Home Equity in AA

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Investing is boring
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Home Equity in AA

Post by Investing is boring »

I have long been thinking about how to simplify decision making from a comprehensive view of my financial picture. Of course I have adopted the boglehead philosophy for investments of setting an AA based on need and ability to take risk, but I am always troubled by two things. 1) the exclusion of Emergency Fund or near term liquidity needs from the AA, 2) the exclusion of home equity from the AA.

Today I run a 73/27 equity/FI split where I include my EF (ibonds) within FI as I calculate current position vs target. I am fortunate in that I have a large enough NW that I do not need to artificially skew my overall AA towards safety simply to support an EF. I am also not risk adverse, and at age 34 I am - by this calculation method - age -7 in FI. All good so far and I am comfortable with this, taking care of #1 above.

That brings me to Home Equity. According to the WiKi, paying down debt nets out to the equivalence of buying a FI asset of the same after-tax rate. I am still a couple of years from buying a home due to lifestyle choices unrelated to finance, but I have struggled with how to incorporate paying down mortgage debt in the context of my broader financial strategy. My latest thought is to add the following rules to my IPS:

- Set a master AA of age in FI, and include Home Equity in FI
- Set a minimum liquid FI threshold of 1 year expenses (i do not think I would hit this given my portfolio size, but if a great depression lurks, this is in the plan)
- Set a requirement that if Total Bond SEC Yield is > 1% higher then my mortgage rate *(1-marginal tax rate), then invest in Total Bond, else prepay mortgage

If I were to execute this today then I would be increasing my FI by 7%, which supports > 20% downpayment on a home I would be comfortable owning (likely a 10%-15% debt to income level). Going forward I would be able to pre-pay the mortgage based upon a rate comparison with like FI instruments, or cease prepayment and re-direct funds to equities if they fall behind my target AA. With a floor on liquid FI as a safety net, this seems - for my situation and risk tolerance - to be a worthy approach to simplifying my TOTAL financial picture.

I am coming up on my window to make changes to my IPS. I wanted to solicit opinions on this here before I commit. So.. opine?
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Re: Home Equity in AA

Post by YDNAL »

Investing is boring wrote:That brings me to Home Equity. According to the WiKi, paying down debt nets out to the equivalence of buying a FI asset of the same after-tax rate. I am still a couple of years from buying a home due to lifestyle choices unrelated to finance, but I have struggled with how to incorporate paying down mortgage debt in the context of my broader financial strategy. My latest thought is to add the following rules to my IPS:

- Set a master AA of age in FI, and include Home Equity in FI
- Set a minimum liquid FI threshold of 1 year expenses (i do not think I would hit this given my portfolio size, but if a great depression lurks, this is in the plan)
- Set a requirement that if Total Bond SEC Yield is > 1% higher then my mortgage rate *(1-marginal tax rate), then invest in Total Bond, else prepay mortgage

If I were to execute this today then I would be increasing my FI by 7%,.....
This has been discussed to death here.

So, you are 50 years old, with $1 million in investable assets and $1 million in home equity. *Your IPS* is then telling you that you should invest the investable assets in 100% Equities. Good luck with that!

My suggestion is to avoid rationalizing "today" and look at the BIG picture instead. Here are a couple of quick thoughts:
  • 1. One should ALWAYS include net worth in determining ability & need to take risk - which drive the decision to invest the investable assets.

    2. One can't include home equity with investable assets because one can NOT rebalance using home equity.
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Khanmots
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Re: Home Equity in AA

Post by Khanmots »

Think about it in terms of what the intention of the payment is for.

If I use a 30-year mortgage as a baseline then the payment that would go towards a standard 30-year note isn't "saving" it's just meeting an obligation to have a place to live.

Anything extra paid towards principal is done so with the intention of reducing one's future obligations... of paying less future interest. IF I'm willing to commit to having the cash-flow of this reduction of future obligations sent to my retirement account in the future (so if I pay it off in 20 years instead of 30, then the standard payment for years 20-30 needs to go to savings), then I can treat these extra payments as part of my current AA.

One way of managing how to include this in your AA would be to treat each payment as a CD paying your (tax-adjusted) mortgage rate that matures at the time that a standard 30-year note would have expired based on the payments made. Meaning that each extra payment moves this date forward in time. If in month 1 of the mortgage you paid extra, that extra has a 30-year "maturity". If in year 5 you've paid enough extra to only have 10 years to go if you dropped back to the original payment amount, but you still pay extra, then this extra only has a 10-year "maturity".

The key is that you have to be willing to reinvest these "CDs" when the "mature" just like you would with individual bonds or CDs that you hold in an account. If you don't have the self-discipline to treat these virtual "CDs" as though they were real ones, then don't consider this part of your AA. You're saving money, but you've not committed the future (compounded) freed cash flow to retirement.... it'd be like buying a CD then spending the money when it matured instead of rolling it into something else... saving... but not for retirement.
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Re: Home Equity in AA

Post by Khanmots »

And YDNAL's point about rebalancing is a good one to keep in mind. Rebalancing using home equity (or CDs) or other non-liquid investments is difficult and you'll have to think about how you want to handle that.

I'd suggest treating it as fixed income investments, but not having it be the totality of them. Have enough other, liquid, fixed income investments for re-balancing purposes. That said, I do violate my own advice on this bit... ;)
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Re: Home Equity in AA

Post by Investing is boring »

YDNAL wrote: So, you are 50 years old, with $1 million in investable assets and $1 million in home equity. *Your IPS* is then telling you that you should invest the investable assets in 100% Equities. Good luck with that!

My suggestion is to avoid rationalizing "today" and look at the BIG picture instead. Here are a couple of quick thoughts:
  • 1. One should ALWAYS include net worth in determining ability & need to take risk - which drive the decision to invest the investable assets.

    2. One can't include home equity with investable assets because one can NOT rebalance using home equity.
However, on current path at age 50 I am projecting a $5m net worth. Meaning in your example $2.5m in Equities, $1.5m in Bonds, $1m in Home Equity. Again, scale matters. I am in no way suggesting that this is a rule that should be broadly applied. But in my case, the math is the math.

On rebalancing. It doesn't matter if you cannot rebalance out of home equity if you have enough other FI to rebalance with. Again, scale matters.

Edit: Thats $5m in todays dollars at 2.5% inflation. In nominal terms it is $6.7m. Also, only looking to buy a house ~$550k - $600k.
Last edited by Investing is boring on Thu Oct 03, 2013 12:31 pm, edited 1 time in total.
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Re: Home Equity in AA

Post by bottlecap »

Yeah, you can't eat or rebalance your home, absent reverse mortgages, therefore it makes no sense to include in AA. If you're looking to simplify, including it raise a whole host of issues that do the exact opposite.

Paying down debt seems to be equal to FI, but it's not, either. It only acts like fixed income with respect to cash flow. It doesn't allow you to rebalance or spend principal.

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Re: Home Equity in AA

Post by YDNAL »

Investing is boring wrote:
YDNAL wrote: So, you are 50 years old, with $1 million in investable assets and $1 million in home equity. *Your IPS* is then telling you that you should invest the investable assets in 100% Equities. Good luck with that!

My suggestion is to avoid rationalizing "today" and look at the BIG picture instead. Here are a couple of quick thoughts:
  • 1. One should ALWAYS include net worth in determining ability & need to take risk - which drive the decision to invest the investable assets.

    2. One can't include home equity with investable assets because one can NOT rebalance using home equity.
However, on current path at age 50 I am projecting a $5m net worth. Meaning in your example $2.5m in Equities, $1.5m in Bonds, $1m in Home Equity. Again, scale matters. I am in no way suggesting that this is a rule that should be broadly applied. But in my case, the math is the math.

On rebalancing. It doesn't matter if you cannot rebalance out of home equity if you have enough other FI to rebalance with. Again, scale matters.

Edit: Thats $5m in todays dollars at 2.5% inflation. In nominal terms it is $6.7m. Also, only looking to buy a house ~$550k - $600k.
Good luck, investing_is_boring.
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Topic Author
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Re: Home Equity in AA

Post by Investing is boring »

YDNAL wrote: Good luck, investing_is_boring.
Thank you. I will take that at face value vs assuming you are being sarcastic with no counter-point to offer.
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Re: Home Equity in AA

Post by YDNAL »

Investing is boring wrote:
YDNAL wrote: Good luck, investing_is_boring.
Thank you. I will take that at face value vs assuming you are being sarcastic with no counter-point to offer.
I offer (and have) what I want to offer. You take what you want to take. There is no need to read further into a gesture of goodwill.
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Re: Home Equity in AA

Post by Investing is boring »

Khanmots wrote:Think about it in terms of what the intention of the payment is for.

If I use a 30-year mortgage as a baseline then the payment that would go towards a standard 30-year note isn't "saving" it's just meeting an obligation to have a place to live.
I agree that the interest and taxes fit this description. But principle repayment, be it through the standard payment schedule or prepayment, is what I would question here.
Khanmots wrote: Anything extra paid towards principal is done so with the intention of reducing one's future obligations... of paying less future interest. IF I'm willing to commit to having the cash-flow of this reduction of future obligations sent to my retirement account in the future (so if I pay it off in 20 years instead of 30, then the standard payment for years 20-30 needs to go to savings), then I can treat these extra payments as part of my current AA.
Absolutely. We agree. I get the remainder of your note and agree with that as well. The avoidance of future payments (negative cash flow) would need to go to savings, or else this shouldn't count towards savings.
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Re: Home Equity in AA

Post by Clearly_Irrational »

I would not include my home equity in the AA of my financial assets portfolio, however I do use a meta-AA to divide funds between real estate, financial assets and small business ownership. So in general if I had $X worth of home equity I would want to also have $X in my portfolio. Since both small business ownership and real estate are less granular investments I generally try to match my financial assets to those rather than the other way around.
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Re: Home Equity in AA

Post by Khanmots »

bottlecap wrote:Yeah, you can't eat or rebalance your home, absent reverse mortgages, therefore it makes no sense to include in AA. If you're looking to simplify, including it raise a whole host of issues that do the exact opposite.

Paying down debt seems to be equal to FI, but it's not, either. It only acts like fixed income with respect to cash flow. It doesn't allow you to rebalance or spend principal.

JT
If it's secured debt it does, as you can take out the debt again (in the same or different form). For example cash-out refis, home equity loans, etc. You could do this to spend principal if you really needed to, or you could rebalance if you really wanted.

Keeping debt and investing instead is just running leveraged and brings additional risks to the table.
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Re: Home Equity in AA

Post by HomerJ »

bottlecap wrote:If you're looking to simplify, including it raise a whole host of issues that do the exact opposite.
This. You're always going to need a place to live, and probably your goal is that you don't have to draw from the house equity to pay bills in retirement.

So pay it off by the time you retire, and ignore it for AA purposes. Paying it off means you need less income in retirement, but don't use it your calculations otherwise (unless you plan to downsize to a cheaper house in retirement).
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Re: Home Equity in AA

Post by FNK »

A lot of people around here get the AA religion and try to AA across their entire lives. That's wrong. AA is a tool. Your use of your assets is primary, AA is secondary. AAs like 60/40 or age in bonds are meaningful for stock/bond portfolios, not stock/bond/house/mortgage/credit card/human capital/expected SS/net present value of future government shutdowns. What should that AA even look like? Anybody knows?

Besides, a house is resolutely stock-like, not bond-like.
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Re: Home Equity in AA

Post by technovelist »

FNK wrote:A lot of people around here get the AA religion and try to AA across their entire lives. That's wrong. AA is a tool. Your use of your assets is primary, AA is secondary. AAs like 60/40 or age in bonds are meaningful for stock/bond portfolios, not stock/bond/house/mortgage/credit card/human capital/expected SS/net present value of future government shutdowns. What should that AA even look like? Anybody knows?

Besides, a house is resolutely stock-like, not bond-like.
You mean I'm not supposed to rebalance my friends and spouse? :oops:

Seriously, I don't count my home equity in my AA. The fact that it is a very small part of my net worth makes that easier to justify.
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Re: Home Equity in AA

Post by Meg77 »

HomerJ wrote:
bottlecap wrote:If you're looking to simplify, including it raise a whole host of issues that do the exact opposite.
This. You're always going to need a place to live, and probably your goal is that you don't have to draw from the house equity to pay bills in retirement.

So pay it off by the time you retire, and ignore it for AA purposes. Paying it off means you need less income in retirement, but don't use it your calculations otherwise (unless you plan to downsize to a cheaper house in retirement).
I agree with this. Paying off your mortgage (and paying it off early especially) is an good financial goal since it will reduce your expenses, freeing you up to invest more and/or reducing the level of income you need your portfolio to generate for you in retirement. However that is a cash flow decision I believe should be likened to boosting funds in 529 plans or fattening up your emergency fund. Or paying down your car loan or boosting your insurance coverage. All have financial implications, but none should be included in your AA directly.

Now, the existence of a large paid off property - or heavily levered property - may change your desire/tolerance to take on risk, so it may indirectly affect your AA targets. This to me goes into the category of having the security of multiple streams of passive income, a pension, a big inheritance coming, or a steady paycheck in a solid industry. In those cases it's futile to try to technically measure those thigs as if they were literally part of your AA - as someone else pointed out, you can't rebalance any of that stuff. But those factors should be considered as part of your IPS when it comes to how much to save and how much risk you need/want to take on.
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Re: Home Equity in AA

Post by Khanmots »

Meg77 wrote:I agree with this. Paying off your mortgage (and paying it off early especially) is an good financial goal since it will reduce your expenses, freeing you up to invest more and/or reducing the level of income you need your portfolio to generate for you in retirement. However that is a cash flow decision I believe should be likened to boosting funds in 529 plans or fattening up your emergency fund. Or paying down your car loan or boosting your insurance coverage. All have financial implications, but none should be included in your AA directly.
If I have a loan due in 10 years at a rate of 3%, then (excluding tax considerations) the following two scenarios are essentially equivalent:
1) Paying $10000 today early, cutting the loan to 8 years, then investing what I would have paid on the original payoff schedule for years 9 and 10.
2) Buying a $10000 CD that matures in 10 years and earns 3%

At the end of year 10 I'm in the same financial situation regardless of the approach I take.

Removing future obligations is an investment. It's two sides of the same coin. Money is money regardless of if you have to pay it today or 10 years from now. Compounding works the same way for investments as for debt. People who treat the two as somehow different are the ones who are confused.

That said, I'm in now way saying that equity should be treated as part of one's AA. Removing future obligations is what should... until the time that future obligation comes to pass, then you must roll that money into something else, the same as you would a CD.
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Re: Home Equity in AA

Post by curmudgeon »

To me, a *paid for* house, which you expect to live in for an extended time, is very reasonably counted as a fixed income investment. It fills the function very well of providing you with an income equivalent (shelter) on an ongoing basis. It doesn't necessarily have an exact correspondence to bonds, but that's fine, bonds aren't the only form of fixed income.

Where it gets a lot more tricky is when you consider a house with a mortgage. If the mortgage is fairly small and/or within a year or two of being paid off, it's not too hard to do a bit of tweaking or discounting to come up with a reasonable valuation. If you are in the early or middle stages of paying off a mortgage, however, it's much trickier. I guess you count it as a leveraged fixed income investment, but that's hard for me to quantify. Maybe if you count the mortgage amount as a negative FI, and the equity as a positive FI; then once you get past 50% equity, the home actually starts to count (starting from zero at 50% equity) as FI in your AA.
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Re: Home Equity in AA

Post by bottlecap »

Khanmots wrote:If it's secured debt it does, as you can take out the debt again (in the same or different form).
Maybe, maybe not.
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Re: Home Equity in AA

Post by adam1712 »

I include the amount of mortgage I've paid off as part of my AA. Specifically, I include extra payments as if they were bonds. I use the regular 30 year amortization as my baseline. Basically, I printed out the original payoff schedule and any amount ahead of that I count as bonds. For rebalancing, I mainly rely on new contributions. I was aggressively paying off the mortgage until 2008 then switched to paying the minimum and loaded up on stocks. I also keep a small amount of bonds to use for rebalancing. The strategy has worked great for me.
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Re: Home Equity in AA

Post by Investing is boring »

adam1712 wrote:I include the amount of mortgage I've paid off as part of my AA. Specifically, I include extra payments as if they were bonds. I use the regular 30 year amortization as my baseline. Basically, I printed out the original payoff schedule and any amount ahead of that I count as bonds. For rebalancing, I mainly rely on new contributions. I was aggressively paying off the mortgage until 2008 then switched to paying the minimum and loaded up on stocks. I also keep a small amount of bonds to use for rebalancing. The strategy has worked great for me.
Yup. This is exactly what I am looking at.

The interesting thing about these replies is that not one has addressed the specific circumstances I outlined. All replies have been either "here is what I do" or boilerplate "here is the standard advise." This leads me to question the efficacy of all advice given. Unless of course individual circumstance should in no way change the boilerplate response in the minds of those on this forum.
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Re: Home Equity in AA

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curmudgeon wrote:To me, a *paid for* house, which you expect to live in for an extended time, is very reasonably counted as a fixed income investment. It fills the function very well of providing you with an income equivalent (shelter) on an ongoing basis. It doesn't necessarily have an exact correspondence to bonds, but that's fine, bonds aren't the only form of fixed income.

Where it gets a lot more tricky is when you consider a house with a mortgage. If the mortgage is fairly small and/or within a year or two of being paid off, it's not too hard to do a bit of tweaking or discounting to come up with a reasonable valuation. If you are in the early or middle stages of paying off a mortgage, however, it's much trickier. I guess you count it as a leveraged fixed income investment, but that's hard for me to quantify. Maybe if you count the mortgage amount as a negative FI, and the equity as a positive FI; then once you get past 50% equity, the home actually starts to count (starting from zero at 50% equity) as FI in your AA.
You need to count the two parts separately. Regardless of whether you have a mortgage, the house works the same way; it provides a place to live (reducing your living expenses) but has a variable value if you have to sell it. And a loan is negative fixed income regardless of how it is financed; the only difference between a home loan, student loan, and car loan is the consequence of not paying and the deductibility of interest.

So it's not clear how to count your house (because it doesn't work like other assets), but whatever you do for your house, there is a natural way to count the mortgage. If the state must pay you $1000 per month for the next 30 years, that would be a bond portfolio. If you must pay the bank $1000 per month for the next 30 years, that would be a negative bond portfolio. Therefore, your asset allocation should be the same whether you have a $200,000 mortgage and $200,000 in a long-term municipal-bond fund, or no mortgage and no municipal-bond fund. (You might prefer to keep the bond fund, either for tax reasons or because you want the liquidity, but your bond allocation determines the effect of changing interest rates on your portfolio.)
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Re: Home Equity in AA

Post by sls239 »

If the interest rate on your mortgage is lower than what you can get in reasonable FI, then you won't want to pre-pay the mortgage.

If the interest rate on your mortgage is higher than what you can get in reasonable FI, then it is probably time to refinance.

So the situation where you want to pre-pay your mortgage instead of buying FI is just not common. I'd say you can probably ignore it.

I'd just set myself for a 15 year mortgage, 20% down payment and stick to that schedule and consider the purchase as part of the budget, not part of your AA.
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Re: Home Equity in AA

Post by adam1712 »

sls239 wrote:If the interest rate on your mortgage is lower than what you can get in reasonable FI, then you won't want to pre-pay the mortgage.

If the interest rate on your mortgage is higher than what you can get in reasonable FI, then it is probably time to refinance.

So the situation where you want to pre-pay your mortgage instead of buying FI is just not common. I'd say you can probably ignore it.

I'd just set myself for a 15 year mortgage, 20% down payment and stick to that schedule and consider the purchase as part of the budget, not part of your AA.
Vanguard Total Bond is yielding ~2% and 10 year treasuries ~2.5%. And that's up some from where it was. Are there really mortgage rates that low? Why would lenders lend money at a rate lower than the interest rate?
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Re: Home Equity in AA

Post by Investing is boring »

grabiner wrote: So it's not clear how to count your house (because it doesn't work like other assets), but whatever you do for your house, there is a natural way to count the mortgage. If the state must pay you $1000 per month for the next 30 years, that would be a bond portfolio. If you must pay the bank $1000 per month for the next 30 years, that would be a negative bond portfolio. Therefore, your asset allocation should be the same whether you have a $200,000 mortgage and $200,000 in a long-term municipal-bond fund, or no mortgage and no municipal-bond fund. (You might prefer to keep the bond fund, either for tax reasons or because you want the liquidity, but your bond allocation determines the effect of changing interest rates on your portfolio.)
Precisely. And so it makes sense to you if you account for this negative bond, or reduction in the negative bond, in you AA? I think to simplify I will consider equity to be the original purchase price - mortgage balance. I want to avoid the situation of estimating what the home is worth today.
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Re: Home Equity in AA

Post by Investing is boring »

adam1712 wrote:
sls239 wrote:If the interest rate on your mortgage is lower than what you can get in reasonable FI, then you won't want to pre-pay the mortgage.

If the interest rate on your mortgage is higher than what you can get in reasonable FI, then it is probably time to refinance.

So the situation where you want to pre-pay your mortgage instead of buying FI is just not common. I'd say you can probably ignore it.

I'd just set myself for a 15 year mortgage, 20% down payment and stick to that schedule and consider the purchase as part of the budget, not part of your AA.
Vanguard Total Bond is yielding ~2% and 10 year treasuries ~2.5%. And that's up some from where it was. Are there really mortgage rates that low? Why would lenders lend money at a rate lower than the interest rate?
Also you have to include a risk premium in your thought process. I would demand a higher rate from Bonds then the risk free payoff of debt. Hence the rule I proposed of > 1% delta between bonds and mortgage to pull the trigger on the bonds.
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Re: Home Equity in AA

Post by pkcrafter »

Investing is boring wrote:
The interesting thing about these replies is that not one has addressed the specific circumstances I outlined. All replies have been either "here is what I do" or boilerplate "here is the standard advise." This leads me to question the efficacy of all advice given. Unless of course individual circumstance should in no way change the boilerplate response in the minds of those on this forum.
It appears to me that you simply don't like the answers. You asked for opinions, and that is what you received. Opinions can take the form of examples, standard advice, or specific advice related to your situation. Your situation is covered by standard advice because it's not unusual, and you don't actually own a home yet. Some people will use non-invested assets to create an asset allocation and some don't, but again you asked for opinions on whether you should or not.

You are trying to present some rationalization as to why you don't have to "artificially skew" your AA by holding an emergency fund (EF), and you also want to include your home in your AA calculation. "Artificially skewing" is in itself an interesting description of using an EF, and it suggests you don't fully understand the purpose of an EF.

My reply to your question after considering your particular situation, is no, you should not eliminate your EF and should not use your home as part of your AA. I guess in your case you have the financial capacity and ability to take higher risk, but if you include the home, you are effectively using it for leverage. Is that prudent, I'd say no. I'm also a little wary when someone presents an AA like 73/27 because it signals fine tuning far beyond the limits of risk control. I think you are going through a complex thought process in order to justify a higher equity allocation. Why not keep the ER, leave the house out of the mix, and simply up your AA to 85 or 90% stock if you wish.

I also wonder why there is a need to review/tweak your AA if there have been no major changes. You are now at an age where you can pick an AA and let it run the next 15 or twenty years assuming no major life changes. Don't make investing more complicated that it really is.

Paul
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Re: Home Equity in AA

Post by HomerJ »

pkcrafter wrote:I'm also a little wary when someone presents an AA like 73/27 because it signals fine tuning far beyond the limits of risk control.
Yeah I saw this too...
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This.
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Re: Home Equity in AA

Post by Investing is boring »

pkcrafter wrote:Investing is boring wrote:
The interesting thing about these replies is that not one has addressed the specific circumstances I outlined. All replies have been either "here is what I do" or boilerplate "here is the standard advise." This leads me to question the efficacy of all advice given. Unless of course individual circumstance should in no way change the boilerplate response in the minds of those on this forum.
It appears to me that you simply don't like the answers. You asked for opinions, and that is what you received. Opinions can take the form of examples, standard advice, or specific advice related to your situation. Your situation is covered by standard advice because it's not unusual, and you don't actually own a home yet. Some people will use non-invested assets to create an asset allocation and some don't, but again you asked for opinions on whether you should or not.

You are trying to present some rationalization as to why you don't have to "artificially skew" your AA by holding an emergency fund (EF), and you also want to include your home in your AA calculation. "Artificially skewing" is in itself an interesting description of using an EF, and it suggests you don't fully understand the purpose of an EF.

My reply to your question after considering your particular situation, is no, you should not eliminate your EF and should not use your home as part of your AA. I guess in your case you have the financial capacity and ability to take higher risk, but if you include the home, you are effectively using it for leverage. Is that prudent, I'd say no. I'm also a little wary when someone presents an AA like 73/27 because it signals fine tuning far beyond the limits of risk control. I think you are going through a complex thought process in order to justify a higher equity allocation. Why not keep the ER, leave the house out of the mix, and simply up your AA to 85 or 90% stock if you wish.

I also wonder why there is a need to review/tweak your AA if there have been no major changes. You are now at an age where you can pick an AA and let it run the next 15 or twenty years assuming no major life changes. Don't make investing more complicated that it really is.

Paul
Thank you for at least reading the details. That's more then others here. To address the question, and I'll assume its a question, about 73/27. That is how my AA ended up to have whole % numbers in my breakdown and to maintain a 50/50 us/int split in equities. Its a function of math, not fine tuning.

I will also clarify that I never once suggested eliminating my EF. I was very clear on HOW it would be maintained.

I'll also address "complexity" - the stated intent is to REDUCE complexity of decision making. I am unsure of why you are asserting that I am increasing complexity.
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FNK
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Re: Home Equity in AA

Post by FNK »

Investing is boring wrote:The interesting thing about these replies is that not one has addressed the specific circumstances I outlined. All replies have been either "here is what I do" or boilerplate "here is the standard advise." This leads me to question the efficacy of all advice given. Unless of course individual circumstance should in no way change the boilerplate response in the minds of those on this forum.
OK, here's what I am doing that you might find useful. Not boilerplate, and not single AA across my life.

I borrowed from my 401(k), selling TBM in there, to pay down my mortgage and enable a refinance. In my spreadsheet, it's a loan from my retirement portfolio to my house portfolio, treated as a zero-duration bond. If you're willing to handle the extra complexity, you can save on interest while having a meaningful AA.
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Investing is boring
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Re: Home Equity in AA

Post by Investing is boring »

FNK wrote:
Investing is boring wrote:The interesting thing about these replies is that not one has addressed the specific circumstances I outlined. All replies have been either "here is what I do" or boilerplate "here is the standard advise." This leads me to question the efficacy of all advice given. Unless of course individual circumstance should in no way change the boilerplate response in the minds of those on this forum.
OK, here's what I am doing that you might find useful. Not boilerplate, and not single AA across my life.

I borrowed from my 401(k), selling TBM in there, to pay down my mortgage and enable a refinance. In my spreadsheet, it's a loan from my retirement portfolio to my house portfolio, treated as a zero-duration bond. If you're willing to handle the extra complexity, you can save on interest while having a meaningful AA.
Is the loan callable if you leave your job? How do you manage that risk?

It is interesting in concept.
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FNK
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Re: Home Equity in AA

Post by FNK »

Investing is boring wrote:Is the loan callable if you leave your job? How do you manage that risk?
Yes, it is callable. The risk is covered by the same stack as any other risk: EF, standby credit, maintaining my employability, extended family. Worst case is I default on the loan and eat the tax penalty, by which time I might be in a lower tax bracket.

If you have taxable savings, you can do the same conceptual operation without the 401(k) costs and complexities. Will probably work out better on taxes too.
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Re: Home Equity in AA

Post by kenyan »

Investing is boring wrote:I have long been thinking about how to simplify decision making from a comprehensive view of my financial picture. Of course I have adopted the boglehead philosophy for investments of setting an AA based on need and ability to take risk, but I am always troubled by two things. 1) the exclusion of Emergency Fund or near term liquidity needs from the AA, 2) the exclusion of home equity from the AA.
These are excluded quite easily in my IPS. The reason? My IPS is for my retirement portfolio, period. My emergency savings is not. My college savings is not. My house is not. They are all part of my assets, yes, but not part of my retirement portfolio. Trying to include my mortgage as a negative bond, with or without consideration of the house asset, would unnecessarily complicate my retirement asset allocation; my mortgage is larger than all of my liquid assets combined, and I have no desire to completely dismantle my retirement portfolio in order to attempt to approach the same 'risk posture' that I had prior to the house purchase.

There are those who disagree, and believe that mentally separating assets into bins by their intended purpose is an exercise in futility. They are entitled to their opinions, but I believe there is no reason to add this complexity to my retirement portfolio.
Retirement investing is a marathon.
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Re: Home Equity in AA

Post by YDNAL »

Investing is boring wrote:
pkcrafter wrote:I'm also a little wary when someone presents an AA like 73/27 because it signals fine tuning far beyond the limits of risk control. I think you are going through a complex thought process in order to justify a higher equity allocation. Why not keep the ER, leave the house out of the mix, and simply up your AA to 85 or 90% stock if you wish.
Thank you for at least reading the details. That's more then others here. To address the question, and I'll assume its a question, about 73/27. That is how my AA ended up to have whole % numbers in my breakdown and to maintain a 50/50 us/int split in equities. Its a function of math, not fine tuning.
How is 73% divided 50/50 US/non-US other than 36.5/36.5 ????

I agree with Paul (pkcrafter).
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letsgobobby
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Re: Home Equity in AA

Post by letsgobobby »

You've gotten lots of good advice and I agree with all of it.

You're overthinking things.

You're making things less simple, not more.

You're worrying too much about something that hasn't happened yet (a house you don't even own yet).

Your house will be small relative to your net worth so ignore it.

Likewise, include your EF or not, it doesn't matter because it, too, is small.

My AA is 60/40, more or less. I don't include my house, 529s, or EF. If I did my AA would be a little different, but not a lot. It doesn't matter in the long run.
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Re: Home Equity in AA

Post by Lafder »

Investing is boring, I just wanted to add that I agree with your puzzlement of not including emergency funds and home equity in asset allocation. I have just never spoken up about it. And I would like to see them discussed more often.

If I were to hit an "emergency", why not just pull $ from non retirement investments? Why hold emergency funds in an almost zero growth place like a bank account. (I realize this is a different point than not including an emergency fund in asset allocation. But I am being honest that I do not have an actual emergency fund set aside as many bogleheads seem to say they do, since I do not like the idea of the $ "just sitting there.")

I usually only have 1-2 months expenses in my bank account, which is replenished by ongoing income from our jobs. I put extra towards my mortgage as well as investing at my AA ratios.

I wonder how many other people do this and do not speak up about it? Yes there is a chance a $ emergency will hit when markets are down and I pull out a greater percentage. But that feels better to me than a large account sitting there not being used. Actually, if I had a large extra pile of cash I might prefer to pay down my mortgage instead of let it sit there as an "emergency fund." I also consider available home equity loan $ part of my emergency reserves by the way.

I do not own REITS because I feel like I already have real estate investments in my home and a rental home as well. So I do include my real estate equity in my personal investment decisions/calculations. Even though personal real estate is not typically discussed on these forums as a recommended % of allocation, I do think about it. (What is a reasonable % of net worth to hold in personal (and rental/investment) real estate ?)

I think of a house as a necessary place to live. Some people prefer renting so they never have unexpected repair expenses, and other reasons as well. I like feeling the home is mine, and am willing to take on the extra expense/risk. As well as knowing I can possibly sell and get $ back some day.

A huge variable you can choose is how expensive of a house to buy.

Would you like to own a home? How are you calculating in the "lost" money that you are paying to rent all the years until you buy? It may be a $ good idea to buy sooner rather than later if you consider the $ lost to rent could be going towards a house over the next few years. Maybe the 500-600k home is too much now. But consider a less expensive starter home and moving up later.

Because the value of a home is arguable, it is harder to absolutely calculate equity in any financial equations. However, a mortgage is easy to calculate as debt.

My 2 cents

Lafder
letsgobobby
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Re: Home Equity in AA

Post by letsgobobby »

Lafder wrote:Investing is boring, I just wanted to add that I agree with your puzzlement of not including emergency funds and home equity in asset allocation. I have just never spoken up about it. And I would like to see them discussed more often.

If I were to hit an "emergency", why not just pull $ from non retirement investments? Why hold emergency funds in an almost zero growth place like a bank account. (I realize this is a different point than not including an emergency fund in asset allocation. But I am being honest that I do not have an actual emergency fund set aside as many bogleheads seem to say they do, since I do not like the idea of the $ "just sitting there.")
Many Bogleheads have dedicated EFs and many do not. If your net worth is $100,000 and 6 months of living expenses is $50,000, you better have a separate and liquid EF. If your net worth is $1,000,000 and 6 months of living expenses is $50,000, then you may not need a separate EF (but you still may want liquidity).

This has been discussed many times in the forum. If you do a poll asking "what form does your EF take?" you will get a wide range of answers, including cash, I-bonds, taxable investment holdings, home equity, cash value in life insurance, credit cards, HELOCs, retirement accounts, family loans, and piles of gold and silver coins.
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