Mar

23

TEASER ALERT: I am not about to write what you expect!!

A popular blog site recently posted a story that advocated people to tap their home equity and buy stocks. The link is here or if that link doesn't work, here. 

What I find interesting about this article is that it is being met with universal revulsion judging from the blog comments and other related postings. (Not naming names.) The so-called Pros are saying it's irresponsible, ludicrous, sign of a top, etc. etc. etc. And the so-called pros are also saying that people will get sued for giving this advice. (I have no opinion).

Let's ignore the fact that this column's recommendation was extremely good advice for the past 5, 10, 15, 20, 30, 50 years, and let's also ignore some of the weaker arguments in the story.

I think we should step back and analytically consider that there is actually some merit to the concept (for some people). (Caveat: I am not bullish on stocks).

Imagine the very responsible Mr X who every month took all of his extra income and paid off his mortgage early. He's now about 40 or 50 years old. And he owns no stocks. He owns no bonds. And he has no mortgage. And he's got enough cash to meet any emergency. I can make a very rational argument that Mr. X would be very well served to place a modest mortgage on his home and use the proceeds to acquire some financial assets. Not necessarily all stocks. But definitely some financial assets. There are several underlying arguments in favor of this: But first and foremost is diversification. We know mathematically, over time, diversification is the only free lunch.

So the authors of this controversial blog post got distracted by things like positive carry. And some other not-so-true things. But all of the readers spewed venom. And this reaction may have informative value.

Remember: A home is both a consumption good and a store of wealth. If someone put 100% of their net worth in a single undiversified stock, they are asking for trouble. And a home is really no different in that respect.

anonymous writes: 

I agree 100%.

The negative reaction, it seems, mistakenly seems to argue the case of not selling one's residence to buy stocks (which is clearly not what the author of the original piece advocated). Clearly, if one were to buy a second residence with that same home equity, in the case of agnosticism as to the direction of home prices and equity prices, would their reaction be the same?
 

Leo Jia writes: 

I think it all depends on who Mr X is.

If he is financially skilled (which seems not the case at all in Rocky's description), then maybe OK.

If not, then he should stay at where he is.

Or if he is really tempted, he should first spend a lot of effort in getting the skill. But Mr X should be well advised that he would still have no clue of what that skill is after many years of fooling around.

Do we all believe that investing is an easy job for everyone?

Different from the house, a financial asset is liquid and evidently volatile. Ordinary people can not tolerate the pain when the change of their asset value is vivid and clear. With the benefit of liquidity, the pain would cause them to do a lot of stupid things, which will then burn them out in no time.


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2 Comments so far

  1. Andre Wallin on March 24, 2014 9:42 am

    R is a much better programming language than python for testing multivariate time series. don’t waste time with python. download R, Rstudio, fTrading package, and quantmod package. You can import ohlc time series and test anything.

    On the surface programming was intimidating when I first started in November, but now I realize that it’s very simple lines repeated over and over. It’s easier than learning a spoken language.

    Programming in and of itself has no value. It’s application to the real world has all the value. After thinking about Facebook’s success it’s more luck than skilled programming. I think Harvard’s brand had more to do with its success than anything else. Harvard being an aspiration for all early adopters.

  2. Brian Cauthen on March 25, 2014 10:44 am

    One can not forget about the tax deduction in a HELOC or 2nd mortgage in where cash out funds would be used to purchase stocks or financial assets. In some cases they would offset the the incurring taxes from the future sale of the financial assets. The idea you could gain a deduction from both the interest from a home and the interest in margin (if you chose to utilize this also) could be very appealing from built up equity in a dwelling.

    This idea is very similar in theory to the argument of paying off your mortgage quickly or using the extra cash to invest in stocks instead. One creates an asset paid in full that could be spun into reoccurring income (rental property) along with price appreciation where the other allows compounding returns over the time period of the mortgage.

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