Thanks guys. I'm still struggling a bit with this, but I think I'm getting closer to putting my finger on what's bothering me.
I think a way to summarize it is that I see different scenarios that could significantly alter my risk profile, yet each scenario has a 80/20 split of my non-home assets.
To illustrate, below are 2 asset allocation scenarios.
Scenario 1, which is my current breakdown - % of net worth, and this time also including % of non-home assets
- Home Equity 45% of NW (n/a % of non-home assets)
- Stock 45% of NW, (82% of non-home assets)
- Cash 10% of NW, (18% of non-home assets)
Scenario 2 - this is a scenario I could've entered if I didn't choose to pay off my house last year. I assume I could also do this today if I choose to take on debt against my house
- Home Equity 20% of NW (n/a % of non-home assets). This is really an asset of 45% and debt of 25%
- Stock 65% of NW, (82% of non-home assets)
- Cash 15% of NW, (18% of non-home assets)
So both scenarios have non-home asset allocation of 82/18. But isn't scenario 2 significantly more risky? While it does have more cash, it has 65% of my NW in stock, and debt of 25% of my NW in my mortgage. What am I missing? If you agree with me so far, couldn't I argue that at least some of the money I put into my house was the same as putting it in an illiquid fixed income product with yield equal to my old mortgage? Or maybe you guys are implying that it's less risky to have a leveraged position with a larger cash/emergency fund than a non-leveraged position with less cash?
I'm not really itching to put more into the market, but I want to better understand the implications of my decision to pay off my house. I've read elsewhere that people don't even consider primary residence home equity in their net worth calculation. I get that you need a place to live, and that it's illiquid, but I can't get my head around the idea that my NW declined when I paid off my house, and that it would increase again if I took out a loan.