Home equity as % of AA

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blessed
Posts: 43
Joined: Mon Feb 27, 2017 9:55 pm

Home equity as % of AA

Post by blessed » Sun Apr 14, 2019 10:36 pm

Hello all,
I'm curious to know if anyone considers the equity in your home as part of your overall asset allocation for investments. When I do my investing/rebalancing I only consider my stock/bond allocation, typically never giving much thought to home equity. However, I've thought about this when reading the many threads on lump sum investing; one of the suggestions frequently made is to consider paying off your mortgage with a lump sum as it's a guaranteed return of whatever % you financed your home. Example using real numbers:

Pre Lump Sum
Total asset dollars: 700k
AA: 70/30
Stocks: 490k
Bonds: 210k
Mortgage: 300k at 3.5%

If you received a 300k lump sum and opted to pay off your mortgage would your post lump sum portfolio look like:
Total asset dollars: 1m
AA: 70/30
Stocks: 490k
Bonds: 210k
Home Equity: 300k

Or
Total asset dollars: 1m
AA: 70/30
Stocks: 700k
Bonds: 0
Home Equity: 300k

Curious to hear what others think, thanks.

bhsince87
Posts: 2184
Joined: Thu Oct 03, 2013 1:08 pm

Re: Home equity as % of AA

Post by bhsince87 » Sun Apr 14, 2019 10:46 pm

I totally ignore our house in my AA calculations.

IMO it's not an investment per se. It's a place to live, and owning it outright saves on rent. But it IS still an expense, with taxes and maintenance. .

I do use it in net worth calculations, for whatever they are worth.
Retirement: When you reach a point where you have enough. Or when you've had enough.

Thesaints
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Joined: Tue Jun 20, 2017 12:25 am

Re: Home equity as % of AA

Post by Thesaints » Mon Apr 15, 2019 12:22 am

Home equity has to be considered as part of one’s financial assets, yet it is not best filed under “bonds”.

To people who don’t want to consider home equity I ask: would an investment property equity count ? If not, would shares of a REIT count ?
Also, the second one takes out a mortgage and doesn’t count the home value amongst assets, he becomes instantly poorer by an amount equal to the home price. Clearly not good accounting.

To people who want to classify home equity under bonds, I ask: what’s its yield ? Clearly, it cannot be estimated accurately enough to be considered a bond’s yield.

Starfish
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Joined: Wed Aug 15, 2018 6:33 pm

Re: Home equity as % of AA

Post by Starfish » Mon Apr 15, 2019 12:27 am

Imputed rent?

SweetAeromotion
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Joined: Mon Feb 25, 2019 7:58 pm

Re: Home equity as % of AA

Post by SweetAeromotion » Mon Apr 15, 2019 12:54 am

I would say that if you live in a home/property, then I would not add it to my allocation, but I would include it in my net worth. My thinking is that the home is somewhat illiquid and one cannot just squeeze value out of it unless a reverse mortgage situation was happening. Since one is living in their primary home, I believe to get allocation out of it for the purpose of investment figuring, you would have to downgrade to a smaller home or a lower COL area, and then only the realized difference ($$$) in changing homes/residence could be counted and then effectively invested.

A secondary or investment property I could see as a bond-like type of investment. Two factors going on: The actual price to mortgage difference would be a net +/- to net worth and one could add it to their fixed income allocation, but it would take selling to realize this just as in one's main home/residence. Second, net cash flow from an investment property should be considered, but moreso for budgetary purposes like SSecurity/pensions would in retirement. This would be a more variable kind of income than the latter, however. In accumulation phase, the positive cash flow is mostly budget. However, in retirement it works to also factor into ones SWR equation like a variable fixed income would (SS/pension).

Interestingly enough, when modeling various accumulation/drawdown scenarios, different AA, and the SWR as a function of years of income saved, I have been thinking of adding in a REIT position in some manner. This is a more practical way to get real estate exposure than to count ones' own home as a direct asset. I find the low correlation factor towards traditional equities and fixed income compared to REITs intriguing. Main home is just that. A home. Maybe someday I can realize a bit out of it in a downsize situation. Who knows. The issue with personally owning a secondary home (or more) is that it is simply not my "thing" to be a landlord, I would be concentrating heavily in one housing market (area), and would have a larger position to real estate than I feel comfortable with as a part of my overall investments. My thinking is that with REITs, I can control the amount of real estate exposure, and diversify among many areas and many properties.

MotoTrojan
Posts: 3801
Joined: Wed Feb 01, 2017 8:39 pm

Re: Home equity as % of AA

Post by MotoTrojan » Mon Apr 15, 2019 1:17 am

blessed wrote:
Sun Apr 14, 2019 10:36 pm
Hello all,
I'm curious to know if anyone considers the equity in your home as part of your overall asset allocation for investments. When I do my investing/rebalancing I only consider my stock/bond allocation, typically never giving much thought to home equity. However, I've thought about this when reading the many threads on lump sum investing; one of the suggestions frequently made is to consider paying off your mortgage with a lump sum as it's a guaranteed return of whatever % you financed your home. Example using real numbers:

Pre Lump Sum
Total asset dollars: 700k
AA: 70/30
Stocks: 490k
Bonds: 210k
Mortgage: 300k at 3.5%

If you received a 300k lump sum and opted to pay off your mortgage would your post lump sum portfolio look like:
Total asset dollars: 1m
AA: 70/30
Stocks: 490k
Bonds: 210k
Home Equity: 300k

Or
Total asset dollars: 1m
AA: 70/30
Stocks: 700k
Bonds: 0
Home Equity: 300k

Curious to hear what others think, thanks.
The extra $300K, whether put into your home or AA, will change your need, willingness, and ability to take risk. Thus depending on your situation, increasing or decreasing your equity exposure may be prudent, but not in the way you’ve suggested imho.

ThrustVectoring
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Joined: Wed Jul 12, 2017 2:51 pm

Re: Home equity as % of AA

Post by ThrustVectoring » Mon Apr 15, 2019 2:04 am

There's two separate parts of home ownership that I think should be talked about separately. There's the consumption aspect, which is the cash flows involved in owning a house, and the asset part, which is the actual exposure to real estate price volatility.

As far as consumption goes, you should estimate out your cash outlays, and anything that reduces them (eg, paying off your mortgage early) should be considered a bond with a Net Present Value according to the schedule at which you effectively receive them. So paying $300k off your mortgage basically is a bond with coupons equal to the forgone mortgage payments.

As far as the asset part goes, home equity is the wrong way to measure it. You don't want to net out the mortgage. If you have a $500k house that you owe $250k on, and another $250k in stocks, your portfolio isn't 50% real estate and 50% stocks. It's 100% real estate, 50% stocks, and -50% fixed income.
blessed wrote:
Sun Apr 14, 2019 10:36 pm
Example using real numbers:

Pre Lump Sum
Total asset dollars: 700k
AA: 70/30
Stocks: 490k
Bonds: 210k
Mortgage: 300k at 3.5%
Assuming a 60% LTV, the actual calculations should be more like:

Total Equity: 900k
Stocks: 490k
Fixed Income: 210k bonds - 300k mortgage = -90k net fixed income
Real Estate: 500k
Overall AA: 54% stocks / -10% fixed income / 55% real estate
Current portfolio: 60% VTI / 40% VXUS

inbox788
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Joined: Thu Mar 15, 2012 5:24 pm

Re: Home equity as % of AA

Post by inbox788 » Mon Apr 15, 2019 3:30 am

I look at it in various ways. Depends on what you're trying to prove. You can track more than one type of AA calculation if you wish. Comparing across measurements isn't especially helpful IMO, where as using a consistent measurement is better at tracking your plan and using the same adjustments over time that you want to make.

In the simplest sense, just looking at investable assets gives you one AA that's fairly useful. You can layer mortgage, home value estimate, business, other property, illiquid assets, pensions, annuities, SS, rent stream, etc. This give you a different AA measurement that's not comparable except to itself as it changes over time. Or you can use some adjustment and not others as you see fit.

I add on mortgage as a negative bond and invest in that bond as much as I can when it's the best yielding, and it often was. It was incomplete because I ignored the home value and home equity in the equation. The home value is too big a variable to deal with much of the time and skews the plan too much, but maybe including just the equity may be useful, but still too complicated for me and probably not necessary.

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ankonaman
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Re: Home equity as % of AA

Post by ankonaman » Mon Apr 15, 2019 5:10 am

I do not include my residence in AA calculations. If you owned "investment real estate" that may count. Some schools of thought do not utilize your residence in net worth calculations to qualify as a millionaire while others will allow home net worth minus mortgage liabilities to count in that tally. When calculating my net worth I only use liquid assets minus liabilities.

bberris
Posts: 1175
Joined: Sun Feb 20, 2011 9:44 am

Re: Home equity as % of AA

Post by bberris » Mon Apr 15, 2019 5:35 am

blessed wrote:
Sun Apr 14, 2019 10:36 pm
Hello all,
I'm curious to know if anyone considers the equity in your home as part of your overall asset allocation for investments. When I do my investing/rebalancing I only consider my stock/bond allocation, typically never giving much thought to home equity. However, I've thought about this when reading the many threads on lump sum investing; one of the suggestions frequently made is to consider paying off your mortgage with a lump sum as it's a guaranteed return of whatever % you financed your home. Example using real numbers:

Pre Lump Sum
Total asset dollars: 700k
AA: 70/30
Stocks: 490k
Bonds: 210k
Mortgage: 300k at 3.5%

If you received a 300k lump sum and opted to pay off your mortgage would your post lump sum portfolio look like:
Total asset dollars: 1m
AA: 70/30
Stocks: 490k
Bonds: 210k
Home Equity: 300k

Or
Total asset dollars: 1m
AA: 70/30
Stocks: 700k
Bonds: 0
Home Equity: 300k

Curious to hear what others think, thanks.
Your home equity is somewhat irrelevant here. The value of a house changes based on the percentage of its price, not your equity in it.
If your house value becomes too high, or too low, in your target allocation will you sell or add or move in order to rebalance? Are you planning to use your house as a retirement funds source?

noco-hawkeye
Posts: 401
Joined: Sat Aug 16, 2014 8:20 am

Re: Home equity as % of AA

Post by noco-hawkeye » Mon Apr 15, 2019 5:46 am

In my mind, you should only count it if you plan on using this equity for something at some point.

If I pay off my house, and have no plans to relocate - then whatever your house is worth does not really matter.

If I pay off my house and we have a larger house to support a family etc - then at some point later I downsize and I have extra money left over - then this could count. I would be able to tap this extra equity to provide funding for something else.

In general, it's just an expense to me.

If I had rental properties that is different - those I can choose to sell and take the equity out at some point. With your house you don't have the same freedom. I will always need a roof over my head.

Dandy
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Re: Home equity as % of AA

Post by Dandy » Mon Apr 15, 2019 6:20 am

A house with equity is a not a bond it is an non liquid asset. Nice to have an allows you to take more risk with your investments. If you use all your fixed income to pay off the mortgage you will have 100% equities as your investment allocation and a large non liquid asset.

IlliniDave
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Re: Home equity as % of AA

Post by IlliniDave » Mon Apr 15, 2019 6:23 am

I completely ignore all real estate equity when looking at and making decisions about AA of financial investments.

I use a conservative estimate of real estate equity when computing net worth, although net worth is not a real useful number.
Don't do something. Just stand there!

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tennisplyr
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Re: Home equity as % of AA

Post by tennisplyr » Mon Apr 15, 2019 6:49 am

Personally, I consider my home equity to be part of my net worth, not my AA for practical day-to-day financial decisions.
Those who move forward with a happy spirit will find that things always work out.

zeal
Posts: 88
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Re: Home equity as % of AA

Post by zeal » Mon Apr 15, 2019 7:14 am

I don't consider our home equity a part of our asset allocation because it is not comparable to a stock or a bond--it probably most closely represents cash (although extremely illiquid) with an interest rate equal to the home's appreciation. That said, if our home is paid off, we may be more willing to shift our AA to hold fewer bonds, as our financial picture is more stable and our ability to take on risk is increased.

For what it's worth, paying your mortgage off in a lump sum isn't exactly a guaranteed return on that money. If by paying off the 300k you avoid paying a total of 500k, the "interest" is that you will keep an additional 200k out of your next 25 years of future income (or whatever the remainder of the loan is). The 200k saved here will be affected by 25 years of inflation, so when you are deciding whether or not to pay off your mortgage with your lump sum, another thing to consider is that the interest savings of 200k may actually be like only 180k in today's dollars. I'm not using actual calculated numbers in any of this, just exaggerating to prove a point.

That said, I am still an advocate of paying off your mortgage early--the lump sum won't net you much return, but saving interest, having one less bill to manage, and keeping more of your take home are well worth it to me.

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brusan
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Re: Home equity as % of AA

Post by brusan » Mon Apr 15, 2019 7:45 am

bhsince87 wrote:
Sun Apr 14, 2019 10:46 pm
I totally ignore our house in my AA calculations.

IMO it's not an investment per se. It's a place to live, and owning it outright saves on rent. But it IS still an expense, with taxes and maintenance. .

I do use it in net worth calculations, for whatever they are worth.

+1

edgeagg
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Location: WA-US

Re: Home equity as % of AA

Post by edgeagg » Mon Apr 15, 2019 8:05 am

Only place used by me is in umbrella insurance calculation.

JackoC
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Re: Home equity as % of AA

Post by JackoC » Mon Apr 15, 2019 8:40 am

ThrustVectoring wrote:
Mon Apr 15, 2019 2:04 am
There's two separate parts of home ownership that I think should be talked about separately. There's the consumption aspect, which is the cash flows involved in owning a house, and the asset part, which is the actual exposure to real estate price volatility.

As far as consumption goes, you should estimate out your cash outlays, and anything that reduces them (eg, paying off your mortgage early) should be considered a bond with a Net Present Value according to the schedule at which you effectively receive them. So paying $300k off your mortgage basically is a bond with coupons equal to the forgone mortgage payments.

As far as the asset part goes, home equity is the wrong way to measure it. You don't want to net out the mortgage. If you have a $500k house that you owe $250k on, and another $250k in stocks, your portfolio isn't 50% real estate and 50% stocks. It's 100% real estate, 50% stocks, and -50% fixed income.
That is the correct way to look at it. For people who insist on looking at it in other, incorrect, ways (such as 'my house is not an asset'=simply wrong) that can be harmful or not. If the real allocation to your house is small, incorrectly excluding it therefore doesn't affect the answer much, not a big problem, especially if you're all set otherwise to live in that house the rest of your life. For some people though living in higher cost areas and only building up their non-home assets, it's a more serious mistake to ignore home value in allocation. I think the mentality behind not counting houses is in part some kind of albeit arbitrary conservatism*. But if you live in a high cost area that forces a high allocation to your home it's not conservative to ignore the big risk that comes along with that to home values declining, and especially before you're all set and can say 'well I'll just live here the rest of my life anyway so it doesn't matter'. In many cases it's a big risk exposure and it definitely matters. In any case it *is* part of your allocation whether you count it or not.

*though it also comes from
a) personal finance guru's who deal with an audience they probably correctly assume couldn't wrap their heads around the concept of imputed rent
b) financial service providers who seek to make money from you trading assets with them, but they don't deal in houses so your home asset is irrelevant to them and *they* don't count it, That doesn't mean it's correct for *you* not to count it. :happy

Topic Author
blessed
Posts: 43
Joined: Mon Feb 27, 2017 9:55 pm

Re: Home equity as % of AA

Post by blessed » Mon Apr 15, 2019 8:47 am

MotoTrojan wrote:
Mon Apr 15, 2019 1:17 am
blessed wrote:
Sun Apr 14, 2019 10:36 pm
Hello all,
I'm curious to know if anyone considers the equity in your home as part of your overall asset allocation for investments. When I do my investing/rebalancing I only consider my stock/bond allocation, typically never giving much thought to home equity. However, I've thought about this when reading the many threads on lump sum investing; one of the suggestions frequently made is to consider paying off your mortgage with a lump sum as it's a guaranteed return of whatever % you financed your home. Example using real numbers:

Pre Lump Sum
Total asset dollars: 700k
AA: 70/30
Stocks: 490k
Bonds: 210k
Mortgage: 300k at 3.5%

If you received a 300k lump sum and opted to pay off your mortgage would your post lump sum portfolio look like:
Total asset dollars: 1m
AA: 70/30
Stocks: 490k
Bonds: 210k
Home Equity: 300k

Or
Total asset dollars: 1m
AA: 70/30
Stocks: 700k
Bonds: 0
Home Equity: 300k

Curious to hear what others think, thanks.
The extra $300K, whether put into your home or AA, will change your need, willingness, and ability to take risk. Thus depending on your situation, increasing or decreasing your equity exposure may be prudent, but not in the way you’ve suggested imho.

Thanks MotoTrojan,
Just to clarify, I'm not suggesting anything, I'm just posing a question. Clearly, having a paid off mortgage changes your overall financial situation and mindset. The two examples I provided represent the extremes of viewing home equity as it relates to AA: 1) It's never considered when investing/rebalancing (this is where I'm at) 2: The home equity in a paid off home is a 1-for-1 replacement of the bond portion of your portfolio.

I'm just curious what others think and if there is some middle ground that others have implemented. Looks like most would go with option 1, from an AA perspective home equity is not considered at all when planning/investing/rebalancing.

And I completely agree with your statement "The extra $300K, whether put into your home or AA, will change your need, willingness, and ability to take risk".

Thanks,

Topic Author
blessed
Posts: 43
Joined: Mon Feb 27, 2017 9:55 pm

Re: Home equity as % of AA

Post by blessed » Mon Apr 15, 2019 8:51 am

JackoC wrote:
Mon Apr 15, 2019 8:40 am
ThrustVectoring wrote:
Mon Apr 15, 2019 2:04 am
There's two separate parts of home ownership that I think should be talked about separately. There's the consumption aspect, which is the cash flows involved in owning a house, and the asset part, which is the actual exposure to real estate price volatility.

As far as consumption goes, you should estimate out your cash outlays, and anything that reduces them (eg, paying off your mortgage early) should be considered a bond with a Net Present Value according to the schedule at which you effectively receive them. So paying $300k off your mortgage basically is a bond with coupons equal to the forgone mortgage payments.

As far as the asset part goes, home equity is the wrong way to measure it. You don't want to net out the mortgage. If you have a $500k house that you owe $250k on, and another $250k in stocks, your portfolio isn't 50% real estate and 50% stocks. It's 100% real estate, 50% stocks, and -50% fixed income.
That is the correct way to look at it. For people who insist on looking at it in other, incorrect, ways (such as 'my house is not an asset'=simply wrong) that can be harmful or not. If the real allocation to your house is small, incorrectly excluding it therefore doesn't affect the answer much, not a big problem, especially if you're all set otherwise to live in that house the rest of your life. For some people though living in higher cost areas and only building up their non-home assets, it's a more serious mistake to ignore home value in allocation. I think the mentality behind not counting houses is in part some kind of albeit arbitrary conservatism*. But if you live in a high cost area that forces a high allocation to your home it's not conservative to ignore the big risk that comes along with that to home values declining, and especially before you're all set and can say 'well I'll just live here the rest of my life anyway so it doesn't matter'. In many cases it's a big risk exposure and it definitely matters. In any case it *is* part of your allocation whether you count it or not.

*though it also comes from
a) personal finance guru's who deal with an audience they probably correctly assume couldn't wrap their heads around the concept of imputed rent
b) financial service providers who seek to make money from you trading assets with them, but they don't deal in houses so your home asset is irrelevant to them and *they* don't count it, That doesn't mean it's correct for *you* not to count it. :happy
Thanks JackoC, appreciate the perspective.

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TheTimeLord
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Re: Home equity as % of AA

Post by TheTimeLord » Mon Apr 15, 2019 8:52 am

Not part of my AA. Don't see any advantage in making it so.
IMHO, Investing should be about living the life you want, not avoiding the life you fear. | Run, You Clever Boy! [9085]

Dandy
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Re: Home equity as % of AA

Post by Dandy » Mon Apr 15, 2019 10:05 am

The Title of the post is Home equity as a % of AA.

Normally, we discuss your AA as stock equities, bonds and sometimes cash/cash-like assets. Home equity is an asset but isn't a stock equity, bond or cash/cash-like asset. It is an asset-- a real estate asset. So it seems ok to say your assets are X% equities (stock), X% bonds, X% cash/cash-like assets and X% real estate equity.

I don't know any particular value of doing that but it is the asset side of a net worth calculation. I suppose you could expand the allocation to include meaningful other assets like collections of art, coins, stamps etc. Just don't morph things into bonds that aren't bonds.

Also getting meaningful valuation of your real estate equity is problematic. You need to know with reasonable confidence the Selling price less commissions and the outstanding mortgage. With a large home asset the degree of precision can make a decent difference in the valuation you decide to list as your real estate asset. e.g. your neighbor down the street has a house like yours that just sold for 50k more than you carried as a real estate asset. Should you raise your valuation in your asset allocation by 50k? Or look at Zillow every once in awhile?

To me with a 100% real estate equity I can't be bothered with it. I know it allows me to take more risk.

bhsince87
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Re: Home equity as % of AA

Post by bhsince87 » Mon Apr 15, 2019 11:23 am

JackoC wrote:
Mon Apr 15, 2019 8:40 am
ThrustVectoring wrote:
Mon Apr 15, 2019 2:04 am
There's two separate parts of home ownership that I think should be talked about separately. There's the consumption aspect, which is the cash flows involved in owning a house, and the asset part, which is the actual exposure to real estate price volatility.

As far as consumption goes, you should estimate out your cash outlays, and anything that reduces them (eg, paying off your mortgage early) should be considered a bond with a Net Present Value according to the schedule at which you effectively receive them. So paying $300k off your mortgage basically is a bond with coupons equal to the forgone mortgage payments.

As far as the asset part goes, home equity is the wrong way to measure it. You don't want to net out the mortgage. If you have a $500k house that you owe $250k on, and another $250k in stocks, your portfolio isn't 50% real estate and 50% stocks. It's 100% real estate, 50% stocks, and -50% fixed income.
That is the correct way to look at it. For people who insist on looking at it in other, incorrect, ways (such as 'my house is not an asset'=simply wrong) that can be harmful or not. If the real allocation to your house is small, incorrectly excluding it therefore doesn't affect the answer much, not a big problem, especially if you're all set otherwise to live in that house the rest of your life. For some people though living in higher cost areas and only building up their non-home assets, it's a more serious mistake to ignore home value in allocation. I think the mentality behind not counting houses is in part some kind of albeit arbitrary conservatism*. But if you live in a high cost area that forces a high allocation to your home it's not conservative to ignore the big risk that comes along with that to home values declining, and especially before you're all set and can say 'well I'll just live here the rest of my life anyway so it doesn't matter'. In many cases it's a big risk exposure and it definitely matters. In any case it *is* part of your allocation whether you count it or not.

*though it also comes from
a) personal finance guru's who deal with an audience they probably correctly assume couldn't wrap their heads around the concept of imputed rent
b) financial service providers who seek to make money from you trading assets with them, but they don't deal in houses so your home asset is irrelevant to them and *they* don't count it, That doesn't mean it's correct for *you* not to count it. :happy
I've never seen a allocation study that treats a home that way (say, the Trinity study, etc.) Of course that doesn't mean they don't exist.

But thousands exist where stock/bond allocations have been back tested, modeled, Monte Carlo'ed, etc, ad nauseum, with no accounting for home equity or mortgage added in.
Retirement: When you reach a point where you have enough. Or when you've had enough.

MotoTrojan
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Re: Home equity as % of AA

Post by MotoTrojan » Mon Apr 15, 2019 11:23 am

blessed wrote:
Mon Apr 15, 2019 8:47 am
MotoTrojan wrote:
Mon Apr 15, 2019 1:17 am
blessed wrote:
Sun Apr 14, 2019 10:36 pm
Hello all,
I'm curious to know if anyone considers the equity in your home as part of your overall asset allocation for investments. When I do my investing/rebalancing I only consider my stock/bond allocation, typically never giving much thought to home equity. However, I've thought about this when reading the many threads on lump sum investing; one of the suggestions frequently made is to consider paying off your mortgage with a lump sum as it's a guaranteed return of whatever % you financed your home. Example using real numbers:

Pre Lump Sum
Total asset dollars: 700k
AA: 70/30
Stocks: 490k
Bonds: 210k
Mortgage: 300k at 3.5%

If you received a 300k lump sum and opted to pay off your mortgage would your post lump sum portfolio look like:
Total asset dollars: 1m
AA: 70/30
Stocks: 490k
Bonds: 210k
Home Equity: 300k

Or
Total asset dollars: 1m
AA: 70/30
Stocks: 700k
Bonds: 0
Home Equity: 300k

Curious to hear what others think, thanks.
The extra $300K, whether put into your home or AA, will change your need, willingness, and ability to take risk. Thus depending on your situation, increasing or decreasing your equity exposure may be prudent, but not in the way you’ve suggested imho.

Thanks MotoTrojan,
Just to clarify, I'm not suggesting anything, I'm just posing a question. Clearly, having a paid off mortgage changes your overall financial situation and mindset. The two examples I provided represent the extremes of viewing home equity as it relates to AA: 1) It's never considered when investing/rebalancing (this is where I'm at) 2: The home equity in a paid off home is a 1-for-1 replacement of the bond portion of your portfolio.

I'm just curious what others think and if there is some middle ground that others have implemented. Looks like most would go with option 1, from an AA perspective home equity is not considered at all when planning/investing/rebalancing.

And I completely agree with your statement "The extra $300K, whether put into your home or AA, will change your need, willingness, and ability to take risk".

Thanks,
Definitely an interesting question though. For many your AA is driven by emotion; how far can this go down as a %/$ without me freaking out. This wouldn’t change that much with a paid off home and gets more sensitive if you just invested it outright. Hence I like to think I’d ignore it and just reevaluate my AA based on the situation, but I’m a young renter with a portfolio that has risk > 100% global equities.

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midareff
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Re: Home equity as % of AA

Post by midareff » Mon Apr 15, 2019 11:41 am

)% .... I count only assets at Vanguard and Fidelity.

ThrustVectoring
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Re: Home equity as % of AA

Post by ThrustVectoring » Mon Apr 15, 2019 12:11 pm

JackoC wrote:
Mon Apr 15, 2019 8:40 am
ThrustVectoring wrote:
Mon Apr 15, 2019 2:04 am
There's two separate parts of home ownership that I think should be talked about separately. There's the consumption aspect, which is the cash flows involved in owning a house, and the asset part, which is the actual exposure to real estate price volatility.

As far as consumption goes, you should estimate out your cash outlays, and anything that reduces them (eg, paying off your mortgage early) should be considered a bond with a Net Present Value according to the schedule at which you effectively receive them. So paying $300k off your mortgage basically is a bond with coupons equal to the forgone mortgage payments.

As far as the asset part goes, home equity is the wrong way to measure it. You don't want to net out the mortgage. If you have a $500k house that you owe $250k on, and another $250k in stocks, your portfolio isn't 50% real estate and 50% stocks. It's 100% real estate, 50% stocks, and -50% fixed income.
That is the correct way to look at it. For people who insist on looking at it in other, incorrect, ways (such as 'my house is not an asset'=simply wrong) that can be harmful or not. If the real allocation to your house is small, incorrectly excluding it therefore doesn't affect the answer much, not a big problem, especially if you're all set otherwise to live in that house the rest of your life. For some people though living in higher cost areas and only building up their non-home assets, it's a more serious mistake to ignore home value in allocation. I think the mentality behind not counting houses is in part some kind of albeit arbitrary conservatism*. But if you live in a high cost area that forces a high allocation to your home it's not conservative to ignore the big risk that comes along with that to home values declining, and especially before you're all set and can say 'well I'll just live here the rest of my life anyway so it doesn't matter'. In many cases it's a big risk exposure and it definitely matters. In any case it *is* part of your allocation whether you count it or not.

*though it also comes from
a) personal finance guru's who deal with an audience they probably correctly assume couldn't wrap their heads around the concept of imputed rent
b) financial service providers who seek to make money from you trading assets with them, but they don't deal in houses so your home asset is irrelevant to them and *they* don't count it, That doesn't mean it's correct for *you* not to count it. :happy
The big complicating factor here is that buying a house exchanges your need to find and pay for a rental for the real estate + mortgage position. Very roughly speaking, the conservatism is that the mortgage and home upkeep nets out against the imputed rent you collect for thirty years, then the mortgage is paid off and you're good to go.

Personally, for ease of analysis, I'm planning on netting out my obligation to remain housed with whatever house upkeep and mortgage payments I'm making. I'm also planning on doing cash-out refinances and/or a HELOC to ensure that my LTV stays high, depending on interest rates and terms. Then when my liquid assets are rich enough that it's time to start de-risking things and start looking at a retirement/FI date, start paying down mortgage(s) in lieu of buying bonds (assuming, again, that this makes sense given interest rates).

One intuition pump for this strategy is that a paid off house can and should reduce your need for fixed income assets, since you no longer have to come up with fixed payments under the threat of foreclosure. For the purpose of analysis, you should be in roughly the same spot if you were to sell your house and use the proceeds in fixed income assets to pay for rent. Thus, the mortgage you don't have is essentially a fixed income asset that pays you your imputed rent.

Side note: If you're in a high cost of living area, you absolutely should be renting for the labor flexibility. If the spigot of money that lured you to the HCOL area dries up, you're going to be out of work at the worst possible time to want to sell your house. An illustrative case (albeit at a lower socioeconomic class) is Detroit in 2007/2008, where the big auto employers downsized a ton while housing prices plummeted in the area.
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Re: Home equity as % of AA

Post by JackoC » Mon Apr 15, 2019 12:59 pm

ThrustVectoring wrote:
Mon Apr 15, 2019 12:11 pm
JackoC wrote:
Mon Apr 15, 2019 8:40 am
ThrustVectoring wrote:
Mon Apr 15, 2019 2:04 am
There's two separate parts of home ownership that I think should be talked about separately. There's the consumption aspect, which is the cash flows involved in owning a house, and the asset part, which is the actual exposure to real estate price volatility.
That is the correct way to look at it... I think the mentality behind not counting houses is in part some kind of albeit arbitrary conservatism*. But if you live in a high cost area that forces a high allocation to your home it's not conservative to ignore the big risk that comes along with that to home values declining, and especially before you're all set and can say 'well I'll just live here the rest of my life anyway so it doesn't matter'. In many cases it's a big risk exposure and it definitely matters.
Side note: If you're in a high cost of living area, you absolutely should be renting for the labor flexibility. If the spigot of money that lured you to the HCOL area dries up, you're going to be out of work at the worst possible time to want to sell your house. An illustrative case (albeit at a lower socioeconomic class) is Detroit in 2007/2008, where the big auto employers downsized a ton while housing prices plummeted in the area.
Whether or not one really should be renting (sometimes yes, but terms like 'high cost' are relative to income), again this is the factor that can make it mistaken and harmful not to include an owned residence in asset allocation. As opposed to mistaken but relatively harmless: it's always mistaken.

The people making the dangerous mistake are those saying 'look at me I'm worth X without even counting my house!', but ignoring the fact that that house value could plunge, where that could constitute a serious reduction in their actual total wealth, which they would at that point realize. Especially in parts of the US where you cannot shield all other assets from paying off an underwater mortgage, but even in places where you can. In high cost areas of CA your mortgage lender probably has no recourse to other assets (in high cost NJ they generally do have recourse to at least non retirement account assets) but a person saying 'I only count my Vanguard account' at say $500k in CA and also $500k home equity* is still going to take a big hit if that home equity goes to zero, also fairly likely to correlate with a need to move for job reasons. They might then ask themselves, "why did I insist on ignoring that risk with the 'my house isn't an investment' fallacy?"

Which may indeed lead some people back around to your statement: home ownership in their situation might be too financially risky to justify itself.

*with a non recourse mortgage the equity value actually is relevant, a small quibble with your earlier statement that it's not. Equity isn't relevant to the extent the lender could come after assets other than house at negative equity on the mortgage.

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Re: Home equity as % of AA

Post by rh00p » Mon Apr 15, 2019 1:02 pm

I consider my home a liability, because it costs me money to maintain and doesn't generate income.
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Re: Home equity as % of AA

Post by JackoC » Mon Apr 15, 2019 1:11 pm

bhsince87 wrote:
Mon Apr 15, 2019 11:23 am
JackoC wrote:
Mon Apr 15, 2019 8:40 am
ThrustVectoring wrote:
Mon Apr 15, 2019 2:04 am
There's two separate parts of home ownership that I think should be talked about separately. There's the consumption aspect, which is the cash flows involved in owning a house, and the asset part, which is the actual exposure to real estate price volatility.
That is the correct way to look at it. For people who insist on looking at it in other, incorrect, ways (such as 'my house is not an asset'=simply wrong) that can be harmful or not.
I've never seen a allocation study that treats a home that way (say, the Trinity study, etc.) Of course that doesn't mean they don't exist.

But thousands exist where stock/bond allocations have been back tested, modeled, Monte Carlo'ed, etc, ad nauseum, with no accounting for home equity or mortgage added in.
I'd worry about that more if analysis of past performance of stock/bond combinations gave more precise insights into future performance. As it is there is some possibility of gleaning useful info from past results, but also potential to be misled, as in the common fallacy of believing, at least implicitly, that future excepted asset returns must eventually equate to long term past ones.

An owned house is part of your asset allocation whether or not you recognize it as such, also whether or not a particular calculator based on past performance includes it or not. It simply is part of your asset allocation, as an objective fact in the real world. :happy But again it's only an important mistake to omit if it the house asset value represents a serious portion of your risk to asset price changes. The smaller a portion of the real asset allocation it is, the less important a mistake it is to omit it.

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Re: Home equity as % of AA

Post by Dandy » Mon Apr 15, 2019 1:38 pm

Maybe it is me but being aware of all your assets and liabilities makes sense. Making your house real estate equity part of your investment allocation seems a bit problematic. You can list it if it makes you aware but you really can't do much with it since it is non liquid.

So it is nice to see say $200k listed next to your stocks, bonds and cash. But, you can't rebalance with it, can't make it part of your withdrawals, etc. Selling all your fixed income to pay off your mortgage will surely increase the real estate equity asset but it isn't like the rest of your investments that are (or were liquid).

Lose you job and home equity isn't as valuable as an equal amount of fixed income. Listing as part of your AA it can easily lead you to think you are in a better short term position than you really are -- in bad times selling a house may be much harder, cost you money and will probably sell for less than your listed value when times were better.

So being aware of your home equity makes sense but making it a part of your Investment allocation -- not for me - it is part of my net worth calculation.

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Re: Home equity as % of AA

Post by ThrustVectoring » Mon Apr 15, 2019 1:48 pm

JackoC wrote:
Mon Apr 15, 2019 12:59 pm
*with a non recourse mortgage the equity value actually is relevant, a small quibble with your earlier statement that it's not. Equity isn't relevant to the extent the lender could come after assets other than house at negative equity on the mortgage.
Home equity is only relevant since it determines the strike price of the implied put option of foreclosure (along with moving costs, negative effect on credit profile, and imputed rent during the time period between cessation of mortgage payments and eviction). This is only really relevant for people with a high LTV living in single-action or non-recourse states - the further out of the money a put option is, the less it's worth, and with housing price volatility being what it is, at 80% LTV the put option is near-worthless.
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Re: Home equity as % of AA

Post by Rus In Urbe » Mon Apr 15, 2019 1:54 pm

*

Our home equity is 0% of AA.
AA = investments, equities, bonds, CDs, cash, et cetera.

Our home equity as % of NW?
Different question.

=7.8%
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Re: Home equity as % of AA

Post by JackoC » Tue Apr 16, 2019 8:59 am

ThrustVectoring wrote:
Mon Apr 15, 2019 1:48 pm
JackoC wrote:
Mon Apr 15, 2019 12:59 pm
*with a non recourse mortgage the equity value actually is relevant, a small quibble with your earlier statement that it's not. Equity isn't relevant to the extent the lender could come after assets other than house at negative equity on the mortgage.
Home equity is only relevant since it determines the strike price of the implied put option of foreclosure (along with moving costs, negative effect on credit profile, and imputed rent during the time period between cessation of mortgage payments and eviction). This is only really relevant for people with a high LTV living in single-action or non-recourse states - the further out of the money a put option is, the less it's worth, and with housing price volatility being what it is, at 80% LTV the put option is near-worthless.
All true, but you'll note I already said it applied to non-recourse, and it isn't 100% to the point here, which is what's the % allocation to your house? With $500k in stock and $750k house with $500k mortgage, the allocation with a no recourse mortgage is $500k stock, $250k home equity, but 'home equity' is a more volatile asset than 'house'. With idealized complete recourse the allocation is $500k stock $750k house in a portfolio levered $1250k/$750k overall. It's true that those two things will become closer to the same the lower the volatility of 'house' and the lower the mortgage balance is relative to the house value. But it's definitely not incorrect to treat the allocation as being home equity with a non-recourse mortgage, and population-wise that includes a good deal of the US though it's not that many states.

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Re: Home equity as % of AA

Post by GAAP » Tue Apr 16, 2019 11:34 am

"Home Equity" is basically useless/meaningless until you either sell the house, or get a loan against it. The second case only provides true value if it is a non-recourse loan that you walk away from, or a HECM that you draw from. Until then, it's basically a guess, determined by an estimate of sales value.
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Re: Home equity as % of AA

Post by beyou » Tue Apr 16, 2019 1:08 pm

On one hand...

Whatever appreciation I get, I pretty much have to put back into the house as it ages.
I consider this a roof over my head, only a additional investment property would be part of my "portfolio".

On the other hand, if I kept borrowing and had little equity in the house,
and invested the cash in funds etc, then this amount would end up as part of my AA.
That said, I think this is leverage when used to purchase equities/bonds.
I don't think of this as leverage when financing 30 years of home ownership/consumption of the house.

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Re: Home equity as % of AA

Post by cherijoh » Tue Apr 16, 2019 3:08 pm

Thesaints wrote:
Mon Apr 15, 2019 12:22 am
To people who don’t want to consider home equity I ask: would an investment property equity count ? If not, would shares of a REIT count ?
Also, the second one takes out a mortgage and doesn’t count the home value amongst assets, he becomes instantly poorer by an amount equal to the home price. Clearly not good accounting.
You appear to be confusing net worth and AA. I don't think anyone is arguing that you NOT include home equity in your net worth (aka balance sheet). So in that sense I'll agree it is an asset. But AA is asset ALLOCATION, which to my mind indicates purposeful setting the amount of resources you allocate to each category. But once you buy a house, it's value is what it is and you only have a binary choice of keep it or sell it. If the stock market declines 25%, you cannot say let's sell that extra bedroom we hardly ever use to buy more stocks while they are at bargain prices. (I'm ignoring the notion of borrowing against your house to invest in stocks since that is a different animal called leverage).

I use AA to evaluate my risk level and to determine when (or if) to rebalance. That is it, period. REITs (unless in a partnership deal) are liquid and would be included in my AA (if I owned any separately - other than the ones already in TSM). I would consider rental property an investment, but I wouldn't force it into an AA. How do you determine it's current market value easily and how would you use it for rebalancing? If you leave it as a static % of your total portfolio with infrequent (say less frequently than annual) adjustments in value, then you can rebalance just as easily and to the same result by leaving it out of the AA. An AA of 80/20 stocks and bonds and 64/16/20 stocks/bonds/RE has the same 4:1 ratio of stocks to bonds. If you own 1 (or even a handful) of rental properties, its not as though you could dial your exposure to real estate up or down very easily or quickly. So I'd include it in net worth, which is big picture/long range but not tactical. AA can be both tactical (i.e., rebalancing) and big picture (i.e, risk, glide path AA to prepare for retirement).

Your primary residence is an asset but NOT an investment - it is where you live. IMO anyone who argues that it is an investment most likely is trying to justify purchasing more house than they need (or possibly can afford).

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Re: Home equity as % of AA

Post by grabiner » Tue Apr 16, 2019 9:19 pm

A home works more like an annuity than a conventional asset; it provides a place to live for much less than the market rent. Thus a home, like a pension, increases your ability to take risk even if it is not counted in your asset allocation.

Conversely, the mortgage you used to buy the home is a negative bond portfolio; if you don't count it as such, then it decreases your ability to take risk.

When I bought my home, I increased my net stock allocation from 90% to 100% because the home increased my risk tolerance. If I had paid cash for the home, I would have left all my other investments in stock. But instead of paying cash, I took a large mortgage, and I did count that as a negative bond and offset it with an equal amount of positive bonds. For the first two years, I kept my bond and mortgage balances equal, so I sold some bonds to buy more stock the year after I bought the home. Since then, I have decreased my net stock allocation as retirement approaches.
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Re: Home equity as % of AA

Post by Dottie57 » Tue Apr 16, 2019 10:16 pm

My home is part of my net worth. It does not affect my allocation since. the purpse of my home is to live in it.

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Re: Home equity as % of AA

Post by averagedude » Tue Apr 16, 2019 10:34 pm

Do not include your home equity as a percentage of your AA. If you have insufficient funds to support you if you happen to live a long life expectancy, than i would include it as a fixed income investment, but using your house in a reverse mortgage as part of a financial plan should be a last resort option.

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Re: Home equity as % of AA

Post by NYCguy » Fri Apr 19, 2019 5:39 pm

Here are my rules for including a portion of home value in considering my asset allocation.

1. I own the house debt-free.
2. I would be willing to sell the house.
3. My replacement cost of housing is less than the net sale proceeds of my current house (such difference, “Excess Value“).

I consider all or a portion of such Excess Value as excess investable cash for the purposes of asset allocation ie short term fixed income. Whether I consider all or a portion of the Excess Value is a function of how willing I am to sell the house ie the PITA factor.

I used this complicated mental exercise after I chose to purchase more house than my family needed and I chose to pay off the mortgage very quickly rather than investing in taxable accounts and keeping the mortgage outstanding.

Today, 1/3 of our home value represents our approximate replacement cost of housing and 2/3 represents Excess Value.

I then apply a 50% PITA factor to the Excess Value which leaves us with adding about 1/3 of the home value to our fixed income portion of our asset allocation. I also use the discount to account for the fact that house prices may fall precisely when I would be willing or need to realize the excess value.

The net effect of all this is to allow me to sleep better at night while taking slightly more equity risk.
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Re: Home equity as % of AA

Post by Independent George » Fri Apr 19, 2019 7:32 pm

I do not, because it is not something I would ever intend to consume as part of my retirement. While paid-off mortgage is indeed an asset, I consider that only insofar as it counts towards how many assets I have saved versus annual expense.

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Re: Home equity as % of AA

Post by camillus » Fri Apr 19, 2019 8:00 pm

As you can see from above, there are many different rationalizations and explanations. Ultimately, your AA is a gut decision that you have to live with. I prefer to keep things simple, and do not reckon my home equity in my AA.

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