Asset Allocation

[Edgar]

Hello All:

How do you account for a personal residence that is owned when allocating your assets. I have seen some posters inicate that they have 55% of their assests in equities. For the sake of simplicity lets say a person owned their home with a value of 200,000 and had other investable assets of 800,000 including retirement accounts, 401K's, IRA and regular accounts.

How do you account for the house? Is 55% 550,000 or 440000 ? the 200K in the house is not at risk based on equity performance.

Then if the person has a private pension that will pay them 30K a year do you consider that in this formula, for example it takes 600K at 5% to generate 30K of income. The more I conteplate it the more I get confused. I better stop now.

Edgar

[d]

I do not consider my home equity as part of my investable assets. I don't have a private pension, but if I did I'd also not include that in any way. That said, a good case could be made for including both ... but I believe a better case can be made for excluding them.

[mathjak107]

well my feeling is i dont count anything in my net worth that is for personal use...the origonal artwork on my wall,the house etc may one day be up for sale or avail for sale but until it is its more for personal consumption..unless a house is sold or avail to be sold a 500,000 dollar house is worth no more or less than a million dollar house unless its for taxes,a loan or your heirs....if it makes you happier than count it

[yakers]

Lots of ways to look at it. If you didn't own the house and had to pay rent, what would that cost? But you still have to consider your taxes and maintenance. I have a pension which I do count as part of my fixed income so in my 401k type account I go heavy on stocks. It seem to me that if you owned your house and even if you didn't plan to sell it would still allow you a more aggressive AA.

[lazygood4nothinbum]

i consider my house to be an asset that i will live in for another 5 years and then i will move onto a boat which i consider to be a liability that i will live on for the following 20 years.

but i only consider the house to be an asset that will buy me a really fun liability, not an asset that will bring me income.

as i'm just learning all this stuff i've no doubt i'm misusing those terms, but as far as i can so far decipher, that's my intended allocation and i'm sticking to it.

[youbet]

I don't have a strict rule or guideline for accounting for my paid-for house or dbp pension.* But I do consider them when doing total portfolio assest allocations and carry a slightly higher equity percentage than if I didn't have the house or pension.*

[Nords]

Quote:

Originally Posted by Edgar How do you account for a personal residence that is owned when allocating your assets.

Judging by the number of times we've had these threads on the portfolio values of houses & pensions, it doesn't matter how you count it. *There's no GAAP or investing standard. *Count it if you want to, don't count it if you don't want to-- whichever makes you feel more comfortable. *But don't put anything in your portfolio that you're not willing to sell to avoid going back to work!

Just be aware of a few caveats:
- It's much easier to determine your retirement budget and to pick an inflation rate. *Inflate your retirement budget by that amount every year and then add in that year's capital expenses of a new roof or replacement vehicles/appliances or a fantasy vacation or a kid's wedding. *Subtract your pension amount from the total, and what's left is the annual expenses you're going to have to fund that year.
- A rough safe withdrawal rate of 4% would require a portfolio of 25x your annual expenses. *A portfolio that's very high in equities might only need 20x, but a portfolio that's high in fixed income/cash might need 33x.
- If you're going to count the house as part of your portfolio then it implies that you're willing to sell it if necessary to get you through times when the other parts of the portfolio can't support your expenses.
- If you're counting your pension as part of your portfolio then its source makes a difference in its "quality". *A federal pension is probably worth the cash yielded by its equivalent in Treasuries while an airline or automotive pension is probably the equivalent of junk bonds. *A pension from the steel industry is probably worthless.
- If you're not counting your pension as part of your portfolio then your portfolio allocation may end up holding too much in bonds & cash.
- Overconcentrating on bonds/cash will lower your portfolio volatility but raise your risk of losing to inflation. *
- Overconcentrating on equities will raise your portfolio volatility but will probably reliably beat inflation.

[2B]

Here's my rules.

1. Equity in any physical property is just that. You don't have an income but you may avoid an expense (rent) but you incur maintenance which must be accounted for. The asset appreciates (or doesn't) and that can be accounted for in an assesment of assets. You can always sell a residence or any prized asset as an income stream of "last resorts."

2. Pensions are an income stream similar to a bond. That's how FireCalc will evaluate them. If they are COLA'd you are in great shape. If not, they will depreciate with the inflation rate used in the evaluation. A reasonable assumption I have seen is to depreciate the value of a pension like it is a 7% bond. If you have $10,000 per year in non-COLA'd pension, it would be equivalent to about $142,800 in assets. Apply SWR to that under the assumption you'd save the excess in the early years to pay for the reduction later on.

[d]

as other have noted, if home equity and pensions are not included in the "investable assets", they certainly should affect the risk profile of that portfolio. Question for those who favour including pensions: would you similarly include the "asset equivalent" of social security? Further question: if a pension has no death benefit, does it not distort the asset picture?

[mb]

I track AA and net worth in a spreadsheet and calculate it both with and without home equity included. I use which one I think is most appropriate for the purpose. For example for FIRECalc I exclude home equity because I don't want to rely on selling or doing a reverse mortgage,

MB

[2B]

Quote:

Originally Posted by mb For example for FIRECalc I exclude home equity because I don't want to rely on selling or doing a reverse mortgage,

I agree. A paid off home is the asset of last resort. It becomes a financial insurance policy. It's what will pay for about half of my in laws nursing home care. They certainly will never return (once we get FIL out).

[audreyh1]

Quote:

Originally Posted by mb I track AA and net worth in a spreadsheet and calculate it both with and without home equity included.* I use which one I think is most appropriate for the purpose.* For example for FIRECalc I exclude home equity because I don't want to rely on selling or doing a reverse mortgage, MB

I know that house net value can be a considerable percent of an individuals net worth, but it has never made sense to me to include it as part of AA for the exact reasons that MB outlines.

Also FWIW - owning a REIT fund is not the same investment as home ownership. Two different animals.

None of the AA papers that I ever read suggested tailoring your AA to take into account the value of your home.

Audrey