Market Overview

One Common Investing Mistake Homeowners Make - And How To Find It

By: Craig Birk, CFP

You probably do not think of yourself as a rogue trader. But more than half us take huge bets in an opaque market - on assets that we can’t easily trade and rarely mark-to-market. 65 percent of Americans own a home. Yet we often forget real estate exposure when we make a financial plan. Here’s how homeowners need to think differently.

Your house, apartment, or condo is likely your biggest asset. When you buy a home, you increase your real estate allocation. That part is obvious. But here’s the part most of us don't realize: When you buy a home with a mortgage, you increase real estate and decrease your fixed income allocation.

When you buy a bond, someone owes you money and pays you interest. When you take a mortgage, you owe someone else money and pay them interest. This is the effective equivalent of shorting bonds.

How might this play out in your portfolio? Let’s compare two people with different levels of mortgage debt.

Jim and Bill both have homes worth $500,000 and a total net worth of $500,000. Jim has $400,000 of mortgage debt and buys $400,000 of stocks. Bill has only $100,000 of mortgage debt and so buys less in stocks - $100,000. Jim thus has 80% of his net worth in stocks, while Bill has 20%. Both have full exposure to price fluctuations of their $500,000 dollar homes.

Based on historical returns, the expected future value of Jim’s assets after 30 years would be about four times that of Bill’s. Even after Jim pays the higher mortgage interest costs.

A simple tradeoff of stock vs. mortgage debt can mean a drastically different retirement.

The point here is not to take a bigger mortgage. (This is often a terrible idea – especially to use cash to rack up credit card debt or stretch to make mortgage payments with no emergency fund.) And Jim's level of leverage is likewise too high for many.

The real takeaway is to look at the whole pie. If you own a home, remember your real estate - and your mortgage. Be cautious of allowing equity exposure to fall below 35% of your total net worth until you are within 10 to 15 years of retirement.

Personal Capital offers the platform and expertise you need to understand how real estate is impacting your portfolio. With the Investment Check-up feature in our award-winning app, you can see if you are skewing aggressive or conservative - in a few minutes. 

Get an Investment Check-Up to see how your allocation stacks up.

The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

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Personal Capital Advisors is an SEC registered investment advisor. Any reference to the advisory services refers to Personal Capital Advisors. SEC Registration does not imply a certain level of skill or training. This communication and all data are for informational and educational purposes only.. You should not rely on this information as the primary basis of your investment, financial, or tax planning decisions. You should consult your legal or tax professional regarding your specific situation. Third party data is obtained from sources believed to be reliable. However, PCAC cannot guarantee that data's currency, accuracy, timeliness, completeness or fitness for any particular purpose. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Keep in mind investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Posted-In: Personal Finance


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