Mortgage rates remain near all-time lows, real estate prices are escalating, and the stock market has been on fire for the past few years. Inevitably, an age-old question has resurfaced, “Should I borrow against the equity in my home to invest in the market?” Seems like a no-brainer, with cash-out refinancing and Home Equity Lines of Credit (HELOCs) carrying interest rates in the 3% range.
One of Van Wie Financial’s foremost suggestions (read: rules) for investors is to never expose money to the stock market unless you have a minimum of 5 years before needing to touch the funds. Risk is a function of time, and market risk is not tolerable to many people. In any single year, the probability of loss is about 37%. Even after 5 years, the probability of loss is about 22%, and in ten years the risk of loss shrinks only to 14%. It is critical to note that these numbers apply to a theoretical diversified portfolio; 100% stock portfolios are even riskier.
How long would you be willing to pay interest on your borrowed money before realizing a positive return? Six months, one year, two, five, ten, or more? Sizing up market risks, then adding the cost of borrowed money, most investors get a bit queasy if they don’t show a positive return for several months or years. Here are just a few pertinent forms of risk:
Stock Market Risk is always present and unpredictable. Ten-year periods ending in 1999, 2000, 2001, and 2002 produced sequential S&P500 Index returns of -3.8%, -3.4%, -0.9%, and 0.4%. So that readers might breathe a little easier, there has never been a 15-year period in which the broad U.S. stock market lost money.
Credit Rating Risk results from borrowing against a home, which could lower your credit score. Excellent credit scores are hard-earned and easily “dinged.” Credit scores impact everything from credit card and loan interest rates to insurance premiums. For people with marginal credit scores, the loss of a few FICO points could be costly.
Real Estate Market Risk is real. “Recency Bias” is an observable phenomenon that causes people to believe that the future will emulate the present and recent past. House prices have been rising for some time now. When the country undergoes another real estate Bear Market, and prices begin to fall, investors who borrowed could get caught in a cash crunch.
We have no philosophical bias against the “borrow-to-invest” concept. Our arguments, both pro and con, are practical, based on decades of experience, and reflective of a deep understanding of people and their relationships with money. Generally, as we discuss risks with clients or potential clients, enthusiasm for the “borrow to invest” concept wanes.
Anyone considering tapping home equity to risk investing in the market should be financially stable, educated, and mentally prepared. And, did we mention patient?
Van Wie Financial is fee-only. For a reason.