The following commentary is by James E. Veale | CPA, MBT

Advice About Reverse Mortgages

The more I read and hear so called financial advisors presenting the use of reverse mortgages, the more troubling it becomes.  For example, one California reverse mortgage broker who allegedly provides retirement advice has issued press releases declaring that seniors are getting reverse mortgages to allow their portfolios and (401k and IRA) retirement accounts time to recover from recent investment losses.  He provides no caveats or warnings.  In so doing he all but endorses the strategy.

The same strategy was publicly espoused by an acknowledged industry leader who is properly considered very knowledgeable in financial matters.  Now there is a prominent author of financial literature proclaiming the same message.

Such advice is dangerously derelict; bad advice is bad advice no matter who provides it.  No reverse mortgage has ever caused an inappropriately mixed portfolio to recover.  Nor is a reverse mortgage by itself likely to help a senior homeowner recover losses in a 401k or IRA account.  This type of strategy could in fact make the situation far worse.

Risk Balanced and Diversified Investing

Some in the industry who try to help their customers understand their financial position have noted an interesting trait among their prospects.  If the seniors have investments, they tend to be exclusively equity mutual funds.  Investments in such funds are more of an investment in the transaction decisions of fund management than in any specific stock or mix of stocks.  While this maybe the safest way for inexperienced investors to invest in equities, it is not a risk balanced and diversified approach.

While a high concentration of diversified investments in equities is a reasonable strategy for those under 40, it is far less so for those over 70.  The percentage of total assets most of those over 40 should have in riskier investments should be decreasing over time.  Most prudent advisors use a rule of thumb which states that one should subtract their age from 100 and that difference should be the percentage of her/his portfolio which is held in riskier investments such as growth stocks.

Financial Promises

“… just hang in there, value will return.”

Twenty-three years ago, a managing partner at the CPA firm where I was the partner in charge of taxes confronted me with stockbroker statements.  The statements showed five years before he had converted a significant percentage of his IRA investments into Kaiser Steel Corp.  (“KSC”) preferred stock.  They also revealed that over time this investment had been all but wiped out.  Because he knew I had headed up the KSC income tax department at the time he bought the shares, he asked if I believed there was any hope for the stock to recover to which I shook my head emphatically “no.”

The partner told me that a stockbroker had convinced him to buy KSC preferred with his IRA funds because it was “a steal” at the price.  In the short run the stock climbed in value.  When KSC began announcing huge losses, price support collapsed.  The stockbroker told the partner that if he just hung in there, value would return.  So the partner did but the value just kept plummeting.

After our conversation, even though he was 68, the partner carefully restructured his investments to emphasize less risky investments.  Because he was a high income earner, he did not currently need the cash from his investments so he began purchasing investments that generated cash at ordinary income tax rates (such as high yield corporate bonds) from his retirement accounts and those which he held for long-term growth or which earned tax-exempt income through his personal bank accounts.  As a result of his efforts, he was able to help some very important people to our firm prudently restructure their portfolios as well.  Over the next decade, the strategy did not bring in huge returns but those who participated saw substantial growth in their asset base and slept a little better every night.

Proper Use Of Reverse Mortgages

“Financial Planning Is an Art.”

Financial planning is an art.  When done correctly it is masterful.  When done in the amateurish way promoted by some today, it can lead to ruin.

Please remember, a reverse mortgage by itself can never help a retirement plan or portfolio recover from previous losses.  In fact, living off a reverse mortgage and leaving the portfolio alone could lead to the incurrence of larger losses and costs than might have been sustained if no reverse mortgage had been acquired.

Some portfolios and retirement plans may never fully recover in the lifetime of the senior; however, that does not mean that a prudent restructuring will not help.  The first step in such restructuring is to seek the advice of a competent and knowledgeable financial planner who is experienced in such matters.  However, for a senior who owns her/his own home, a reverse mortgage should be considered as a means to enhance a recovery strategy.

The irresponsible advice we are hearing both inside and outside the industry could do permanent damage to all of us.  While we need to promote our products to more affluent seniors and into the financial community, it should be done prudently.

James E. Veale is a California CPA and real estate broker with a master’s degree in business taxation from the University of Southern California.  Jim is a Senior Vice President at Security One Lending, Inc.