When determining the mix of stocks and bonds in your financial portfolio, should you include the equity in your home? It’s an important question. If you add the value of your home (minus the outstanding mortgage) to your portfolio, you may find that the mix of stocks and bonds needs to be adjusted.
A general rule that some follow states that the stock portion of your portfolio (including stock mutual funds) should equal 100 minus your age. Using this rule, a fifty-year-old man should invest 50% of his portfolio in stocks and the rest in bonds or other generally conservative investments. Real estate fits into this “other” category. Say you have a financial portfolio that’s worth $500,000, evenly allocated between stock and bond mutual funds. Let’s further hypothesize that you have $100,000 in home equity. Adding that equity to your financial portfolio will change the mix of stocks and other investments from 50/50 ($250,000 in stocks; $250,000 in bonds) to 42/58 ($250,000 in stocks; $350,000 in bonds/other). Because your portfolio is now less heavily weighted toward stocks, you may decide to increase the stock portion. That will mean, other things being equal, accepting greater volatility and risk.
How does home equity compare with more traditional investments? For one thing, a primary residence is a “consumable.” You have to live somewhere, and when you sell one home, you’ll likely use the proceeds to purchase another. Your home may not be easy to sell, especially in today’s housing market. Most mutual funds, on the other hand, can be easily sold and converted to cash. And determining the market value of your home may be difficult. Until you sign a contract with a willing buyer, you won’t know the final price. Want to know the value of your mutual fund? Open today’s newspaper.
A home is also expensive relative to mutual funds. Each year, the cost of maintenance, property taxes, and homeowners insurance might equal 3% or 3.5% of your home’s value. When you want to sell, moving costs, lawyer’s fees, and commissions can easily eat up 5% or more of your home’s selling price. Holding and selling shares in a mutual fund will generally cost less.
Is a home an investment or simply a place to live? It may be both. But think twice before treating home equity as part of your investment portfolio.
The post Is Home Equity An Investment? appeared first on Thaney & Associates.
