Include Home Equity as a Non-Correlated Asset in Your Retirement Portfolio

My Comments: First, the title above may seem long but is shorter than the actual title of the article behind this blog post.

Second, for those of you who read my blog posts, from time-to-time going forward you’re going to see posts about reverse mortgages. A few months ago I became a fully qualified mortgage broker here in Florida. While I can proudly say I’m fully licensed, I really don’t yet have a clue what I’m doing but am extremely thankful for what a reverse mortgage has done for me personally.

Further, I can assure you the topic of reverse mortgages is potentially critical for about 50% of those folks already retired, or soon to be retired. Maintaining financial sanity in retirement is increasingly difficult, and reverse mortgages are playing an increasing role in preserving the sanity of our senior citizens.

I’ll be working with a husband-and-wife team, Kathy and Bob Muni. Bob worked as a mortgage broker here in Alachua County for many years before they moved to Colorado to open an office near Denver specializing in reverse mortgages.  With their children living in Florida, they decided it was time to move back and be closer to them as the years roll by.

This post is not the time to argue the merits and safety of reverse mortgages. Suffice to say that after 45+ years as a financial planner, etc., I now recognize the inherent value of being able to help others access home equity to help pay the bills as one ages. We face far different threats to our sanity as we age than what we faced in our 40’s. Imagine being threatened by high grocery and health care bills while at the same time having equity in your home that cannot be touched to help you sleep at night.

The article behind this post can be found here:

It’s long, written by long winded experts complete with charts, 3 appendices, citations, and end notes. Suffice to say I’ve only copied the Executive Summary for your reading pleasure.

It appears, written by Philip Walker; Barry H. Sacks, Ph.D., J.D.; and Stephen R. Sacks, Ph.D., in the Journal of Financial Planning: December 2021. Here is the Executive Summary:

  • Financial planners have long regarded diversification and asset allocation as essential tools for reducing portfolio risk for their clients. This is especially true for retired clients who regularly draw on their portfolios for income.
  • Another essential tool for risk reduction, but one not adequately recognized by financial planners, is the inclusion of home equity in the retirement portfolio, as an asset along with, and similar to, investment securities. An essential aspect of the inclusion of home equity in the portfolio is a withdrawal strategy that, in a disciplined way, uses that asset.
  • The inclusion of home equity as an asset in the portfolio is notional; the equity serves as a source of retirement income just like the other assets in the portfolio, according to the algorithm described herein; but there is no transfer of ownership, control, or management of the home.
  • This paper consolidates the results of several previously presented research papers and recasts them into a novel approach to the meaning of “risk” for certain retirees. These retirees are those whose primary source of retirement income is a securities portfolio; typically, but not necessarily, a 401(k) account or a rollover IRA.
  • This paper is primarily an instructional vehicle, both to help financial service professionals better understand this vital concept of risk reduction and to help them better educate their colleagues and their clients about the concept.
  • Financial planners who have clients approaching, or having recently entered, retirement, should revise their understanding of how to view the volatility of securities portfolios. For clients who are mid-career and are building wealth (i.e., not distributing from their portfolios), short-term volatility generally does not present a significant risk.
  • By contrast, for clients who are retired and are distributing primarily from a securities portfolio for their normal living expenses, short-term volatility is risk. The adverse effects of regularly distributing from a volatile portfolio can be substantially diminished by distributions from the home equity instead of the other portfolio assets whenever determined by the algorithm described. The term “risk” is only meaningful if expressed in terms of a chance, a probability, of a specific event adverse to the interests or well-being of the person bearing the risk. Risk, in the context of retirement, means the probability of cash flow exhaustion or the probability of a required significant reduction in lifestyle or spending level. The probability of such an event is the measure of the risk about which this paper is concerned.
  • Examples are presented to illustrate the use of home equity as a component of the portfolio to increase the percentage of initial distribution from the securities in the portfolio to a level substantially above the traditional 4 percent and still retain an acceptably low risk of cash flow exhaustion.
  • Financial planners who act in a fiduciary capacity should recognize the utility of the added diversification resulting from the inclusion of home equity in retirees’ portfolios and should include this asset in fulfillment of their fiduciary duty of diversification of investments in order to reduce risk.