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Debt Reserves as Asset Allocation Strategy
Old 10-14-2020, 03:35 AM   #1
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Debt Reserves as Asset Allocation Strategy

I'm about 100% equities except for cash and playing around in my head this morning on withdrawal strategies (especially since I don't trust current valuations). Assume the WR is "safe" for the ER's comfort level (say <2.5% with a planned draw period of 50 years).


I was thinking of treating the HELOC like a bond fund in a sense. In years where portfolio growth is negative and/or gains are less than the required withdrawal (and/or calculated), borrow from the HELOC to cover the difference and pay off in years when the portfolio is generous.


Obviously there are interest costs (expected to be offset by gains upon market return to mean, and a risk of compounding SORR if there were multiple years of declines that required a larger withdrawal to pay the HELOC at even further depressed market prices. (but historically unlikely to have too many bear years without a bull)


This is not my plan but a thought experiment, for now the HELOC is just to mitigate cash flow risks from unknown unknowns and for tax planning purposes to disjoint spending from realized income (or floating till EOY when I can plan taxes better).


Thoughts/anyone tried this?



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Old 10-14-2020, 05:36 AM   #2
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I think it's a mistake. Think of it like a corporation issuing debt to pay for a shareholder dividend during lean years of profit.

If you're going to maintain your withdrawal rate with this approach, you're better off not using the HELOC - just withdraw the extra amount from your holdings. The HELOC is effectively a "margin loan", where you're borrowing against your house, effectively mortgaging it for some period of time...using it as a piggy bank, even if it is just for some (anticipated "short") period.

Bottom line, with this approach you're expecting that going forward your portfolio will earn more than the HELOC rate + fees. Maybe it will, maybe it won't - do you feel lucky?
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Old 10-14-2020, 06:09 AM   #3
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I think you lost me at 100% equities. Why not something a bit more "conventional." 40% to 80% equities and just withdraw as a part of your rebalancing. No opinion on your use of HELOC except it sounds like using leverage to increase your potential gains on equities. Sometimes that works and sometimes it doesn't but YMMV.
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Old 10-14-2020, 06:26 AM   #4
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I guess that you could use the HELOC as a liquidity tool, but if 2.5% WR is safe, it is safe... just skip the HELOC.

Or alternatively, go from 100/0 to 95/5 or 90/10 and you can supplement equity dividends with draws from the fixed income in down years.
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Old 10-14-2020, 06:28 AM   #5
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I think a line of credit has nothing to do w/ one's AA.
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Old 10-14-2020, 07:12 AM   #6
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I think it's a perfectly reasonable approach, and would suggest that you would be better off if the market was low early in your retirement, and you needed living expenses.

I'm an outlyer on the house as an asset thinking, so take this with a grain of salt, but I think all significantly sized assets should be in your asset allocation. That includes your house. So you aren't 100% stock, because you have your (presumably) paid off house in the "hard assets" category.

To make the blanket statement that borrowing with your house as collateral is not a good idea seems illogical without knowing the interest rate expense and the inflation rate. As a thought experiment, what if the cost to borrow is essentially zero?

So if your plan includes spending borrowed money temporarily if the market is depressed, I don't see an issue with it. There is the possibility that the market will keep going down for a long, long time, and your cost of borrowing will become an issue. But if you have enough years of expenses covered, you will be unlikely to run out of borrowing before the market recovers.
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Old 10-14-2020, 07:49 AM   #7
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Originally Posted by sengsational View Post
To make the blanket statement that borrowing with your house as collateral is not a good idea seems illogical without knowing the interest rate expense and the inflation rate. As a thought experiment, what if the cost to borrow is essentially zero?
When your intent is to use the money to invest in the stock market, it is a perfectly logical blanket statement. Would you take out a mortgage against your house to use the money to invest in the stock market? Seriously? That is exactly what is being contemplated here.
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Old 10-14-2020, 07:59 AM   #8
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Old 10-14-2020, 08:14 AM   #9
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Originally Posted by njhowie View Post
When your intent is to use the money to invest in the stock market, it is a perfectly logical blanket statement. Would you take out a mortgage against your house to use the money to invest in the stock market? Seriously? That is exactly what is being contemplated here.
Yes, I would do that if my target asset allocation dictated I do so.

Look at an extreme example for purposes of illustration. You have a huge house and grounds that are worth the same as your liquid portfolio, which is all in equities. Your AA is currently 50% equities, 50% hard assets. Say you expect real estate to have a low growth rate and expect equities to be a high growth rate and you have an AA target of 60% equities and 40% hard assets. If the expected growth rate between the asset classes is enough to offset the cost of borrowing, then it would seem logical to borrow to invest.

This is essentially the "should I pay off my mortgage" discussion, and so I know I'm not going to convince anyone of anything. This is one that's never going to get consensus because people on both sides have a built-in idea that's amazingly resistant to change.

PS: If I got a zero percent line of credit, I'd max it out and invest the proceeds, without a doubt.
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Old 10-14-2020, 08:36 AM   #10
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Interesting. I might do it in a short term special circumstance, if the HELOC interest rate was very low. Otherwise I would be hesitant.

I have a different angle on this however. Lots of folks that say you have to set aside an emergency fund, effectively withholding the money in that fund from investing. I have a $250K HELOC at a very low interest rate, that I consider to be my emergency fund. The relatively low chance of needing emergency funding doesn't seem to justify holding back investable monies, if the HELOC terms are decent.
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Old 10-14-2020, 08:56 AM   #11
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I am doing something similar. I have about a 90/5/5 AA. I use the HELOC for cash flow and to smooth income for ACA subsidy purposes. I also have a very low withdrawal rate.

This does increase your risk as you noted, but with the low WD , there is a lot of room to play around. I say go for it!
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Old 10-14-2020, 09:03 AM   #12
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I like the idea! Putting an asset like a house to use as a means to extract cash during market downturns, smart. That said, the interest rate would have to be low and you would still have to have some cash on hand to make the min monthly payments.
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Old 10-14-2020, 09:06 AM   #13
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Yes, I would do that if my target asset allocation dictated I do so.
That's ridiculous. Your target allocation never dictates you take out a loan to keep your investments. Your target allocation for investment can always remain where you want - in this case, where you are short on cash because of poor performance, just sell a little of everything - that is what your target allocation dictates. You personally don't want to sell, and that is a different issue.

Quote:
This is essentially the "should I pay off my mortgage" discussion, and so I know I'm not going to convince anyone of anything. This is one that's never going to get consensus because people on both sides have a built-in idea that's amazingly resistant to change.
No, it is not, not at all - it is taking out a mortgage to finance that which you cannot afford.
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Old 10-14-2020, 09:10 AM   #14
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I like the idea! Putting an asset like a house to use as a means to extract cash during market downturns, smart.
SERIOUSLY SMART

You like gambling with the roof over your head? I cannot believe some of you folks.

I suspect we are very overdue for a good market flushing. Might bring some of you folks back to reality.

I have to ignore this thread - giving me high blood pressure.
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Old 10-14-2020, 09:13 AM   #15
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Quote:
Originally Posted by dcoy View Post
I like the idea! Putting an asset like a house to use as a means to extract cash during market downturns, smart. That said, the interest rate would have to be low and you would still have to have some cash on hand to make the min monthly payments.
+1.
I've done this before, and just reserved some of the withdrawal to use as min monthly payments.

However, I did it when the market was down, figuring it would revert to normal and go up, which it did, and I made free money

I wouldn't do it now, as I think a reversion to the mean would be a drop.
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Old 10-14-2020, 11:52 AM   #16
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I never had HELOC with a loan period longer than 7 years or a fixed interest rate. I wouldn't want to be significantly borrowing from it near the end of it's term and risk it not being renewed. Same thing if interest rates started rising significantly.

I ended up using a 75/25 AA instead. During the latest bear market I was able to move to 85/15 near the bottom and then return to 75/25 after recovery. I can take living expenses just from the bond side if the market is down.

This year the portfolio hit a target to raise cash for expenses. I usually do that from my taxable account, as part of my retirement withdrawal strategy. But I am also doing a big Roth conversion this year and didn't want the large capital gains. Instead, I just sold some equities in a Roth account and bought bonds with the proceeds. Next year I'll sell equities in the taxable account and exchange the extra Roth bonds back into equities.

Plenty of flexibility. Several years of bond-only liquidation is possible. Opportunities during bear markets to make up some of the gains lost by holding 25% bonds. And 25% is not a huge drag on the portfolio. So far I've really liked this allocation.
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Old 10-14-2020, 01:01 PM   #17
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Interesting topic.

On one hand, this is just market timing:

"If the market is down, I will do xyz. I will stop doing xyz when the market is up."

You would be choosing to sell debt on the pretense that you can time the right point to buy that same debt back using gains on equities. Good luck with that.

Slightly less pessimistically, its a bit of a do-over on choosing to pay off the house but without the tax benefits.

I do think that a HELOC as part of an emergency cash strategy is sensible. Sort of a second moat behind cash reserves.

The notion of using a HELOC to smooth income and manage ACA thresholds is interesting and never occurred to me.

I love thought exercises! Keep them coming.
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Old 10-14-2020, 01:59 PM   #18
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I probably could have named this as a WD strategy... I'm ok with the 100% equity but there is no adjustment for when valuations get weird. Returns should be greater after a decline (the only time I would use home equity to fund expenses) so their should be a greater expected return (assuming I'm investing with the expectation of long term gains). I would think that such a strategy could lead to higher returns (just the same as someone leveraging by carrying a mortgage that they expect to cost less than the gains to be had in the market). This would just be a shorter time period(s) as the "rule" would be to pay off the loan when the returns of the portfolio are again positive. Essentially, for the cost of the interest, I would be deferring my withdrawal until the market is higher/avoiding withdrawing when the market is lower. It could also possibly, allow me to defer starting a SEPP or otherwise tapping into tax advantaged accounts by stretching the time my after tax investments last (again, by not selling "low" but paying some interest to do so)



I'm pretty debt averse (actually, paying interest averse, I do like my 0% CC offers when I can take advantage of them for a little arbitrage) so I do not think I would like borrowing from my HELOC as a strategy but thought it fun to think about.


Animorph mentioned the term of the HELOC; mine has a 20 year draw period followed by a 20 year repayment period. I really set it up as an emergency fund and for cashflow/income management.


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Old 10-14-2020, 02:16 PM   #19
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Sounds like a goofy idea on the surface, but if the OP had a current mortgage, and was asking whether to pay off the mortgage or invest it, either would be acceptable, right? Many like the safety and comfort of a paid off house, but I don't think would strongly object to keeping the mortgage.

This is essentially the same thing, but rather than having an actual mortgage, they have a line of credit to tap if needed. It's like having cash and a mortgage, but without actually having any debt unless they have a need to tap it.

FLSun, you have no regular mortgage, right? Just a HELOC?

It's riskier than I would do, because in bad times your investment value goes down, and you are also taking on debt at the same time. If the market recovers, no problem, but in a deep or extended downturn you might run into trouble. Can a HELOC loan balance be called, perhaps because the house has lost value and the outstanding loan is too long? Is there a time limit on a HELOC? All of these kind of things might have you forced into selling more investments or your house at a very low point. I haven't really looked into a HELOC, maybe those situations are extremely unlikely to hit.

I feel like given your low WR, I don't see why you want to be so aggressive with stocks and to tap a HELOC. I don't have it at my fingertips, but I've seen graphs that show that 80/20 is historically less prone to failure than 100/0. I'd go with the lower risk 80/20, with a HELOC solely as a backup for an extraordinary situation, rather than tapping it quickly in any downturn.
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Old 10-14-2020, 07:11 PM   #20
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Sounds like a goofy idea on the surface, but if the OP had a current mortgage, and was asking whether to pay off the mortgage or invest it, either would be acceptable, right?
Precisely the same thing. Existing mortgage of $X, and wad of cash of amount $X. Pay off mortgage or invest it. No existing mortgage, generate a wad of cash of amount $X from a loan and invest it. Same thing. Yes, yes it is.

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Your target allocation for investment can always remain where you want - in this case, where you are short on cash because of poor performance, just sell a little of everything - that is what your target allocation dictates.
True, one may always rebalance liquid assets back to asset allocation targets without borrowing. If the market was depressed, that would involve "selling low", which is the whole thing that the OP is trying to explore the avoidance of using the HELOC. You don't have to take out a loan to keep your investments, but one may wish to use borrowed money for a while, in order to not sell depressed assets.

I grant you that this isn't for everyone (to say the least). And the chances that an economic environment coupled with a personal finance environment that made this borrowing scenario the best choice would be rare. But I'd do it if the circumstances dictated it. I don't hold any asset in higher regard than another. My house is just an asset I own. I could sell it and rent a place to live. I could go back to the way I was when I bought it (owning 20% and borrowing 80%). The difference between these positions don't bother me. I realize it bothers other people. I'm not asking anyone to change how they feel about having a debt. It's all fungible to me.
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