Should they take their winnings off the table?



Taking their winnings off the table:
Are seniors over-invested in their home?

Let’s say in January 80% of your assets were invested in hotel and entertainment stocks that made you a healthy chunk of change. For sake of argument, let’s say these stocks consistently out-performed your expectations. Then came March and the arrival of the novel coronavirus. If you found yourself holding these positions after the pandemic broke you probably got clobbered in the market.

Much like being over-invested in one or two companies, many are over-invested in their home. That’s a point Hometap Equity Partners CEO & Cofounder Jeffrey Glass made in a last month’s RMD virtual event HEQ- the future of home equity in retirement. If the bulk of a client’s wealth was tied up in one stock a financial professional is likely to strongly recommend diversification. “If that were a stock, and you had 60-90% of your net worth tied up in one stock, no matter how much you love that stock, any financial advisor would tell you you’re over-concentrated, particularly since you’re over-concentrated in an asset that’s illiquid,” While Glass’ was speaking in the context of alternate equity products, his analogy nevertheless rings true.

So what about housing wealth?

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3 comments

Jim Warns October 19, 2020 at 7:13 am

Excellent video, Shannon – thanks!

Reply
Shannon Hicks October 19, 2020 at 9:33 am

Thank you Jim.

Reply
James E. Veale, CPA, MBT October 20, 2020 at 1:56 am

Equity is in fact a fleeting concept except equity in the legal sense. Generally, when we talk about equity, it is nothing more than the difference in a subtraction problem. Home value which is the minuend of the subtraction problem is dynamic and is subject to continual change not only from factors in the home but far more by factors outside the home such as the quality of schools in the immediate area, deterioration in homes near the subject property, the economy in that area and its effect on income from jobs, availability near the subject property such as grocery stores, gas stations, doctors, restaurants, jobs, and other community characteristics, and even drought on the landscape surrounding the property, frequency of fire in the area, overall weather conditions, location of polluting factories, and many other factors.

Debt, on the other hand, is the subtrahend of the subtraction problem that results in the difference that we name, “home equity.” Debt is changing but its changes are generally less volatile than the changes related to home value. However, unless the mortgage is an adjustable rate mortgage, the change is confined to the mortgage documents and compliance with their terms and covenants. An adjustable rate mortgage has one additional factor and that is the impact of changes in the index selected in the mortgage documents.

A reverse mortgage does NOT take equity out of a home. It will generally increase debt. When it comes to the two variables, home value and debt, home value has generally been the more volatile in the last two decades. What few talk about is that using the proceeds of a debt to invest with is known as leveraging. Leveraging should be discouraged when it comes to seniors. Its risks are simply too great whether such investing is done in a disciplined manner as those who advocate using reverse mortgage proceeds to mitigate the risk of the sequence of returns or not. Although the big three publicly traded stock indices have seen bear markets in the last seven months, the bear markets have been short lived. While the indices have also experienced correction, most of the time, their values have been above the correction range (generally considered values of 80% to 90% of an identified peak value) even though they are less than than peaks.

While risk can be hedged against, loss in the later years of life is much more difficult to recover from.. Too often in our industry we assume that the stocks in a portfolio or in an income tax favored retirement plan are not volatile; however, most growth stocks are and few seniors with stock investments in today’s investment world do not hold at least some growth stock. This is not to discourage all leveraged investing (otherwise, how would most seniors own a home?) but it is to discourage a thoughtless and reckless exercise of mitigating loss by simply taking out more reverse mortgage proceeds as some advocate. Afterall there has been no substantial empirical evidence demonstrating the prudence of this strategy even though there has been well written white papers on this strategy.

Some in the industry falsely claim that home equity is an asset and even refer to a reverse mortgage as a buffer asset but such is not the case. Home equity can be positive or negative even when nonrecourse debt is involved. For example, if a borrower decides to keep title to a HECM at termination and the unpaid principal balance is greater than the value of the home, the amount due and payable is not limited to the value of the home but is equal to the unpaid principal balance. Some have stated since home equity is an asset (just shown to be a false assumption), the debt related to it is an asset but that again is false. In accounting parlance, the phrase used to describe the subtrahend in the calculation of home equity is a contra asset, since its value is negative in the home equity value computation.

The home is not an investment like a stock. Imputed rental income is not generally spoken of when discussing a principal residence but it is the basic reason for owning the home. What stock can be lived in? A home is the place we raise our children, place musical instruments, have our clothes cook our meals, eat with family and friends and do many other activities. Who does any of that with stock? While Shannon appreciates the statements of Jeff Glass in the 10/11/2020 RMD article, I prefer those of Tom Sponholtz. Jeff makes rather thin arguments while Jeff dwells on the true nature of the home.

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