All Your Eggs in One Basket

We have all heard it, some of us practice it, unfortunately an overwhelming majority of us fail miserably at it. What is it? Diversifying our investments. It is a basic tenet of investing and most of us know it. If so many of us know it then why do so many homeowner’s put all their eggs in one basket?

It consistently surprises me that homeowners don’t think of the equity in their home as an asset. You don’t see this asset in your monthly statements (bank or investment), it’s not in your end of year investment summary, you really don’t see it anywhere on your personal balance sheet. We treat our homes with the out of sight out of mind mindset- and that’s a monumental mistake.

Two basic asset classifications are safe and unsafe. Defining them by saying safe investments can’t go down in value (absolute value) these include CD’s, checking and savings accounts, money market mutual funds, and some investment grade life insurance policies. The unsafe versions earn an unpredictable return (positive or negative) and would include bonds, stocks, mutual funds, and other traded securities. Please note that investments whether safe or unsafe that earn less than the rate of inflation actually lose value.

Most consider the equity in their home as a safe investment we disagree. Every other safe investment earns a return while the equity in your home doesn’t earn one penny. Yet, most homeowners with very little in their investment, savings and retirement accounts have a huge amount of equity in their home. This is very evident, one recent visit to the Kendall Todd website showed that the current cumulative value of residential real estate is $19 Trillion and we only owe $8.8 Trillion- that is $10.2 Trillion Dollars tied up in an asset that isn’t very liquid, not necessarily safe and earning a 0% rate of return.

Here’s a common client scenario that we see on a regular basis:

• $100,000 total income
• $2,500 in their checking account
• $11,250 in a money market
• $13,400 in retirement accounts
• $250,000 home value
• $80,000 mortgage
• $45,000 in consumer debt
• In their early 40’s

We asked why their mortgage balance was so low? They had basically taken every extra penny they could and applied it to paying off their mortgage. It’s what their parents and grandparents did so that is what they were doing. They fell into the trap of owning their home free and clear so they could reach their retirement without having a mortgage payment.

Is this a well-diversified portfolio? They have 86% of their net worth tied up in their house. What if they had 86% of their net worth in their Company 401k tied up in their company’s stock? Any financial pro would have a heart attack about that situation. Having 86% of your money in company stock- having it in one investment is very risky, yet a majority of planners I have spoken with wouldn’t think twice if a client had 86% of their net worth tied up in their house. We disagree with that stance.

Look at it another way they only have $24,650 of their $197,150 in assets earning interest. That’s not very efficient or productive.

Would you have 86% of your net worth tied up in an investment that you probably couldn’t get the money out when you needed it, thanks to the inherent risks in life the investment isn’t necessarily safe and it earned you a 0% rate of return? You would be crazy to put any of your money in that type of investment. Unfortunately, we have $10.2 Trillion Dollars in this investment and you probably have a sizeable amount in this account- it’s the equity in your home.

What if their home value decreased say 5%? That would reduce their net worth $12,500 if any of their other investments dropped 5% the impact is much smaller. Financial Planners that fully understand how important a well-diversified portfolio is as well as the value of mortgage interest tax deductions wouldn't let their clients be exposed like this. No investment or asset, especially Real Estate should be 86% of any person’s total investment assets.

Do you have too much real estate equity in your investment portfolio? Let us take a look for you to see what you can do to better protect yourself by diversifying your asset allocation.  By filling out the information below we will conduct a Complimentary Mortgage Planning Session where we will uncover strengths and weaknesses in your overall financial picture and give you a plan to improve your situation and take advantage of the power of your home and your mortgage.

Creating Wealth Through Smart Mortgage Planning