You Have Got to Be Kidding Me

Having sprouted some gray hairs and lost more than few others I have heard some horrifically bad advice in my lifetime. Always bet the favorite. Go all in with Ace-King. Never eat at a place called Moms. Buy stocks because they return 10% a year. Get a real job. Use managed futures to properly diversify a portfolio. Buy real estate because it never goes down. Buy internet stocks because they are changing the world and it's a new paradigm. There have been oceans of poor advice that have crossed my desk and that I have seen given to others over the year but this latest is in the top 3 examples of bad advice. It is seriously a contender for the worst advice ever given. I am speaking of course of the article suggesting that investor should mortgage their homes to buy stocks. The article has 3 major points that are highlighted in bold type as to why this might be a great idea. Lets examine and debunk them one by one shall we? The first is that it diversifies the core value of the largest asset of most Americans. Seriously? If your home is your only investment then this alleged diversification would expose you to a whole new form of retirement commonly known as homelessness. Exactly what set of unique market conditions would lead to other assets performing in such a manner to protect your from falling home prices? If you should diversify your portfolio and markets turn south everything is going down except the loan balance on the mortgage you took out to finance this folly. You are not diversifying your portfolio You are simply increasing your risk exposure. It might help to keep in mind that your home already performs diversified duties. It is an asset and as such can move up and down with the market levels with the hope being that over a long period of time the asset value increases as the mortgage decreases. But it is more than that isn't it? It is also your home, your residence, your shelter. It is the neighborhood with the good schools for you kids. It's the safe community where your want to spend your golden years. One of the leading causes of the recent credit meltdown was that people treated houses as ATMs instead of homes. Now, they do not have one anymore. It is not just an asset. It is your Home. There are many stocks that have dividend yields higher than mortgage rates. This is just laughable. Yes many stocks currently have a dividend yield higher than mortgage rates. Or do they? It looks like cash out refinancing right now is going to go off at about 4% or so . A new home rate is going to be a little bit better than that but not a lot. Let's call it 3.5%. So we need to find stocks that yield more than 4% to fund our little scheme. Using a stock screener I see that we have about 403 stocks to choose from. But since we are diversifying our assets lets take out all the REITs and other real estate related securities ( the article suggest a package of higher yielding REITs which would indicate a poor understanding of how this diversification stuff works). That brings us down to just 302 stocks to choose from. We also need to take out all the closed end bond funds and mortgage REITs as they will respond to rising rates in exactly the manner as housing. We now down to just 253 stocks that will fund our mortgage adventures. Almost all of them are either utilities or energy Master Limited partnerships. If we take those out we are down to just 145 companies that have dividend yield of more than 4%. Now, we want the dividends to be safe so we want financially healthy companies that are committed to paying a dividend. Let's cut our list to just those companies with Altman Z-scores of 3 or higher so we know beyond a shadow of doubt that the company is fiscally sound. After all if they cut or eliminate the dividend our little scheme doesn't make much sense. That brings us down to just 12 operating companies that pay dividends high enough to cover the mortgage and have balance sheets safe enough to feel secure in the payments continuing. So in order for plan to work we are going to have to own a bunch of oil and gas limited partnerships, REITs and utility stocks. While this may or may not be a grand idea do you REALLY want to bet your house on it? Let's even say that you find enough companies to pay high dividends and cover your mortgage payments and engage in the interest rate arbitrage as the author calls it. Let's imagine you have a portfolio of 30 stocks or so that pay over 4% and you feel pretty good about this idea. Now let's imagine that shots are fired in the Ukraine, Russia shuts off the gas to Europe and the Eurozone economy collapses and over the next several months stocks tumble by 40%. How happy are you with the little scheme now? Can't' happen you say? It has happened twice in the last 14 years. Stocks are much more liquid than real estate. This is actually a great reason to not do this. It is the liquidity of stocks that leads investors to chase hot stocks and over trade their accounts. Individual investors badly underperform the market averages because of such destructive behavior. Countless studies have documented this unfortunate fact and you would have to have a high degree of conviction that you are an above average investor with the discipline to stay the course. Add in the fact that instant liquidity is overvalued. Warren Buffett once said that if he bought a stock and the next day the markets closed for five years he would not really care. Buying stocks is buying a piece of a business and liquidity should be your last concern. If you feel the need to be able to sell a long lived asset instantly, you probably should not buy it in the first place. Consider 2008 as a great example of the cost of instant liquidity. Housing was dropping in value and markets were crashing around our ears. Most people panicked and sold their stocks and missed the subsequent recover that would have least given them their money back by now. They could not sell their house and as long as they didn't have one of those stupid mortgages they have seen their house values stabilize and have regained some of their equity. The fact that they could not sell the asset kept them from selling at the lows. Nothing is so overvalued as liquidity in the world of long term investing. If you need liquidity you have no business investing in stocks or real in the first place. The only way you could ever justify taking this advice is if you didn't need to in the first place. Only someone with lots of other assets can afford to take money out of their house to invest in the stock market. I suppose a young person who didn't mind the idea of going back to apartment life with a horrid credit rating could take a long shot but I doubt many would have sufficient equity to make it worthwhile. This little scheme doesn't increase your diversification or let you engage in some fanciful arbitrage that gains you a free house. All it does is increase your exposure to rising rates and falling markets. It increases your risk level. Thats all. Live in your home. Pay down the mortgage over time. Spend less than you make. Save your money and invest excess cash in the stock market. It is not just an asset. It's your home.