Living in a Van Down by the River:
A couple of months ago millionaire pitcher Daniel Norris made headlines for living in a van down by the river (okay he actually parked his van down by a beach or a stream somewhere, but the link to Chris Farley’s SNL character Matt Foley was too irresistible to pass up). It all started after Norris got his $2 million signing bonus in 2011 when he initially signed on with the Toronto Blue Jays. So what did Norris do after he got the money? Did he buy a luxurious house? No. He bought a 1978 Volkswagon Westfalia microbus. The same vehicle Scooby Doo hangs out in. Norris appropriately named the vehicle “Shaggy.” Once he had given his new home a name, Norris then proceeded to outfit the van with solar panels and a small kitchen and starting embracing what he calls “the simple life.” Now I’m not suggesting you live in a van down by the river, but I am suggesting you attempt to buy a house for less than you can afford so that you can have more money left over to invest.
Follow the Lead of Some of the Greatest Money Managers of Our Time
Buying a house for less than you can afford and investing the difference would definitely put you in good company. Billionaire investor Warren Buffett still lives in the same house he bought in 1958 for $31,500 (the equivalent of $263,000 in today’s dollars). What does Warren Buffett’s house tell you about his net worth? Nothing. Even though Warren Buffett is estimated to be worth a staggering $65 Billion and is ranked the third richest person in the world, he is still perfectly happy living in the same 5 bedroom home he bought close to 60 years ago. What’s more, the Oracle of Omaha has been quoted as saying – “I would have made far more money had I rented and invested the money instead.” All of this would seem to suggest that Warren Buffett is content to live in a home for far less than he can afford and that he also believes the less you spend on your home and the more you invest, the richer you will become.
Warren Buffett isn’t the only famous money manager that would appear to subscribe to this philosophy. When Sir John Templeton (labelled by Money Magazine in 1999 as “arguably the greatest global stock picker of the century”) first started working on Wall St. in 1940, he and his wife rented their Manhattan apartment for only $50 a month. Furthermore, they furnished it for only $25. Sir John and his wife achieved this feat by gong to second-hand auctions and making some of the furniture themselves. Why did Sir John chose to live in a home well below his means? He did it so that he and his wife could save and invest 50% of the money they brought in. Let’s take a look at an example to see how a strategy like the one Sir John Templeton used when he started working could pay off today.
A Million Dollars in Twenty Years
The average house price in Canada currently sits at about $500,000. Let’s say you are buying a house in Canada and you get a $500,000 mortgage with a 20 year term and a fixed interest rate of 3.5%. If this were the case, this mortgage would cost you roughly $2,900 a month. Now let’s say you decide to buy a house for a little less than you can afford and settle on one for $400,000. A $400,000 mortgage with the same 3.5% interest rate would result in mortgage payments of roughly $2,300 a month. Let’s take this one step further. Let’ say you get a $400,000 mortgage and rent out the lower level of your house for $1,000 a month. This is exactly what my wife and I did when we bought our house in Greater Vancouver ten years ago. We were originally looking at $500,000 homes and instead settled on a $400,000 home and rented out the lower level for about $1,000 a month to save even more money. With a 20 year mortgage and a fixed interest rate of 3.5%, you would end up with monthly mortgage costs of only $1,300 a month if you used the rent to help pay the mortgage.
So what would you do with your extra $1,600 ($2,900-$1,300) a month in savings? How about investing it in a low cost S&P index fund? That way, just like Sir John Templeton, you would be living frugally and freeing up a significant chunk of your income for investing. So just how much money could you make by adopting a strategy like this?
Assuming you realized a compound annual growth rate (CAGR) of 7% (compounded monthly), you would wind up with a staggering $830,000 over the life of your mortgage. If you realized a CAGR of 8% (compounded monthly) you would wind up with just shy of $1 million.
Again, no one is saying you need to live in van down by the river, but it’s obvious that a strategy of buying a house for less than you can afford and investing the difference can pay off in a pretty big way.
Pay Yourself First
If this is sounding like a pretty good idea to you, and you see some merit in buying a house for less than you can afford so you can invest the difference, the first thing you need to do is buy a house for less than you can afford. The next thing you need to do for this plan to work, however, is to make the act of saving and investing all the savings you realize automatic.
In other words you need to make sure you pay yourself first. Paying yourself first was a concept I first came across in David Chilton’s book The Wealthy Barber. It refers to the act of having a certain amount of your biweekly paycheck automatically put aside for investments. The money automatically gets debited from your account and gets invested before you have the chance to spend it. The simple truth is that unless you pay yourself first you will, more than likely, just spend everything you earn.
Like it or not, we are a society of spenders. If you don’t make a conscious effort to put money aside, it will get spent. Chilton is not the only financial author to highlight a strategy of paying yourself first. In fact, some of the most popular books on personal finance ever written, including bestsellers such as Rich Dad Poor Dad and The Richest Man in Babylon, all highlight this important strategy.
My wife and I absolutely made use of this strategy. Just like Sir John Templeton, we came up with a plan to save 50% of our earned income and then we made sure these savings automatically got put aside and invested.
It was a plan that paid off. And I can honestly say that over the years my wife and I were never really bothered by our less expensive house. We also never really noticed the smaller living space we ended up with. What we did notice, however, was the large amount of savings we ended up with a decade later.