Tuesday, September 18, 2007

Home versus Investments

People ask why I would not pay off my home faster than 30 years. Well for myself personally our home is worth a lot about $600k, so if I paid off our home it would be disproportionally a large percentage of our net worth.

Home equity and investments in Stocks/Bonds I think needs to be balanced. When considering a portfolio home equity does play a role in stabilzing and diversifying most people's investments. Unfortunately for us, we had a lot of home equity and still do, but little equity investments. This I think is a terrible position to be in, home rich and cash poor. Thus to me the next 5 years is to be spent bulking up our equity positions and retirement funds. That way our overall portfolio will be balanced.

Right now we have $155k in home equity with our DP and equity paydown. This is not counting any appreciation period. I think it hasn't moved since we bought it in 2005, I think below market price. We also did some major improvements which probably have helped the value including repairing a retaining wall for parking and installing a retaining wall for the backyard. Cost of those projects have been minimal, and currently we're installing a gas fireplace which is the first major cost incurred.

However, we unfortunately only have $61k in retirement and $30k in cash. This means we have $91k equity position. That means we have 63% of our net worth tied up in our house. In reality it's more like 80% because the $30k is partially an EF and the rest is cash for DH's school tuition (so it's gone though we're holding onto it). We carry too much cash I feel for people in our 20s, except that we need it to pay for tuition every three months. This is too risky to be investing in stocks or mutual funds of any sort.

This really scares me to have so much tied up in an illiquid asset. I don't think we're in a great financial position. We have too much money tied up in one asset. And as most people know tying up any portofolio weighted too heavily in one asset/stock is a bad idea. It increases the risk/volatility of the portfolio.

Thus I am hoping in the next 5 years to be at 50% home equity and 50% investments. I think this is a realistic goal. But our precarious position is an example of why paying off a home when you have few other assets can actually increase your risk.

Another point is that when we have enough in our taxable account to pay off our mortgage in one fell swoop I'll feel more comfortable. Until then we're going to hang on to cash so we can easily ride out a job loss for say at least 3 years and potentially 5 years. Chances are that if we lost our jobs, we'd have a substantial severance (happened last time 8 months but potentially 12+ months), and we'd likely find a job before time ran out. Another caveat is we've diversified our risk by broadening our career goals and opportunities with our degrees, hence we're more able to find a job we like and will pay well.


Anonymous said...

I agree with you that you should have more liquid funds and not too much in equity BUT......you are living in a condo now and I don't think this will be your final home. Right? So, no, I wouldn't pay off that mortgage and just keep saving like you are doing. However, when you do move into your permanent home, then yes, try to pay off mortgage as soon as possible.
While it is very nice to have money in retirement and saving investments, the one equation with that and balancing it against a paid off mortgage is the one underlying factor-RISK. Investments, such as savings and retirement can have a certain amount of risk but the home is steady. My advice is to try to get a mortgage paid off while you are still in your 50's, not 60's or even later.
Also, never tap into your equity for anything. That equity is your lifeline. I hate it when people use their equity to buy cars, vacations, college tuition or even remodeling.
Just my 2 cents.

Living Almost Large said...

Boomie, I cannot agree more about tapping home equity. If you have to tap home equity you can't afford it. I also don't like it for consolidating CC, because you learn nothing. All you learn is CC can be charged up again.

The thing about investments is that though it's risky, if you have 2x the investments of your equity, that's a huge hit you'd have to take in the market. And you'd still probably be able to live comfortably if it took 50% dive.

Even in our permenant home I'll pay it in full in one swoop. I think that might happen when we have enough assets we'll wait until 2x the value and then move on paying it off. Keep enough security.

change is a good thing said...

I guess it's all just a matter of personal preference. I feel better knowing that I am paying off a little bit more of the principal balance on my mortgage each month and the bank is going to earn less interest from me. Is my way right? No! Is it wrong? No! I think it's just figuring out what you are most comfortable with and going with it. I completely agree with not tapping into the equity!