Leave Your Equity Alone!

Just when we were set to write something good about Money Magazine, they come along and do this. The nation's number one personal finance magazine, having months ago stopped their incessant cheerleading for the housing bubble and having recently featured a number of very good stories about the perils of too much debt and the downside to real estate, seems to have reverted to their old bad habits.

In the February issue, with the apparent blessing of a senior staff reporter, two certifiably nutty financial planners from San Diego have recommended that a house-rich Los Angeles family borrow hundreds of thousands of dollars against their home to invest in stocks so that they can "catch up" in their retirement savings.

Please, somebody find these people and tell them to leave their equity alone!

The story is titled Cashing in on hot real estate, and just seeing the phrases "cashing in" and "real estate" should set off alarm bells inside your head.

You see, in today's twisted world of contemporary personal finance, otherwise known as "more prosperity through more debt", many would have you believe that by borrowing money you are cashing in.

Borrowing money is not cashing in.

Selling your Los Angeles home for a million dollars, then moving to New Mexico, and buying the same house there for $250,000 - that's cashing in.

Then you'd have the same house and a half a million dollars in cash. If you don't sell the house, all you're doing is borrowing more money. Got it?

We've heard this prosperity through debt rationale many times before, most notably from a Citibank representative about a year ago who referred to "untapped home equity" as "dead money". That is, dead money just sitting there waiting to be put to work by investing in more real estate.

It was disgusting to hear then, and hearing the same theory applied to the purchase of equities today is only slightly less appalling (or maybe more appalling - not much thought has been given to the relative evil of these two).

Prosperity through debt, leveraged speculation for the masses - the Greenspan legacy.

So, the Handel-Laports of Silverlake own a $1 million home on which they carry a $250,000 adjustable rate mortgage which they need to refinance because it's about to adjust.

They unwittingly timed the market perfectly by purchasing in 1995, and along with a few million other Angelenos, they've hit the L.A. lotto.

Bravo. What now?

They seem to be a little behind in their retirement savings having accumulated only $100,000 to date. With a combined income of $120,000, and $42,000 in home equity and credit card debt, the mid-forties couple needs to start getting serious about retirement savings.

But how?

They are "risk-averse when it comes to playing with the stability" of their lives, yet they have all that equity in their house. How are they going to get enough money into those retirement accounts to live a life of leisure down the road.

By saving?

No. The certifiably nutty financial planners would have the Handel-Laports join the ever increasing number of medicated Americans by ratcheting up their debt to a cool half million dollars, increasing their monthly debt service, and taking their chances with U.S. and foreign equities.

The Handel-Laports could potentially add a couple more warm bodies to the growing pharmacy lines for what seems to be an insatiable desire for sleeping pills to go along with all the debt that Americans have been accumulating in recent years.

The financial planners argue that the Handel-Laports can "convert equity that might melt away" and still have a sizeable equity cushion even if the real estate market drops by 30 percent. A better metaphor would really be "open a $200,000 margin account".

And, in case the Handel-Laports are not already aware of this, someone should tell them that in the 1990s real estate prices declined by over 40 percent in many parts of Los Angeles and that the 1990s real estate bubble was just a baby bubble compared to what has developed in recent years.

The 1990s decline played out over a period of about six years, and you're planning to sell when? In "five to seven years". Oh.

It is understandable that Money Magazine would have a sort of happy bias toward equities since mutual fund companies are their core advertisers, but this advice crosses the line.

A constant barrage of overt and subliminal coaxing to buy equities is the price that subscribers pay for getting generally good personal finance advice at a generally low cost, but, since the technology stock bubble burst and real estate took off a few years ago, Money Magazine seems to have been adrift.

So, let's see how many ways this could turn out badly.

Figuring that the tax break on the interest for the borrowed money roughly offsets the taxes paid on the money earned, the Handel-Laports would have to earn more than six percent on the invested money to come out ahead.

How do you do that?

You can't do it with any sure-fire investment, since treasuries pay a mere 4.5 percent and quality corporate debt is not that much higher. The house-rich family would have to take on more risk in order to make this gambit succeed.

But didn't they already make clear that they are "risk averse"?

With the suggested asset allocation, the Handel-Laports could earn five, ten, or fifteen percent per year and, coming off of an eighteen year bull market in stocks, they could just as easily lose the same amount over the same period.

If their investments gained ten percent a year for six years, they would pocket the four percent per year difference putting them about $50,000 ahead after six years.

If their investment return was zero (which is about the result they would have gotten if they had done this six years ago), they would be out the interest paid, or roughly $50,000.

And, of course, in the event that stocks have difficulty in the next six years, heading back down to their historical mean losing, say, five percent per year, then they would be behind by over $100,000.

That is, assuming that the interest rate on their new $500,000 ARM doesn't go up.

So, Mr. Handel and Ms. Laport, are you feeling lucky?

If so, stock up on your sleeping pills.

ooo

For previous posts about Money Magazine, use the Search Bar at the top of the page, this link, or use the links below:

• Money Magazine Does Real Estate
• Money Magazine Does a One-Eighty
• Money Magazine on "Cashing Out"
• Why is This Couple So Happy?
• The Housing Bubble Poster Boy