Home Equity as "Fixed Income" allocation

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dandan14
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Home Equity as "Fixed Income" allocation

Post by dandan14 » Sun Jan 19, 2014 1:02 pm

As I weigh the merits of putting down a big (or small) down payment on a house we buy in 2014, I'm considering drawing down my fixed income to buy the house in cash. Curious if any of you count the equity in your home as part of your fixed income allocation.

My brother, for example, owns his house outright -- but is 100% stocks in his investable assets. It sounded crazy at first, but if paying down a mortgage is an after tax return of around 3%, then I think that could easily serve as the balancing arm to the rest of his equities. So maybe his total assets are more balanced than I originally thought.

The other risk of course is the value of the home -- but that's a whole other can of worms.

Thoughts?

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Re: Home Equity as "Fixed Income" allocation

Post by galeno » Sun Jan 19, 2014 1:08 pm

Our home eats income.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.13%. Term = 34 yr. FI Duration = 6.2 yr. Portfolio survival probability = 95%.

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Re: Home Equity as "Fixed Income" allocation

Post by dbr » Sun Jan 19, 2014 1:14 pm

I count the equity in my home as equity in my home. My assets comprise stocks, fixed income, and equity in my home.

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Re: Home Equity as "Fixed Income" allocation

Post by Longtimelurker » Sun Jan 19, 2014 1:17 pm

Dan - I posted this in another thread, but it applies here. In short, I think if you are > 10y from retirement, and have liquidity needs covered at least to 12 months of expenses, then you can increase risk to the portfolio while you pay off your house. We chose to increase risk by refusing to sell equities to rebalance, and instead rebalance only through contributions. This will require us to buy bonds heavily over the next couple of years, but will give our equities more time in the market.Here is what we did/are doing:

- 2 years ago we had a 75/25 AA, where the 25 in bonds would not quite cover the 20% down payment and all bonds were in tax deferred
- Within the brokerage we were 100% equities

The thought process at this point was to project taxable savings (after 401k's and IRA's are maxed), and figure out when we wanted to buy a home. We decided that anytime in the subsequent 7 years would be fine to buy, and we project ~$60k per year in taxable savings (highly volatile). With this we:

- maxed out ibonds these last two years ($40k)
- continued to invest 100% equities in taxable
- maintained 75/25 AA INCLUDING funds reserved for home

Fast forward 2 years - we made an extra ~$30k on our taxable investments after taxes compared to having simply put the down payment into a savings account. This pushed us into a position where we can do the 20% down, keep a 6-month EF, buy a second car for cash. This extra $30k was a result of adding more risk to the portfolio, as the money needed for the downpayment was NOT segregated from the AA. Just two weeks ago we did:

- Sold equities in taxable and moved to savings account
- Sold bonds in tax advantaged and purchased the same equities we owned in taxable
- maintained 75/25 AA including funds reserved for home
- Savings now going entirely to building up more liquidity

********* We are here currently ***********
We will likely buy within the next couple months, or at least within the next 18 months. At that point we will:

- Build liquidity reserves to 12-months expenses
- rebalance to 75/25 through contributions only
- Once we have 12-months expenses liquid again, we will take our taxable savings (~$60k per year, highly volatile) and use that to pay down the mortgage and perhaps some light renovations

Once house is paid off (projected 4-7 years) we will:

- do renovations based on experience with home
- build a 529 for kids with taxable savings and funds that would normally go to a mortgage
- rebalance to 60/40 through contributions only

It worked out very well for us to keep risk on while saving up to do this. But we were well aware of the risks and comfortable with Plan B, should an event like 2009 occur again. We continue to be comfortable with the risks of the go forward plan - as we will have a 4-7 year focus on liquidity improvements and liability reductions - both very conservative actions.

Hope this helps
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Re: Home Equity as "Fixed Income" allocation

Post by Rodc » Sun Jan 19, 2014 5:05 pm

dbr wrote:I count the equity in my home as equity in my home. My assets comprise stocks, fixed income, and equity in my home.
Me too. I don't get the whole let's pretend apples are oranges thing.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: Home Equity as "Fixed Income" allocation

Post by EternalOptimist » Sun Jan 19, 2014 5:45 pm

I own my house debt free. My AA is 50 stocks/50 bonds. For what it's worth I do not count my home in my AA which could be considered conservative for my age...64.
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Re: Home Equity as "Fixed Income" allocation

Post by cfs » Sun Jan 19, 2014 5:54 pm

Leaders, good morning/afternoon/evening

All good questions - As far as allocation, in our SWAN we account for equities, bonds, cash reserves. Homes properties, pensions, social security, stamps collection, coins and precious metals collection are not counted as part of the SWAN, too complicated and we like to keep things simple.

Thanks for reading.
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Re: Home Equity as "Fixed Income" allocation

Post by sscritic » Sun Jan 19, 2014 6:05 pm

I don't think about my AA, although I do know how to divide (either long division or using a calculator).

When I bought my house, I sold bonds for the downpayment, which was roughly 65% of the price. I did not rebalance in any way after selling those bonds.

Why did I use bonds and not stocks? If I had sold stocks, I would have paid capital gain taxes, which in essence would have meant I paid even more for my house than I did. Given the recent markets, you should even be able to harvest losses with your bonds while avoiding even larger gains in your stocks. Why anyone would sell stocks with big gains to buy a house, I do not know. Even if you have carryover losses, I would save them to use against ordinary income, not to waste against long term capital gains.

P.S. I also liked the equities I had, and I have been well rewarded over the last two years for keeping them.

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Re: Home Equity as "Fixed Income" allocation

Post by Professor Emeritus » Sun Jan 19, 2014 6:07 pm

Rodc wrote:
dbr wrote:I count the equity in my home as equity in my home. My assets comprise stocks, fixed income, and equity in my home.
Me too. I don't get the whole let's pretend apples are oranges thing.
Equity is a realtor fantasy

your asset is the home , your liability is the debt

Owning a home you live in creates imputed income, which you spend on housing

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Re: Home Equity as "Fixed Income" allocation

Post by sscritic » Sun Jan 19, 2014 6:22 pm

Added:

Risk comes from equities. When I sold bonds to buy my house and kept the equities I had, my risk remained exactly the same as before. I know some people measure risk differently, but I measure risk in dollars, as dollars are what I use to buy food and pay bills.

If I had $500k in stocks before I bought my house because I figured I could withstand a $250k loss if the market dropped 50%, I still had $500k in stocks after I bought my house because I still figured I could withstand a $250k loss if the market dropped 50%. If you can withstand losing $250k without a house, you should be able to withstand losing $250k with a house. People who keep the same percentage in stocks after buying a house (which requires selling stocks, either for the purchase or when you rebalance after) are implicitly saying that they are scared and can't take it anymore. Why buying a house should make you afraid of equities, I don't know.

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Re: Home Equity as "Fixed Income" allocation

Post by dandan14 » Sun Jan 19, 2014 6:25 pm

Professor Emeritus wrote:
Rodc wrote:
dbr wrote:I count the equity in my home as equity in my home. My assets comprise stocks, fixed income, and equity in my home.
Me too. I don't get the whole let's pretend apples are oranges thing.
Equity is a realtor fantasy

your asset is the home , your liability is the debt

Owning a home you live in creates imputed income, which you spend on housing
Ok. So let's take that train of thought a step further. If owning a home outright creates imputed income isn't that exactly the same thing as owning bonds (which create real income) and borrowing money from the bank to buy the house? Seems like the same thing to me.

Let's say you have a 100k house.

100k house with borrowed money producing no income.
100k in bonds = x income.

100k house owned. x imputed income.
0 in bonds producing no income.

Aren't those the same thing?

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Re: Home Equity as "Fixed Income" allocation

Post by DonCamillo » Sun Jan 19, 2014 7:44 pm

I could think of my home equity as a bond that pays interest in the amount of my former mortgage payment. That reflects what I did after I paid it off.

When I paid off my house in 1996, that increased my available income for investing. Until then, I was paying my mortgage plus an extra $1000 a month. After that, I had extra after tax income of my mortgage payment plus $1000. Funding pre-tax investments with that money allowed me to increase the invested amount by the tax savings. Within a year I was able to save 40% of my gross income. I have kept it up for 18 years, currently saving significantly more than 40%. I have averaged about a 7% return on my investments, despite 2000 - 2003 and 2008, so I do not miss the mortgage deduction.
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Re: Home Equity as "Fixed Income" allocation

Post by grabiner » Sun Jan 19, 2014 7:54 pm

dandan14 wrote:As I weigh the merits of putting down a big (or small) down payment on a house we buy in 2014, I'm considering drawing down my fixed income to buy the house in cash. Curious if any of you count the equity in your home as part of your fixed income allocation.
A partially equivalent belief is to count the mortgage as a negative bond. The house is an asset, and however you view the house, a house with a $100K mortgage is $100K less in fixed income than a paid-off house is.

But I wouldn't suggest viewing the house itself as fixed income, because it can't be converted to another investment easily. You can sell a bond fund at a reasonably well-established price; if you sell your house, you have to deal with a volatile housing market. A house which you don't intend to sell is more like an annuity, guaranteed to pay your "rent" for as long as you live. A house which you do intend to sell is primarily a risky investment; the rent you don't pay is like a dividend, but the value of the house could grow much more or less than inflation.
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Re: Home Equity as "Fixed Income" allocation

Post by Professor Emeritus » Sun Jan 19, 2014 8:22 pm

dandan14 wrote:
Professor Emeritus wrote:
Rodc wrote:
dbr wrote:I count the equity in my home as equity in my home. My assets comprise stocks, fixed income, and equity in my home.
Me too. I don't get the whole let's pretend apples are oranges thing.
Equity is a realtor fantasy

your asset is the home , your liability is the debt

Owning a home you live in creates imputed income, which you spend on housing
Ok. So let's take that train of thought a step further. If owning a home outright creates imputed income isn't that exactly the same thing as owning bonds (which create real income) and borrowing money from the bank to buy the house? Seems like the same thing to me.

Let's say you have a 100k house.

100k house with borrowed money producing no income.
100k in bonds = x income.

100k house owned. x imputed income.
0 in bonds producing no income.

Aren't those the same thing?

A house you live in produces imputed income (roughly equal to its rent) without regard to whether you have a debt.

So if you own a 100000 house with a rental value of 500 per month you have imputed income of $6000 year minus certain costs.

Any mortgage is just a debt.

my point is that "equity" is a meaningless concept Assume that instead of being secured by the house it is secured by bonds or a bar of gold or anything else.
you still have the asset and the debt

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Re: Home Equity as "Fixed Income" allocation

Post by Professor Emeritus » Sun Jan 19, 2014 8:25 pm

grabiner wrote:
dandan14 wrote: But I wouldn't suggest viewing the house itself as fixed income, because it can't be converted to another investment easily..

What does the liquidity of fixed income have to do with anything. My pension is fixed income but it cant be converted. It is still a stream of income.
Liquidity is simply a characteristic of some securities. many are not liquid. Pension funds typically charge a premium for buying non liquid securities

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Re: Home Equity as "Fixed Income" allocation

Post by Professor Emeritus » Sun Jan 19, 2014 8:27 pm

DonCamillo wrote:I could think of my home equity as a bond that pays interest in the amount of my former mortgage payment. That reflects what I did after I paid it off.
.
The mortgage payment is irrelevant. So is equity
the value of an asset you use is the rent you avoid paying.

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Re: Home Equity as "Fixed Income" allocation

Post by KyleAAA » Sun Jan 19, 2014 8:31 pm

As we discovered recently, real estate prices are a heckuva lot more volatile than bond prices.

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Re: Home Equity as "Fixed Income" allocation

Post by robertalpert » Sun Jan 19, 2014 8:34 pm

Perhaps, if and only if, you could get a home equity loan; Then invest the proceeds in total bond fund and have bond fund yield that is substantially higher than the home equity loan rate. That is not very likely. Variable rates for equity loans would always rise higher than the yield on relatively safe bond funds. An investment with nominal yields less than zero would not be a good investment.

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Re: Home Equity as "Fixed Income" allocation

Post by Clive » Sun Jan 19, 2014 8:46 pm

Ancient Talmud - something like two millennia past advocated a third each in land (your home), commerce (stocks) and reserves (bonds).

More generally after your home, split the rest 50/50 stocks/bonds.

If your home is a third of total wealth and that drifts to being 20% weighting over time then consider up-sizing. If it rises to being 50% then consider releasing some of the capital (downsizing) [or whatever rebalance bands you prefer]. Such events might coincide with property prices being relatively low/high (respectively). In later life 'land' might include a second or third home/rentals.

You might be surprised how well such a Talmud asset allocation performs over time, more so if you diversify 'reserves' across perhaps some of each of TIPS, bonds, gold and diversify commerce across domestic and foreign stocks.

Often stocks will carry you, but during a bad decade reserves will bear the load but deplete. After a bad decade often there's a good decade where stocks resume bearing the load and advance sufficiently enough to also replenish bonds. Trading properties in a buy-low/sell-high like manner over the years combined with some commerce exposure together with reserves has stood the test of time.
Last edited by Clive on Sun Jan 19, 2014 8:48 pm, edited 1 time in total.

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Re: Home Equity as "Fixed Income" allocation

Post by 555 » Sun Jan 19, 2014 8:48 pm

sscritic wrote:Added:

Risk comes from equities. When I sold bonds to buy my house and kept the equities I had, my risk remained exactly the same as before. I know some people measure risk differently, but I measure risk in dollars, as dollars are what I use to buy food and pay bills.

If I had $500k in stocks before I bought my house because I figured I could withstand a $250k loss if the market dropped 50%, I still had $500k in stocks after I bought my house because I still figured I could withstand a $250k loss if the market dropped 50%. If you can withstand losing $250k without a house, you should be able to withstand losing $250k with a house. People who keep the same percentage in stocks after buying a house (which requires selling stocks, either for the purchase or when you rebalance after) are implicitly saying that they are scared and can't take it anymore. Why buying a house should make you afraid of equities, I don't know.
This is a kind of litmus test that can be applied to people's asset allocation strategies. You should ask yourself, would buying or selling a house make me do something crazy with my portfolio.

Consider a thought experiment. Suppose you have to sell your house, move to a different city, rent for a year, then buy another house of about equal value to the one you sold. What do you do with the money from selling your old house, which you need for your new house?

People need to stop thinking about asset allocation in terms of percentages. It's too simplistic. It breaks badly at major life transitions.

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Re: Home Equity as "Fixed Income" allocation

Post by Clive » Sun Jan 19, 2014 8:57 pm

555 wrote:Consider a thought experiment. Suppose you have to sell your house, move to a different city, rent for a year, then buy another house of about equal value to the one you sold. What do you do with the money from selling your old house, which you need for your new house?
That's one area where 'real' (cost of living) adjusted gains tend to differ. Generally investors invest with a view to spending money at a later date rather than today and seek to retain or more preferably improve the purchase power.

The CPI basket of goods based indicator of inflation tends to under-state. It reflects more common household expenditure and as technologies/efficiencies improve so goods/products tend to become cheaper.

If you're putting money aside to buy a house at a later date rather than today then your 'inflation' rate tends to be higher, as house prices tend to outpace CPI. A general approximation is that 50/50 stock/bonds will broadly compare to house price inflation. But that is volatile.

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Re: Home Equity as "Fixed Income" allocation

Post by Kevin M » Sun Jan 19, 2014 10:25 pm

No. I consider my fixed income as made up of relatively safe assets. Stocks are risky. Real estate is risky. Real estate is more like stocks than fixed income. Plus, a house is not a diversified investment, so there is much more unsystematic risk (which we try to diversify away in a portfolio). A house has unique risk/return characteristics, not to mention a variety of tangible and intangible benefits, costs, etc.

I don't include physical real estate in my portfolio of financial assets (which I can rebalance, quickly liquidate, etc.), but of course I include my real estate equity in my net worth, and consider how it affects my cash flow (home or rental), both of which affect my need and ability to take risk.

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Re: Home Equity as "Fixed Income" allocation

Post by J295 » Sun Jan 19, 2014 11:12 pm

I own my house debt free. My AA is 50 stocks/50 bonds. For what it's worth I do not count my home in my AA which could be considered conservative for my age...64.
Fyi, we too own our home debt free and do not consider it in our AA. Likewise we do not count anticipated social security in our AA. It's a sleep easy sort of thing. We are age 54 and transitioned to part time one year ago.

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Re: Home Equity as "Fixed Income" allocation

Post by sscritic » Mon Jan 20, 2014 12:00 am

I think dandan had a real question, but hanging around bogleheads caused him to ask a distractor question, distracting not only himself but the posters trying to help.

Real question (modified): I want to pay off my mortgage. Should I use bonds, stocks, or a mixture?
I'm considering drawing down my fixed income to buy the house in cash.
This has nothing to do with counting your home equity as this or that in your asset allocation.

Let's take some numbers:
$400k of equities
$400k of bonds
$400k of mortgage debt ($0k of home equity)

After paying off the mortgage, he will have
$Xk of equities, X <= 400
$(400 - X)k of bonds
$400k home equity ($0k of mortgage debt)

Note that no matter which choice he makes, his allocation to equities and to bonds will have to be different than it was before as the total is now only $400k when before it was $800k.

I voted for using bonds because I did not want to change my allocation to stocks, so I let X=400.
$400k of equities
$0k of bonds
$400k home equity ($0k of mortgage debt)

One poster stated that he considered home equity like the other equities, so I would guess his choice would be
$0k equities
$400k bonds
$400k home equity ($0k of mortgage debt)

So what would you suggest dandan do?

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Re: Home Equity as "Fixed Income" allocation

Post by YDNAL » Mon Jan 20, 2014 7:40 am

dandan14 wrote:As I weigh the merits of putting down a big (or small) down payment on a house we buy in 2014, I'm considering drawing down my fixed income to buy the house in cash. Curious if any of you count the equity in your home as part of your fixed income allocation.
Without a mortgage, we have more disposable income to save going forward (increased savings rate); and have LESS (not more) Need for risk.

To answer your question (OP), home equity is part of our net worth, so to buy the house in cash - whether you reduce the Stock, Bond, Commodity, Real Estate (whatever) side - these remaining investable savings should be divided as per your Ability & Need for risk.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Re: Home Equity as "Fixed Income" allocation

Post by sscritic » Mon Jan 20, 2014 8:23 am

YDNAL wrote: Without a mortgage, we have more disposable income to save going forward (increased savings rate); and have LESS (not more) Need for risk.
And less disposable income as we no longer receive the dividends and interest from the stocks and bonds we sold. I don't know about having less or more need for risk given that our investable assets have been depleted. Retirement is just as close, and we have less saved for it. Does that really equate to less need for risk?

In my example, I had $800k saved for retirement. After paying off the mortgage, I had only $400k. My income needs have been reduced, but my income and my assets have been reduced by half.

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Re: Home Equity as "Fixed Income" allocation

Post by YDNAL » Mon Jan 20, 2014 9:18 am

sscritic wrote:
YDNAL wrote: Without a mortgage, we have more disposable income to save going forward (increased savings rate); and have LESS (not more) Need for risk.
And less disposable income as we no longer receive the dividends and interest from the stocks and bonds we sold. I don't know about having less or more need for risk given that our investable assets have been depleted. Retirement is just as close, and we have less saved for it. Does that really equate to less need for risk?
You see this from a *retiree's* standpoint, saying things like "disposable income from dividends and interest," while the OP has not once stated he is retired. This is the closest I got to guesstimate DanDan's age.
dandan14 » Sat Sep 11, 2010 9:10 pm wrote:My first investments were:

1989: McDonald's stock
1991: Twentieth century Ultra
1991: Janus 20

I haven't looked at these in a while.

I made 3x my money in MCD as a teen when I sold. I think that's the best I've ever done on a stock to this day. Now I see that it is 8x what I paid. Wish I had held onto it!

Of course the kicker was that I bought 10 shares @ 30. The commission was $50 in and $50 out. Yowsa.
1. Yes, less need to take risk because our forward savings will increase; and lower investable savings (more liquid) are chosen to be placed in real estate savings (less liquid).

2. There is this [sick] fascination with returns, when we should see our savings as deferred compensation to maintain purchasing power in order to consume when we no longer have *compensation* from a job. My $0.02 short rant for the week!!!!!!
Last edited by YDNAL on Mon Jan 20, 2014 9:34 am, edited 1 time in total.
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Re: Home Equity as "Fixed Income" allocation

Post by sscritic » Mon Jan 20, 2014 9:34 am

YDNAL wrote:
sscritic wrote:
YDNAL wrote: Without a mortgage, we have more disposable income to save going forward (increased savings rate); and have LESS (not more) Need for risk.
And less disposable income as we no longer receive the dividends and interest from the stocks and bonds we sold. I don't know about having less or more need for risk given that our investable assets have been depleted. Retirement is just as close, and we have less saved for it. Does that really equate to less need for risk?
You see this from a *retiree's* standpoint, saying things like "disposable income from dividends and interest," while the OP has not once stated he is retired.
Interesting point. I never realized that Vanguard didn't pay dividends and interest to people who weren't retired yet. You used the term disposable income, which I thought meant income that you had to spend. I always thought dividends and interest were income you had to spend. If you choose to save and not spend your disposable income, that doesn't change then disposable nature of it, retired or not.

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Re: Home Equity as "Fixed Income" allocation

Post by YDNAL » Mon Jan 20, 2014 9:44 am

sscritic wrote:
YDNAL wrote:
sscritic wrote:
YDNAL wrote: Without a mortgage, we have more disposable income to save going forward (increased savings rate); and have LESS (not more) Need for risk.
And less disposable income as we no longer receive the dividends and interest from the stocks and bonds we sold. I don't know about having less or more need for risk given that our investable assets have been depleted. Retirement is just as close, and we have less saved for it. Does that really equate to less need for risk?
You see this from a *retiree's* standpoint, saying things like "disposable income from dividends and interest," while the OP has not once stated he is retired.
Interesting point. I never realized that Vanguard didn't pay dividends and interest to people who weren't retired yet.
Dividends+Interest = part of total return for accumulators. Your usual sarcasm doesn't really work effectively.
sscritic wrote:You used the term disposable income, which I thought meant income that you had to spend. I always thought dividends and interest were income you had to spend. If you choose to save and not spend your disposable income, that doesn't change then disposable nature of it, retired or not.
That's what happens when we *think* we know what others said.
  • Disposable income to "spend."
    Disposable income = to dispose as we see fit.*

    * like saving when no longer paying (from paycheck) Interest+Principal on a loan.
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Re: Home Equity as "Fixed Income" allocation

Post by sscritic » Mon Jan 20, 2014 9:51 am

Disposable income is total personal income minus personal current taxes.
The amount of money that households have available for spending and saving after income taxes have been accounted for.
the money a person has available to spend after paying taxes, pension contributions, etc
The pittance you have left after rent, food, clothes, insurance and dog food. It's how much you really have to spend on whatever you want.
Whether you are accumulating or not, dividends and interest in a taxable account are taxable. What is left after paying taxes is disposable income.

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Re: Home Equity as "Fixed Income" allocation

Post by YDNAL » Mon Jan 20, 2014 9:55 am

YDNAL wrote:Without a mortgage, we have more disposable income to save going forward (increased savings rate); and have LESS (not more) Need for risk.
sscritic wrote:You used the term disposable income, which I thought meant income that you had to spend.
sscritic wrote:
Disposable income is total personal income minus personal current taxes.
The amount of money that households have available for spending and saving after income taxes have been accounted for....
This cracks me up! LOL
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Re: Home Equity as "Fixed Income" allocation

Post by dandan14 » Mon Jan 20, 2014 12:12 pm

Professor Emeritus wrote:

A house you live in produces imputed income (roughly equal to its rent) without regard to whether you have a debt.

So if you own a 100000 house with a rental value of 500 per month you have imputed income of $6000 year minus certain costs.

Any mortgage is just a debt.

my point is that "equity" is a meaningless concept Assume that instead of being secured by the house it is secured by bonds or a bar of gold or anything else.
you still have the asset and the debt
That's very reasonable. I like that line of thinking.

As I've listened to (i.e. read) this thread, I'm first thankful for a group of people that share my geekiness on this sort of thing.
It seems to me that indeed there is a bond aspect here.

So if I were to buy a house for 150k, I'm giving up ~3% (using penfed Cds as a proxy) on that money. In return, I have imputed income equal to the market rental rate minus expected expenses.
~$1400 rent * 12 months - (1 month vacant) = 15400
- Taxes and insurance $4300 = 11,100
- maintenance $1200 = $9900
- annualized tenant turnover costs $600 = $9300
$9300 / 150k = 6.2%
Last edited by dandan14 on Mon Jan 20, 2014 12:25 pm, edited 1 time in total.

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Re: Home Equity as "Fixed Income" allocation

Post by Ron » Mon Jan 20, 2014 12:16 pm

EternalOptimist wrote:I own my house debt free. My AA is 50 stocks/50 bonds. For what it's worth I do not count my home in my AA which could be considered conservative for my age...64.
Same here (age of 66).

A home is a home is a home. It has nothing to do with my AA.

Does it have value? Of course, but in an estate valuation sense, which value get's to be passed on to my/our estate beneficiaries; nothing more, nothing less.

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Re: Home Equity as "Fixed Income" allocation

Post by Clive » Tue Jan 21, 2014 3:59 am

dandan14 wrote:It seems to me that indeed there is a bond aspect here.

So if I were to buy a house for 150k, I'm giving up ~3% (using penfed Cds as a proxy) on that money. In return, I have imputed income equal to the market rental rate minus expected expenses.
~$1400 rent * 12 months - (1 month vacant) = 15400
- Taxes and insurance $4300 = 11,100
- maintenance $1200 = $9900
- annualized tenant turnover costs $600 = $9300
$9300 / 150k = 6.2%
Isn't that the real return though? (Assuming house prices generally rise with inflation over the longer term).

- House price rises 3% ($4500) = $13,800
$13,800 / 150k = 9.2% nominal.

UK national average for house prices since the mid 1950's have broadly risen at around a 2.5% real rate, such that that 9.2% nominal could be an understatement (11.7% nominal).

Unlike CPI which tends to be based more on a average basket of goods/products and that through technological/efficiency improvements tend to relatively decline in price (robots working 24/7), house prices tend to rise with increasing population (become a relatively rarer and hence more expensive asset).

That also excludes other potential sources of income - renting part of the land, or the garage, or taking in a lodger ..etc.

The process of buying a house can be highly leveraged, perhaps starting from a young age (20's) with a $150K house price, $120K mortgage. Where the yield (11.7%) exceeds the mortgage cost (perhaps 6% cost to borrow $120K).

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Re: Home Equity as "Fixed Income" allocation

Post by Rodc » Tue Jan 21, 2014 9:45 am

Professor Emeritus wrote:
Rodc wrote:
dbr wrote:I count the equity in my home as equity in my home. My assets comprise stocks, fixed income, and equity in my home.
Me too. I don't get the whole let's pretend apples are oranges thing.
Equity is a realtor fantasy

your asset is the home , your liability is the debt

Owning a home you live in creates imputed income, which you spend on housing
Agree completely with points 2 and 3.

Equity is real and easily defined, if not precisely knowable until you sell. The asset has some (unknown) value, (though I have a very good chance of estimating it to +/- 20% say) and I have a known amount I owe the bank. Equity is simply the difference. I may not know the exact amount, but if I choose to sell my house today, there will be some difference between the selling price and the loan pay off (and if one wants, account for transaction costs).

This for example is often how elderly people come up with the required cash for a continuing care community. Others use equity as collateral for loans (so if a fantasy it is sometimes a useful one shared by banks making loans).

It is not terribly liquid, though one can tap it in various ways, but that does not make it not "real". IMHO

For any given person it may or may not be a useful construct. But again that does make it not real.

FWIW: I primarily track home value on the asset side of the ledger and mortgage balance on the liability side, and don't do anything in particular with concept of equity in the house. I am aware that it is there and should I ever need a loan a home equity line of credit is an option.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

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Re: Home Equity as "Fixed Income" allocation

Post by abuss368 » Tue Jan 21, 2014 9:52 am

I do not combine home equity with our retirement portfolio bond allocation.

I keep investing separate.
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Re: Home Equity as "Fixed Income" allocation

Post by YDNAL » Tue Jan 21, 2014 10:01 am

Professor Emeritus wrote:Equity is a realtor fantasy
You must have failed Accounting 101 in school. :)

Assets - Liability = Equity.

ps. Anything can be sold to a buyer for the right price.
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Re: Home Equity as "Fixed Income" allocation

Post by abuss368 » Tue Jan 21, 2014 4:00 pm

YDNAL wrote:
Professor Emeritus wrote:Equity is a realtor fantasy
You must have failed Accounting 101 in school. :)

Assets - Liability = Equity.

ps. Anything can be sold to a buyer for the right price.
True however the correct equation in financial accounting when auditing an entities Financial Statements is Assets = Liabilities + Equity.

Best.
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Re: Home Equity as "Fixed Income" allocation

Post by Kevin M » Tue Jan 21, 2014 4:16 pm

dandan14 wrote: It seems to me that indeed there is a bond aspect here.
Why, just because there's imputed income? Stocks also generate income in the form of dividends. The imputed income is not "fixed", since it varies with rental rates. And the fact remains that the value of equity in real property has much more uncertainty (risk) than something like a CD.

"Equity" implies ownership, whether it's applied to stocks or real property. Ownership involves more risk than a debt obligation, and of course potentially higher expected return.

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Re: Home Equity as "Fixed Income" allocation

Post by EnjoyIt » Tue Jan 21, 2014 4:43 pm

I feel using a home in AA is improper unless you are willing to rebalance your AA via selling that home or though a second mortgage or HELOC.

I do however believe that a home is a "reasonable" place to store some of your wealth as it generally keeps value with inflation over long term. One nice benefit of this asset protection is you get to live in it, for the price of mortgage interest, property tax, and home maintenance cost. Eventually in retirement you can downsize putting that well into some asset allocation

Now if you are willing to take the risk of buying your home with all of your fixed income (bonds/CDs,) then how would you handle a 50% loss in equities in the near future? Would you take on the second mortgage to re-allocate funds in the market? That is way to much risk for me.

If I was so debt averse, I would sell stocks and bonds to buy the home. But I am not that debt averse and I would sell just enough to pay 20% and then try to pay off the house faster with increased payments.

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Re: Home Equity as "Fixed Income" allocation

Post by Dandy » Tue Jan 21, 2014 6:25 pm

If you want to take more risk buy more equities don't use the house equity as fixed income. If equities lose value you can't rebalance by selling part of your house -- it just makes investment and allocation more complicated. If you take out a home equity loan are you going to sell equities? If you redo the kitchen does that increase your equity? If so, by how much? Keep it simple.

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Re: Home Equity as "Fixed Income" allocation

Post by Kevin M » Tue Jan 21, 2014 8:40 pm

This is really just another "should I pay down the mortgage or invest" thread. It is convoluted by the strange notion of treating equity in a home as a bond, which makes no sense.

As grabiner pointed out, a more common notion is to treat a mortgage as a negative bond. If you do that, and say have $500K each in stocks and bonds, and have a $500K mortgage, then your AA theoretically is 100% stocks, in which case selling the bonds and paying off the mortgage doesn't change your AA if you continue to hold the stocks (this is similar to what sscritic did). Similarly, according to this notion anyone who owes more on a mortgage than they have in bonds has a net negative bond position, and if they own stocks has a stock allocation of greater than 100% (leveraged). I wonder how many people actually think of it this way?

A house is a risky asset. Anyone who thinks otherwise has been hibernating since 2007.

The size of your mortgage simply changes your leverage in a risky asset; the bigger the mortgage the greater the risk (the possibility of walking away from an underwater property limits your loss to 100%--no margin calls).

Decreasing leverage in a risky asset (e.g., paying down a mortgage) does reduce risk, at least if the asset is viewed in isolation, but it doesn't convert the risky asset to a low-risk asset. Equity is simply your ownership share in a risky asset.

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Re: Home Equity as "Fixed Income" allocation

Post by ladunkulus » Fri Aug 05, 2016 9:58 am

$500K each in stocks and bonds, and have a $500K mortgage, then your AA theoretically is 100% stocks, in which case selling the bonds and paying off the mortgage doesn't change your AA if you continue to hold the stocks
I get the negative bond aspect, but if you pay off your mortgage then you fully own an asset which gives you imputed income. Surely that would factor into ones AA?

Sorry to necro this thread, but it comes up in a google search for "home equity imputed income".

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Re: Home Equity as "Fixed Income" allocation

Post by KlangFool » Fri Aug 05, 2016 10:40 am

dandan14 wrote:
Ok. So let's take that train of thought a step further. If owning a home outright creates imputed income isn't that exactly the same thing as owning bonds (which create real income) and borrowing money from the bank to buy the house? Seems like the same thing to me.

Let's say you have a 100k house.

100k house with borrowed money producing no income.
100k in bonds = x income.

100k house owned. x imputed income.
0 in bonds producing no income.

Aren't those the same thing?
dandan14,

Are they the same in term of liquidity? If not, they are not the same thing.

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Re: Home Equity as "Fixed Income" allocation

Post by KlangFool » Fri Aug 05, 2016 10:46 am

Folks,

Many of my peers are "House Poor". And, they got caught into this "Home Equity" as an asset and so on stuff to justify their "House Poor" position. Many of them are in Telecom industry. So, with the simultaneous crashes of real estate and Telecom industry in 2008, they did not survive.

Liquidity matters.

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Re: Home Equity as "Fixed Income" allocation

Post by Kevin M » Fri Aug 05, 2016 1:09 pm

ladunkulus wrote:
$500K each in stocks and bonds, and have a $500K mortgage, then your AA theoretically is 100% stocks, in which case selling the bonds and paying off the mortgage doesn't change your AA if you continue to hold the stocks
I get the negative bond aspect, but if you pay off your mortgage then you fully own an asset which gives you imputed income. Surely that would factor into ones AA?
Income, whether imputed or not, does not directly affect one's asset allocation (AA). The first "A" in AA stands for "asset", so AA has to do with assets, not income and expenses.

However, income and expenses can affect ability and need to take risk, which in addition to willingness to take risk are the key considerations in determining an appropriate AA. The higher your guaranteed net income (income minus expenses), the higher your ability to take risk, but also the lower your need to take risk, all other things being equal.

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Re: Home Equity as "Fixed Income" allocation

Post by Kevin M » Fri Aug 05, 2016 1:15 pm

KlangFool wrote:Folks,

Many of my peers are "House Poor". And, they got caught into this "Home Equity" as an asset and so on stuff to justify their "House Poor" position. Many of them are in Telecom industry. So, with the simultaneous crashes of real estate and Telecom industry in 2008, they did not survive.

Liquidity matters.

KlangFool
This emphasizes the fact that real estate is a relatively risky asset (like stocks), not a relatively safe asset (like high quality, short-to-intermediate-term bonds). So your example also illustrates that risk matters, and that real estate really is a risky asset.

The liquidity aspect could be illustrated even if real estate didn't crash. Even with 100% equity, you still have property taxes, insurance, and maintenance costs, and if you have no income nor can you extract some of the equity to pay for these, then you still have a problem. Of course you could sell your house and perhaps still "survive" for longer, so not as bleak as your example.

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Re: Home Equity as "Fixed Income" allocation

Post by KlangFool » Fri Aug 05, 2016 1:20 pm

Kevin M wrote:
KlangFool wrote:Folks,

Many of my peers are "House Poor". And, they got caught into this "Home Equity" as an asset and so on stuff to justify their "House Poor" position. Many of them are in Telecom industry. So, with the simultaneous crashes of real estate and Telecom industry in 2008, they did not survive.

Liquidity matters.

KlangFool
This emphasizes the fact that real estate is a relatively risky asset (like stocks), not a relatively safe asset (like high quality, short-to-intermediate-term bonds). So your example also illustrates that risk matters, and that real estate really is a risky asset.

The liquidity aspect could be illustrated even if real estate didn't crash. Even with 100% equity, you still have property taxes, insurance, and maintenance costs, and if you have no income nor can you extract some of the equity to pay for these, then you still have a problem. Of course you could sell your house and perhaps still "survive" for longer, so not as bleak as your example.

Kevin
Kevin M,

When the house is under water, you need money to sell the house. So, that does not help in term of survival. By the way, the houses in my area are still under water as compared to the 2004/2005 level.

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Re: Home Equity as "Fixed Income" allocation

Post by ladunkulus » Fri Aug 05, 2016 2:21 pm

Kevin M wrote:
ladunkulus wrote:
$500K each in stocks and bonds, and have a $500K mortgage, then your AA theoretically is 100% stocks, in which case selling the bonds and paying off the mortgage doesn't change your AA if you continue to hold the stocks
I get the negative bond aspect, but if you pay off your mortgage then you fully own an asset which gives you imputed income. Surely that would factor into ones AA?
Income, whether imputed or not, does not directly affect one's asset allocation (AA). The first "A" in AA stands for "asset", so AA has to do with assets, not income and expenses.
I thought the point of bonds is that they were a "fixed income" asset ie. they pay a set amount per year. Wouldn't the asset (house) be the same kind of idea, just with less opportunity to re-invest proceeds?

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Re: Home Equity as "Fixed Income" allocation

Post by KlangFool » Fri Aug 05, 2016 2:48 pm

ladunkulus wrote:
Kevin M wrote:
ladunkulus wrote:
$500K each in stocks and bonds, and have a $500K mortgage, then your AA theoretically is 100% stocks, in which case selling the bonds and paying off the mortgage doesn't change your AA if you continue to hold the stocks
I get the negative bond aspect, but if you pay off your mortgage then you fully own an asset which gives you imputed income. Surely that would factor into ones AA?
Income, whether imputed or not, does not directly affect one's asset allocation (AA). The first "A" in AA stands for "asset", so AA has to do with assets, not income and expenses.
I thought the point of bonds is that they were a "fixed income" asset ie. they pay a set amount per year. Wouldn't the asset (house) be the same kind of idea, just with less opportunity to re-invest proceeds?
ladunkulus,

House need money to maintain. House is "cash flow" negative. Bonds give you money regularly. They are "cash flow" positive. They are not the same.

Regardless of how people try to play the game and justify their "House Poor" position, the fact that owning a house is risky does not change.

KlangFool

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