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.
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