Some ideas are evergreen. Take second homes. As a personal finance columnist for Vogue magazine in the early 1970s I couldn’t write about plebeian things like buying your first home. So I wrote about posh things, like buying your second home. They were, I declared, savings accounts in disguise.
Buy a house in a vacation area and you had a good chance that its annual appreciation would equal or exceed all the money needed to support it, including mortgage payments. The notion worked out twice for me, first on Cape Cod and later in Santa Fe.
But I learned something else on Cape Cod. A second home could be a major piece of your retirement plan, provided you could afford one in the first place. Not many people can. Another requirement is that your second home has to be less valuable than your first home. Preferably, its value would be a fraction of your primary home. I’ll tell you why in a minute, but first let me tell you what I saw older neighbors doing on Cape Cod.
As they aged into their 50s and early 60s many of the homeowners in the community began to spend more time in their second home. Some cut back on work; they would work four-day weeks and have three-day weekends. Virtually all of them did some remodeling work. First they winterized so they would spend the cold months there. Then they’d replace ancient bathrooms and kitchens. But no one went Taj Mahal. No one tore a house down. No one built the kind of palaces that can be seen all too often in Our Land of the Unlimited Upgrade.
These second homes were valued for their memories, for dozens of summers, multitudes of Thanksgivings, and years of getaways. They were places to relax. Kids had wedding receptions on the lawns, and came back, year after year, as their parents retired and settled in. Changes were limited because, well, everyone liked the houses as they were, not as they might be. As everywhere, some of the retirees were better off than others. But all adapted.
The basic arithmetic here is simple. According to an experimental retiree cost-of-living index, shelter accounts for 48 percent of retiree spending compared to about 40 percent for workers. So if you sell your mortgage-free primary home and it’s worth, say, three or four times what your second home is worth, you’ve got an investment fund that will more than pay for the operating costs of the second, now primary, home.
In fact, since second homes in vacation areas tend to have low taxes because of high property valuations and relatively low demand for services like public schools, a fund equal to the value of the second home is likely to cover its operating expenses. The remaining cash from selling the primary home, which could be two or three times the value of the second home, can generate income to spend beyond shelter.
Add Social Security and, perhaps, a pension, a 401(k) plan or IRA, and you’re done. Remember, Social Security benefits for someone at the top of the wage base (now $132,000 a year) replace about 25 percent of income. More if wages are lower. Add a spousal benefit at about 12 percent of the same income, and you’ve got 37 percent of income replaced from Social Security. But that’s on top of 48 percent replaced in shelter--- not to mention another 5 to 10 percent from the possible additional equity from the sale of the primary home. So we’ve reached a possible 85 percent effective replacement rate--- without counting on income from a 401(k) plan, an IRA or a pension.
What’s most attractive about this plan is that it depends mostly on you and your family. It doesn’t depend on future stock or bond market performance. It will work better than other options if inflation returns.
Success depends on your ability to pay down debt and focus on a concrete long-term goal.
What are the basic requirements for pulling this off so it works?
- Resist Taj Mahaling. Get the value ratios right, and keep them right.
- Don’t try it unless you can afford to support the second home without renting it.
- Save in a taxable account to build liquidity and possibly enjoy low tax rates later.