Advice....Should I look at home equity this way?

[ijuba]

Age 50 and FIRE. We recently paid off our mortgage and now own the house outright. Thanks to the many posts on the subject and for the advice gleaned from the board in making that decision!

My question is:

My total house value/equity now represents 31% of my "total assets" (including the house value of $800K). We plan to re-invest about $350 of that equity in a smaller place at some point in either 2 or 10 years - depending on schools, preference, etc. At that point, $450 K (in today's dollars) would be freed up for paper assets.

My point in explaining this is, should I take that $450K asset "equivalent" today and treat it as a "bond" portion of my asset allocation? The whole $800K? None?

I hope I've explained well enough...

Thoughts and opinions appreciated....

 

[milmoose]

Include all home equity as part of your asset allocation.

But when estimating expenses, make sure to include a large cost item for Housing.

- M

 

[wabmester]

My point in explaining this is, should I take that $450K asset "equivalent" today and treat it as a "bond" portion of my asset allocation? The whole $800K? None?

If you're looking for a rationale to allocate more to stocks, just allocate more to stocks. Unless your home equity is paying you a fixed income and the volatility exactly correlates with bonds, I wouldn't pretend it's your bond allocation.

 

[Gone4Good]

I'm not sure I completely understand, but let me see if I got this right.

At some point in the future you expect to downsize your house, selling an $800K property and buying a $350K property. Your question is whether the $450K difference is a "bond equivalent" for asset allocation purposes?

As always, there is more than one way to skin a cat - but here is my thought. I wouldn't include the expected housing price differential in my asset allocation. Home equity is not a bond; it doesn't produce an income stream, it is illiquid, and the decision to monetize it usually has significant lifestyle repercussions that don't exist with financial assets.

Besides, you may find that you can't get $800K for your property when you decide to sell it, or the place you find to move into costs more than $350K, or both. Then again, you may change your mind and decide not to move at all. Meanwhile I'd leave my asset allocation alone. If in a couple of years I find I'm long an extra $450k of cash, I'd have no trouble putting that to work in my targeted asset allocation - I see no benefit in front-running it.

 

[cute fuzzy bunny]

Didnt we just have a whole thread on this a few days ago?

Absolutely the home is part of your "bond" holdings, at least thats the way I look at it. People hold bonds to provide stability and income in their portfolio. Living in a paid off house removes much of the need for stability and income in your portfolio.

You can always sell and downsize or sell and rent, so its a fairly liquid asset as well.

The whole 800k acts exactly like a "bond" with regards to your investing decisions, IMO.

But heres the twist...you could consider investing more of your non-home assets in stocks to reap the higher potential returns, because you dont care as much about volatility as you dont have a house payment to make.

OR

you could invest more conservatively and divest considerable risk, because you dont care as much about investment upside as you dont have a house payment to make.

 

[clifp]

The whole 800k acts exactly like a "bond" with regards to your investing decisions, IMO.

But heres the twist...you could consider investing more of your non-home assets in stocks to reap the higher potential returns, because you dont care as much about volatility as you dont have a house payment to make.

OR

you could invest more conservatively and divest considerable risk, because you dont care as much about investment upside as you dont have a house payment to make.

I treat significant home equity as REIT for asset allocation purposes. I think in many ways it has exactly the opposite performance of a bond. With high inflation houses go up bonds go down. Rising interest hurt bonds, and only slightly hurt houses. Bonds and stocks are fairly highly coorelated, houses and stocks have a very low maybe even a negative coorelation.

All that being said I agree with CFB conclusions, no matter how you treat your house equity. You can chose to invest more or less in stocks depending on your view point. The only that I would suggest is if you have a large chunk of your net worth tied up in house, you have an inflation hedge. This means you don't need to go overboard in buying other assets with lower nominal yields, like Gold, TIPS, or REITs

 

[cute fuzzy bunny]

I dont disagree with what Clif says, which is a stupid roundabout way of saying "I agree" (with conditions) that got stuck on me from the company that we both used to work for

My comments were less in a technical nature surrounding the structure of the investment and more on the total effect on ones portfolio. I see lots of people who hold a mortgage, then have to hold more bonds to keep their volatility and income in line to pay it. Create a problem and then fix it. Not my bag.

Works fine if you have a decent pension or spousal income, then you can have your cake and eat it too.

One point..the home is a very un-diversified very topical/locational dependent REIT. When I held REITS, I also had a paid off house and didnt correlate them TOO closely as my reit holdings (vanguard) were predominately apartment buildings, strip malls and business offices rather than a single family home sort of thing.

If your house in in a squiggly state, its probably a decent inflation hedge...square/rectangular/non-squiggly state...perhaps not so much.

Anyhow, thats probably a bunch of information to noodle over, and plenty of agreement and disagreement to pick sides over

 

[wabmester]

Absolutely the home is part of your "bond" holdings, at least thats the way I look at it. People hold bonds to provide stability and income in their portfolio. Living in a paid off house removes much of the need for stability and income in your portfolio.

Let me see if I understand this fuzzy bunny logic:

1) Stocks are an investment in the economic engine of commerce, but there's plenty of volatility.

2) Bonds provide predictable income, preservation of capital, and low correlation with stocks.

3) A house is someplace you live in. A fixed asset with utility value.

Therefore, home equity is a bond.

No, I obviously missed a logical leap. Home equity is a bond only after you paid off a loan, right?

OK, so if I had a car loan, and I paid it off, my car becomes part of my bond allocation.

I get it now.

 

[cute fuzzy bunny]

Not taking the bait wab...sorry...but you have a really nice night huh?

 

[wabmester]

Not taking the bait

Well, I tried.

I'll give you this: having a loan is essentially the same as shorting a bond (or issuing your own bond). So if you have an outstanding loan, I suppose it's OK to think of that as a negative bond allocation. That's slightly less weird than thinking of home equity (or a car) as part of one's bond allocation, anyway.

 

[cute fuzzy bunny]

As you wish.

Since you pointed out the root of it...accepting a mortgage on ones property is issuing a bond to a lender.

So holding that 'potential' has no value to the prospective issuer that has not yet executed the bond?

And the financial implications of issuing or holding that value have no bearing on ones financial planning and investment strategy?

Of course not.

And cars are nominal depreciating assets. Homes are not.

But its a nice try. Lets work on upping your game a little before our next talk, shall we?

 

[wabmester]

So holding that 'potential' has no value to the prospective issuer that has not yet executed the bond?

%DCL-SYNERR, CONVOLUTED ARGUMENT. UNABLE TO PARSE LINE.

I know what you're trying to say; I just think you have it backwards. If I decide that 60/40 stocks/bonds makes investment sense, I can see an argument for increasing one's bond allocation above 40% if you have an outstanding loan. That's standard accounting practice: balance debts with income. But you're trying to say the opposite, which is that if you happen to have no debt, then you suddenly become able to handle a more aggressive asset allocation, and you should decrease your bond allocation.

Almost sensible, but not quite.

 

[cute fuzzy bunny]

You almost have it.

Like I said, keep working on that game.

Want to try again?

At a minimum we're giving the OP his moneys worth.

Let me give you a little hand...the 60/40 is good if you have a mortgage. Without it, both 80/20 and 40/60 make a lot of sense, depending on your tastes.

Let me give you another hand (whoops, off the schnozz...sorry man)...if I can get 6% by lending out my property, its potential is worth 6% to me. Now, can you take that out in trade with...?

 

[wabmester]

Let me give you a little hand...the 60/40 is good if you have a mortgage. Without it, both 80/20 and 40/60 make a lot of sense, depending on your tastes.

So, you're saying that a mortgage is either a negative bond or that lack of a mortgage is a positive bond. Depending on your tastes?

I can see we're already going in circles, so let's try to find some common ground here.

How about: evaluate your asset allocation based on your tolerance for risk and how old you are (since the older you are, the less time you have to recover from downward volatility). Consider your home equity as part of the equation, but not necessarily as part of your asset allocation.

For example, if you plan to downsize in 10 years, treat that as a inflow of cash in 10 years. I think FIREcalc has an option specifically for that case. And then, in 10 years, allocate that cash per your asset allocation model for that time in your life.

 

[cute fuzzy bunny]

...and after losing 37 yards on three self-recovered fumbles, he punts like a girl for a net of 14 yards....I think he should have gone for it, dont you Bob?

I'm not saying that girls are bad punters, just to clarify.

I'm also not saying that Bob isnt qualified to be a good #1 man in the booth.

I also think the OP has what he needs.

Wab...go kiss your kid and go to bed...

 

[wabmester]

Wab...go kiss your kid and go to bed...

Done.

Kid> Dad, who was that funny man in the computer with the big ears?
Dad> Those are fuzzy bunny ears, kiddo. He hops around the forum all day dropping, errhm, nuggets in all the threads.
Kid> Nuggets? Are the nuggets scary?
Dad> Sometimes. Now, go to sleep!

 

[sgeeeee]

Age 50 and FIRE. We recently paid off our mortgage and now own the house outright. Thanks to the many posts on the subject and for the advice gleaned from the board in making that decision!

My question is:

My total house value/equity now represents 31% of my "total assets" (including the house value of $800K). We plan to re-invest about $350 of that equity in a smaller place at some point in either 2 or 10 years - depending on schools, preference, etc. At that point, $450 K (in today's dollars) would be freed up for paper assets.

My point in explaining this is, should I take that $450K asset "equivalent" today and treat it as a "bond" portion of my asset allocation? The whole $800K? None?

I hope I've explained well enough...

Thoughts and opinions appreciated....

A house is not a bond. There are very important differences between a house and a bond. If you don't understand those differences, it could cost you a lot of money at some point in time.

 

[Hydroman]

Here is my 2 cents:

House equity is not a bond

That said, I believe house equity will allow you to significantly increase your equities allocation if you meet all the following conditions:


1) You have a fairly secure job or source of income to meet expenses.

2) You plan to sell the house and downsize to less expensive house in the future.

3) You are confident that the market value of your house will remain stable or increase from now until you plan to downsize.

4) You plan to allocate the liquid equity into real FI instruments after you sell the house and move/downsize into the cheaper house.

5) Your house is mortgage free (preferred but optional, depending on your personal sleep at night comfort level)

 

[cute fuzzy bunny]

Nuggets? Are the nuggets scary?

The nuggets are called "smart pills". They actually make you smarter!

Go ahead and try some.

 

[Jarhead*]

Done.

Kid> Dad, who was that funny man in the computer with the big ears?
Dad> Those are fuzzy bunny ears, kiddo. He hops around the forum all day dropping, errhm, nuggets in all the threads.
Kid> Nuggets? Are the nuggets scary?
Dad> Sometimes. Now, go to sleep!

Clever way to attempt to wrap up a late night debate with the "fuzzy-one".

However, "fuzzy" used a sports metaphore (sucker for those), so style points have to be given.

You both made some valid points, and it was entertaining, just sorry that
you started so late.

Incidentally, "Fuzzy" got the last word.

Oh, for me personally, I think the question is age and situation oriented

How's that for weasling out of an argument.

I barely have enough spare energy for "phone sex" anymore, but I really enjoy when you two hook-up.

 

[cute fuzzy bunny]

I barely have enough spare energy for "phone sex" anymore

Is that where you call up your ex on the phone and yell "**** YOU!" ?

Back to the topic at hand, although I'll say for the third time that people are getting too hung up on the technical comparison of a house and a bond and not considering the financial implications within ones total holdings.

A home: usually stable value, appreciates with inflation (ok, most of the time), interest rate sensitive (although usually low, its postulated that the low lending rates sparked the housing boom and I think theres something to that), potentially income producing if you rent a room or rent the whole thing, and avoidance of paying the "bond to the lender" conserves both the payment as cash flow and the interest rate to be paid as a 'coupon'.

A bond: Wow, almost the same thing?

I guess the serious question to be re-asked is this: given the scenario where you have a 250k home with a 200k mortgage at 6% (about the current rate) and a second scenario where you have a paid off 250k home but 200k less in your portfolio...in the latter scenario do you do anything at all differently with how you allocate your funds and what your investment objectives are, and is your risk tolerance any different between the two scenarios.

Before wab or sg spends half an hour contorting themselves to answer the question in a manner to disagree with me, i'll answer first.

Of course i'm going to allocate differently. I've probably cut my spending cash flow by 25-50%. I'm not paying hundreds of thousands of dollars in interest over the next 20 years. I can become more conservative or more aggressive and take more volatility. My overall risk in the latter scenario is lower, although i've increased portfolio risk by reducing the size of the portfolio i've slashed bankruptcy risk by eliminating the largest source of non-controllable spending.

Makes absolutely no sense if you try to jam it into a 1:1 apples to apples comparison. It only makes sense if you look at your entire financial picture in whole. Lots of people have trouble doing that.

Its not a bond, its somewhat "like" a bond in some respects, but its effect on my financial picture? About the same.

 

[ijuba]

What an efficient learning tool this forum is....

I went to bed last night with sugarplums dancing in my head and got all sorts of debate on my question from yesterday!

CFB and Wab, especially to you....thanks - your insight (and humor) are assets to the board.

Such a balnced array of opinions from all leads me to the conclusion that:

- A paid off house is not a bond.
- Yet, for overall portfolio purposes, home equity could be broadly categorized as such with sometimes similar and sometimes not similar performance to a bond - depending on many factors. My conclusion - a paid off house in a "squiggly state" probably correlates closer to a bond than they do equities, a hedge fund or pork bellies.
- Having no mortgage payment is good to keep overall expenses lower.
- The need for a more conservative portfolio to ensure payment of those expenses is lessened, especially with a longer time horizon.
- Finally, As a result of this advice - I will stick to my initial thoughts and take on a somewhat more aggressive stance in equities - say 65-67% vs. 60% - as a result of having the house paid off in a traditionally insulated local market and a somewhat longer horizon than those north of 50.

Bottom line, the home equity provides for a comfort zone to take on marginally more performance and risk than otherwise would be prudent.

Thanks again.....

 

[cute fuzzy bunny]

Somehow you read through all the chaff, smart pills, sports references and phone sex and seem to have come to a reasonable conclusion for your particular situation.

Good job!

 

[Nords]

Sometimes a house is just a home.

 

[lazygood4nothinbum]

i have no idea why i'm living in a ~$400k house. when i bought 12 years ago it was a $70k house. i'd be very happy just living as a vagabond renting 6 months here or a year there, or settle into a $150k house with occasional travel or cruising nonstop in a $250k boat. (that's how you know a true boater: he'll pay more for the boat than the house.) i've been living in this expensive area for 30something years, held here for the last decade by family. while enjoying my garden up to now, when i consider that it might be underwater in 100 years, i no longer feel like i'm guardian of that.

so i don't consider my house just a house, i consider it as part of my net worth. also, since the inherited house has lost so much value, i almost have to consider my house as part of my net worth. i too am confused as to how to look at home equity in regard to constructing a swr for the next five years.

once a house is put into the "it's part of my net worth" catagory, what are the practical & legitimate ways to incorporate the house into swr calculations?

do i separate house into how it will be used into the future? for instance. say i am going to sell & downsize in five years. can i put $250k (400-150 downsized house) into future addition with appropriate year under "one time change to portfolio" while also adding the reverse mortgage dollars based on the $150k house to be purchased in 5 years to the "decrease withdrawals" section.

or if i think i will take to travel and so might live like a vagabond into the future, should i take the entire current value of the house and add that as a one time change to portfolio in five years?

do i do these scenarios for 5 years out? 10 years? and then see where i am at that point and what i can afford to do from there? is this too risky a way to manage my future?