How the housing crash hurts your retirement

You can now see that real estate isn't a sure bet. But that's just one lesson of this market.

By Walter Updegrave, Money Magazine senior editor
Last Updated: September 2, 2008: 7:59 AM EDT

(MONEY Magazine) -- You already know that the housing crisis has wreaked havoc with the economy and financial markets, not to mention the lives of millions who've lost or could lose their homes. But there may be a less obvious casualty too: your retirement prosperity.

According to a recent report from the Center for Economic and Policy Research, a Washington, D.C. think tank, the collapse of house prices that started in 2006 has wiped out more than $4 trillion in home equity, putting a sizable dent in the net worth of millions of baby boomers.

Among its more ominous findings: By next year, the average net worth of households headed by homeowners age 45 to 54 will be almost 25% less than it was in 2004.

Of course, chances are your situation is not anywhere near as gloomy. Unlike most Americans, you probably don't have all your net worth tied up in your house.

If you've been saving diligently, you can rely primarily on your 401(k), IRAs and other investments in retirement. A hit to your home's value, while hardly welcome, is something you can likely take in stride.

Still, I believe the bursting of the housing bubble provides three valuable lessons for retirement planning.

Don't go ga-ga over go-go investments
In the '90s it was tech stocks. Then real estate became the sure thing, which led to a spree of trading up, flipping fixer-uppers, collecting second homes and even buying condos with IRA cash. This year the "can't lose" investments are natural-resources stocks (up 29% for the 12 months to June 30), precious metals (up 29%) and energy (up 26%).

I'm not predicting that Armageddon lies just around the corner for today's winners. But gains of this magnitude aren't sustainable. They're likely to be followed by stagnant returns or outright losses, as was the case with housing. So while it's natural to want to plow money into hot sectors, remember: Big bets on the investment du jour are more often a recipe for downsizing your wealth than growing it.

Gains are no substitute for saving
The housing bubble had another perverse effect on our planning: It led us to save less. "Many people thought, 'I'm wealthier, I already have a big chunk of my nest egg thanks to my house, so I don't have to save as much,' " says Moody's Economy.com chief economist Mark Zandi.

Using asset gains as an excuse to cut back on saving can be dangerous, especially when those gains come during a period of unprecedented returns. Bloated asset values can be illusory - and temporary. So even if your retirement accounts balloon during your career, keep making contributions. If nothing else, you'll give yourself a wider safety margin to deal with setbacks.

Too much debt can compound a crisis
Many homeowners exacerbated the damage done by falling prices by borrowing heavily from their homes. Federal Reserve economist James Kennedy estimates that from 2002 through 2007 owners pulled $2.5 trillion in equity out of their homes via cash-out refinancings and home-equity loans.

That's nearly a third of the increase in home values over that period. While there are many valid reasons to borrow against your home, it can also be comforting to know that your home equity will be there later in life for emergencies.

Today's housing collapse will likely rank among the biggest debacles in modern American economic history. You can't escape it. But it will be an even bigger shame if you don't learn from it.