Thursday, October 29, 2015

'Risk Is' ... Want to Triple Your Existing Home Equity 'Cash' Investment in Less Than 15 Years? ... Here's One Way

Let's assume that our 40 to 50 year old home owner has $200,000 in home equity and has fifteen or more years to work before he will need money to supplement Social Security retirement income.

Finally, while he's not a reckless sort, he does recognize that that you can't steal second base without first removing your feet from first base. He's a thoughtful prudent individual. He knows that there is always risk is doing something, just as there is always risk is doing nothing.

In other words, he realizes that risk is very much a part of everyday life, and that risk and reward go together. Risk is, in other words.

So he borrows $200,000 in the form of a 30 year mortgage loan at less than 4% interest and invests that money in blue chip dividend paying stocks. These stocks currently yield almost 4%, and he will use those dividends to pay the mortgage interest on his new mortgage loan.

Then he sits back while 'time in the market' does the heavy lifting for him. Within the next 12 years or so, his home equity will double to $400,000 at an average rate of appreciation of 6% annually. The stocks will return an average of 9% annually, and the cash dividends will be used to pay down the mortgage loan. That will leave 6% annually for average share price appreciation.

At the end of the 12 years, the house is now worth $400,000 and the stocks are also worth $400,000. He pays off the $200,000 loan and has $600,000 more in assets than he did 12 years earlier. The $200,000 turned into $600,000.

That's a triple. And that's how leverage and stock ownership, coupled with money to invest, makes old age an easy financial trip.

With rates so low, should you pay off your mortgage? says this in part about borrowing to pay off the mortgage:

"While it’s an appealing idea to hold onto a predictable monthly mortgage payment and plow into retirement savings the money that would otherwise go to a home-loan payoff — the thinking is that you come out ahead if you can earn more in the markets than you’re paying to borrow the money — some say that even at ultralow interest rates, it often makes more sense for people to pay off their mortgage before they retire. . . .

That said, these days you wouldn’t need the financial markets to yield much to top the cost of money borrowed to buy a home. In all but one of the first nine months of 2015, the average rate on the 30-year-fixed mortgage was less than 4% (the exception was July’s 4.05% rate). . . .

So why not hold onto that low-rate mortgage and try to make a higher return on your money by investing it? In a word: certainty.

“Do we know that markets are guaranteed or what’s going to happen? No. . . . the decision of whether to carry a mortgage into retirement will vary widely depending on individual circumstances, including, among many other things, whether the mortgage still offers deductible interest and whether the retiree plans to downsize eventually (in which case, perhaps consider doing it sooner than later) . . . .

Don’t forget that the question of whether to pay off the mortgage or invest the money goes beyond a purely financial calculation.

But if you set aside the psychological benefits of paying off that debt, on a purely financial basis it might make sense to hold the home loan, Jennings said. If your mortgage rate is 3.5% or 4% and you believe you can earn 6% to 7% consistently on your investments, maintaining a mortgage for a period may make sense for individuals who are willing to take that risk . . . .

Of course, taxes come into play, on both mortgages and investments. If you’re far enough along on your home loan such that your mortgage-interest tax deduction isn’t worth much, and you plan to invest the money through a tax-qualified account such as a Roth IRA rather than a taxable account, that may skew the numbers in favor of investing over paying down the mortgage — assuming you’re fairly certain about your market returns.

Summing Up

For risk averse individuals who have sufficient financial assets and are on track for a secure retirement, borrowing home equity and buying stocks with that money may not make sense. The same is true for those in or near retirement.

But for those thoughtful and responsible 40 to 50 year olds who believe that for investing purposes cash is trash, taking the equity from a home and converting it into blue chip dividend paying stocks may make sense.

Planning on a rising stock market over a long period of time is an absolute winning approach for individual savers and investors. Planning to hold cash or cash equivalents is a loser. And home equity is a cash equivalent.

In today's low inflation economy, low interest rates and growing cash dividends on stocks have created an opportunity to refinance our home and use the money to buy a solid portfolio of dividend paying stocks.

Time is very much on our side when investing for the long haul, and the ability to borrow at an effective interest rate of zero (cash dividends less mortgage interest = zero) is very appealing.

So if we have an investment horizon of at least ten to fifteen years, what is now $1 in home equity will in all likelihood become $3 --- and $3 is 50% greater than $2.

Hitting an investment triple is better than a double. All that said, 'risk is.'

And that's my mathematical take.

Thanks. Bob.

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