Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
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deaddog
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by deaddog »

Do what ever you want!!

It is your financial plan and it doesn't matter what anyone else thinks as long as you are satisfied with what you have.

Don't get fixated on the percentages because they will change as the markets change. It is your plan, allocate your assets any way you want, no one really cares but you.
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by gobsmack »

cjk2 wrote:
gobsmack wrote:You can stomach seeing your house decrease in value but you are uncomfortable with a 100% equity portfolio because of the "sleep-at-night" factor. Why is this the case (i.e., assuming you are not borrowing money to buy stocks as of today)?
I think the difference is, I know that eventually (when the house is paid off) I will not be including the house value in my portfolio value calculations. Therefore, it doesn't really affect my portfolio in the long run. Even while paying off the mortgage, the portion that I am including in my asset allocation (downpayment + principal payments) is not affected by the house price. These numbers are determined at the time I buy. (i.e. my mortgage amount is not going to change whether the house decreases or increases in value.) In that respect, this portion of my portfolio will remain extremely stable. In terms of asset allocation, it will affect my portfolio just the same as cash does. This is not true of the 100% equity portfolio.

You can argue that this is an inaccurate way to measure the total value of my assets, but my goal is not to include house value in my calculation of assets. I am just looking for a way to still maintain an AA that makes me feel comfortable, while taking into account the money I am pouring into the mortgage.
If you are concerned about the "sleep-at-night" factor, I would say forget about Smith Manoeuvres :D Your statement sounded a bit strange to me. I would consider a sharp correction in the housing market while holding a mortgage a lot more uncomfortable.

Given that you are still young, personally, I do not see any issue with a 100% equity portfolio - particularly while paying off your mortgage.
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by BRIAN5000 »

- It doesn't earn fixed income like bonds;
- You can't sell part of it off to rebalance your portfolio, or to extract cash;
- You can't really liquidate the whole house unless you want to move into a rental.
or

- my first house had a suite (which I put in) so it did have income like bonds, student, boarder of some type may also work?
- I currently have a HELOC so I could borrow some money against the house to rebalance if I felt like it or it was the cheapest money.
- why would I ever want to sell the whole house unless I wanted to move or rent
- in my case, I moved out and rented the top and the bottom almost paid cash for the new PR then had that ugly problem of positive cash flow

How bad do you want what you want are you willing to put up with some/moderate inconvenience now to have something better/different sooner?

That five year time frame that was suggested sounds pretty good.

You also maybe trying to do too much too fast , new house and a stock bond portfolio, new baby?
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by Flaccidsteele »

Ignoring the mortgage and value of a primary residence in one's AA when it may literally dwarf the investment portfolio seems somewhat discomforting to me.

Let's say someone has a $25k investment portfolio in 60/40 stock/bond mix, and a $500k house with a $450k mortgage. We just ignore the primary residence and say the AA is 60/40 stock/bond? It feels like ignoring a whale in the room. Personally I'm more comfortable including it in my AA.

To each their own.
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by SoninlawofGus »

cjk2 wrote:So, those of you advising me to exclude house payments from my AA calculations entirely: what asset allocation would you recommend for my investment portfolio?
As others have written, the values involved, your age, and your income are just some of the factors -- so there is no one-size fits all. FWIW, in our case, not far from retirement, we're at 50/50. The FI is all less than 5 years and in GICs. We also have an RESP that I do not factor in. If I were to factor in our house value (and I don't), it would make up about 38% of our combined assets. However, and again getting into the complexities of everyone's situation, my wife has 15 years in to a Govt. of Canada pension, and will not retire for several years -- probably at least five after I retire. That pension is effectively worth about half of our 50/50 portfolio. In our case, we could take on greater risk, but my wife's pension will probably be deferred, and I like the notion of having some stability in the early retirement years.
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by Peculiar_Investor »

To answer the OP's question about how we handled things when we first bought a home, times were very different. It was the mid-80's and interest rates, both mortgage and savings, were quite different back then. The spread still of course favoured the banks, that hasn't changed much. We bought our first house shortly after starting our careers and getting married so there wasn't any investment portfolio to include in the calculations.

Our strategy was to aggressively pay of the mortgage to become debt free, then funnel the funds that we'd been paying towards the mortgage to build an investment portfolio. We did start with an aggressive asset allocation, I would hazard a guess we started at 80/20.

At the end of the day it is your sleep at night comfort level that matters, FWF members can only give you things to consider in making a choice that suits you.
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by Just a Guy »

Flaccidsteele wrote:Ignoring the mortgage and value of a primary residence in one's AA when it may literally dwarf the investment portfolio seems somewhat discomforting to me.

Let's say someone has a $25k investment portfolio in 60/40 stock/bond mix, and a $500k house with a $450k mortgage. We just ignore the primary residence and say the AA is 60/40 stock/bond? It feels like ignoring a whale in the room. Personally I'm more comfortable including it in my AA.

To each their own.
Let's put it another way then...

First off, your $50,000 "safe", bond like investment can literally disappear overnight in the negotiations. Taking 10% off the sale price isn't really hard to do.

Then, let's look at the cost to list. $7000+$3500+$3500+$3500+$3500 (realtor fees), then $1000+ for lawyer fees, cost to break your existing mortgage, land transfer fees (if applicable), property taxes due at the time of sale, etc.

Then, let's not forget the fact that you put in new floors, painted, maybe new windows, a furnace, the roof...all leading up to the sale.

Oh, then there was your initial down payment, which has been eaten up by all those fees...

Even if you managed to get full price, you're probably walking away with a negative return without even realizing it because most people only look at the final number.

There's a reason why you need 7 years of normal price appreciation just to break even on the average home...and I'm not even talking about the loss of buying power on your money.

There's a reason I say a home is not the same as an investment.
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by OnlyMyOpinion »

Peculiar_Investor wrote:...We bought our first house shortly after starting our careers and getting married so there wasn't any investment portfolio to include in the calculations.
Our strategy was to aggressively pay of the mortgage to become debt free, then funnel the funds that we'd been paying towards the mortgage to build an investment portfolio...
At the end of the day it is your sleep at night comfort level that matters, FWF members can only give you things to consider in making a choice that suits you.
^+1 As did we. Fortunately we didn't have two pennies to rub together when we bought our home one year into marriage, so the question of AA did not rear its ugly head :wink:.
Paid off the 14.25% mortgage off in 5 years then started investing, initially in similarly ridiculously high rate GIC's.
Aside from what the math may say about keeping your investments while still paying off your mortgage, I think the 'value' of the monthly cash flow made available by being mortgage-free at any interest rate is large. Of course you have to have the discipline to then turn it towards your investing, not p^ss it away.
We aso managed to avoid the need to buy progressively larger, more expensive homes that would have reclaimed some of that cash flow. This was because we had the good fortune to initially buy a (smaller) house in a nice location that we've been more than happy to stay in, renovate and improve over 36 years.
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by Flaccidsteele »

Just a Guy wrote:There's a reason I say a home is not the same as an investment.
I agree. Which was my point. With the primary residence making up such a massive proportion in this hypothetical situation, I think it should at least be a red flag when included in an individual's AA.

Also, I wouldn't classify the primary residence as a bond. It would just be "housing" and looking at this hypothetical AA it would show a huge imbalance.
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Re: Asset Allocation: Buying a house, any downsides to classifying real estate under the "bonds" portion of portfolio?

Post by cjk2 »

deaddog: That's true. I've definitely been too fixated on the AA percentages--I'll have to try to move away from that and be more flexible while I have a mortgage. :)

gobsmack: this may sound strange, but the main reason I'm worried about the "sleep-at-night" factor is because frankly, I don't know what my "sleep-at-night" tolerance is! Like I mentioned, unlike many of you here I have never gone through a major crash during my investing lifetime so it's hard for me to determine my risk tolerance. I have seen my portfolio dip a few times and I wasn't worried at all, so I'd like to say I can handle a lot of risk. Obviously a 40% correction is far different than the minor drops I've experienced however. Anyways, based on that I'm still willing to give the Smith Manoeuvre a go. It's not really increasing my leverage/risk since I'm just shifting the loan from mortgage to investments. Again, the reason I'm not concerned abut a housing market correction (vs. my stock portfolio) is because I'm not planning to count my house as part of my retirement assets in the future.

BRIAN5000: not sure what you mean by "put up with some/moderate inconvenience now to have something better/different sooner"? Anyways right now we are just focusing on buying a house, kids will come later. :) So I don't think it's too much on our plate.

Consensus still seems to be to go with a 100% equity portfolio outside of the mortgage, so I think that's what we'll be doing. I'm happy to be able to keep all my stock ETFs intact--not planning to sell those until retirement!
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