The mortgage is finally paid off, some of the kids have left home, and
there is a bit of free cash after the regular bills have been paid. How can a
middle-class moppet prepare for retirement, now that it is pretty sure the
Social Security net is unraveling? GIC rates have fallen, and there's so little
left after taxes. Some Investment Planners have the answers and they want you to
mortgage the house. Caveat Emptor.
Creative financial types have picked up on certain facts - lots of equity in
homes, low interest rates, retirement concerns and ever-rising equity returns. A
powerful combination results. Why doesn't everyone borrow money on the security
of their home, paying low interest rates, use the proceeds to invest in the most
carefully selected conservative mutual funds (to benefit from the best
professional management) and experience the delights of compound interest?
The result will be retirement security, and more! Dreams of millions float
readily through our exhilarated brainbox. Visions of white sand, azure seas and
gently swaying palm trees tantalize our numbed defenses.
Fortunately there is still the stock market. Sure it's up somewhat, but
long-term serious studies by serious academics clearly show that for patient
investors, serious returns are always available. Seriously.
There is no free lunch - we know that, but where's the catch? Even if
interest rates double, after writing off the interest cost, it still makes
sense. Declines in the stock market are always short and sharp, scary as we're
going through one, but the market always pushes through to new highs as the
value of the underlying companies shines through.
Nevertheless, the nagging doubt persists. Could it be that this statistical
view of history somehow distorts the realities of the financial markets? How is
it that the six year decline in the stock market between 1968 and 1974, during
which the broadest measure of US stock market performance declined by more than
70%, has no effect on these long-term calculations?
Some market analysts (not academic statisticians or red-suspendered risk
seekers) consider that the bear market, which began in the late Sixties, did not
truly end until May of 1982 with a decline of 74% after adjustment for
inflation. This 16 year period was only the decline. Full recovery to the
original amount required another ten years.
Be aware that a statistician can prove almost anything with a carefully
selected set of numbers, over almost any time horizon. Maybe the statistician
thinks that a patient long-term investor could smile for six long years at the
worried banker threatening to seize the house. Or maybe bankers will never again
be interested in the collateral underlying their loan.
It won't happen of course, but what if the prime interest rate currently
being charged on home equity loans returned to the peak rates charged in 1981. A
20% hurdle rate would be a tough one for this high risk strategy.
It won't happen of course, but if the stock market declined for six months
or a year, would falling mutual fund values and regular interest payments on the
loan still feel as good? History shows that only the most patient investors have
the staying power for such a strategy. Patience, remember, does not mean 6
months but rather 6 years.
Having taken a $100,000 mortgage on your house to buy a mutual fund, can you
afford to see the stock market drop by 30% and have the banker come by to take
the collateral on the loan back? You're $100,000 mutual fund investment has
fallen to $70,000 and you are now renegotiating with the banker to save your
house.
Greed and need combine, in the practice of leveraging mutual fund
investments by mortgaging an asset, to demonstrate the truth of the old adage
that there are "lies, damn lies and statisticians."
|