rate of $49,006 it would take five and a half years to accumulate the deposit after considering inflation.
If housing prices appreciate 5% every year for the next 5 years while saving for a deposit the increase exceeds the overall appreciation level given the gearing in housing.
In the figure below, I consider a home that costs $1m at the beginning of Year 1 growing by 5% by the end of every year and then examine how much the deposit will increase. Per the calculations below, the house price would be ~$1.28m reflecting a total appreciation of ~28% over five years. This results in the initial $200k deposit (excl. other costs) required increasing to ~$256k after five years. For a prospective buyer, simply saving an extra 5% every year falls short of the increase in the deposit.
This exercise assumes that a couple is earning $160k a year which is broadly in line with the median combined income for the 25-34 age category. However, this would be considerably harder, (if not completely out of reach) for an individual on a median salary wishing to purchase a home independently.
It is no surprise that for those in higher income brackets, it takes considerably less time to save for a deposit. The issue I have with attempting to save for a deposit independently, is that conservatively allocating my salary in the hopes of affording a home in 5-10 years feels like a shout into the void. Saving for a deposit would require an immediate lifestyle sacrifice which doesn't align with the lifestyle I wish to live at this age.
Put simply, I don’t think buying a median house at 35 shouldn't require sacrificing your youth and the experiences that shape it. I understand this may be the ‘gotcha!’ moment for older generations who imply that simply working hard and making sacrifices is all that is required to achieve homeownership. However, it is important to note that the period of sacrifice is significantly longer now than it was in the past. At some point, everybody must make the trade-off between the viability and purpose of achieving homeownership and the considerable sacrifice to do it.
Others will make different choices. However, for the median Aussie, other financial goals may be better suited. Read Shani’s article about other goals to focus on when buying a home feels out of reach.
Valuing flexibility
Being relatively new to Sydney, I still have a considerable amount of exploring to do before deciding which area I’d most like to settle down in. Whilst I have somewhat of an idea, this could easily change depending on my circumstances. Renting provides me the flexibility to live in the areas that I want to live in and move with ease when plans change. Given my current lifestyle, the thought of purchasing a property I can afford that is a two-hour train ride to the city isn't attractive.
Tying myself down to a mortgage would also limit the flexibility I have to pursue other goals that require funds such as yearly travel. Whilst a property would be a great asset once paid off, the period between purchasing and paying it off would require a significant depression of cash flow which would not allow me to pursue these alternative goals.
As cliche as it sounds, time is the only thing that money cannot buy. The question many young people are faced with is whether to forgo prime years of youth to purchase a property based on the assumption they will also experience the financial success of previous generations.
Here’s my take: Yes, perhaps I will regret not purchasing a home earlier and missing out on price appreciation, however, no return figure can ever buy back my youth. There is no right or wrong answer here. It largely depends on where you receive fulfillment. If owning your own home derives greater pleasure than the experiences you have in your 20s, then saving for a deposit is likely the correct choice.
A mixed approach
My favourite thing about investing in shares is that you never get an email from a plumber quoting $5,000 for an urgent leak repair. The cost of owning a property does not stop at mortgage repayments. Ongoing liabilities for the maintenance of a property are estimated at ~1% of the property’s value. This means for a $1m house, you should allow for at least $10,000 per year for unforeseen circumstances. Furthermore, insurance, property tax and other administrative fees should also be taken into account. With share investing, the only significant cost I am faced with are fairly negligible ETF fees (as my brokerage on purchases is free).
Investing in shares also opens up more options for the future. Hypothetically, if the Australian housing market plummets in five years’ time, a diversified portfolio of shares leaves me well equipped to capitalise on a downturn to purchase a property if I wish to. In such a case, owning shares instead of property means my wealth is not tied to a single asset, given global financial markets have little correlation to the local property market.
Opportunity cost of saving
Investing will generally always generate higher returns than a savings account at the price of volatility. Given market volatility, it is possible that when the time comes to withdraw funds for a deposit, the market may be experiencing a downturn resulting in a withdrawal before the full potential of returns is realised, or even worse – withdrawing at a loss. That is why for short-term goals savings accounts are recommended.
There is an opportunity cost to choosing a savings account. $2,000 invested monthly for the next 8 years at an 8% annual return after inflation results in ~$265k. In comparison, this same contribution to a cash account paying 2.5% p.a. would net $212k. This difference of $53kg and illustrates the impact that choice has on long term wealth accumulation.
As an analytical person, this opportunity cost is simply too large to justify putting money into a savings account over the share market.
Conclusions
A common argument is that housing is the best way to build wealth in Australia. We have all heard the story of an uncle buying a middle-of-nowhere property in 1985 for $50,000 and then selling for $1 million a few decades later. Whilst this may have been the case 30 years ago, it simply isn’t reflective of the current market. I believe it would be irresponsible of me to reinforce the idea of property ownership and encourage young people to commit to substantial mortgages assuming the same outcomes as previous generations.
Investing additional funds into the share market provides an alternative to saving for a house deposit. Whilst not entirely risk-free, long-term returns are almost certainly higher than savings rates, given your withdrawal date isn’t rigid (creating risk of coinciding with a market downturn).
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