People often write to me asking for a second opinion on their financial advisers’ suggestion of using their home equity to build an investment portfolio. If you’re feeling rich “on paper,” you may be ripe for the picking. The next time someone comes a’callin’ with a great investment spiel about how you can use your home equity to diversify your investment portfolio and make lots of money, ask some questions.
Historically, you have to be fully invested in stocks to earn a return of 9 per cent. Are you ready to take on that much risk? Do you have the time (and guts) to wait out the dips that come with equity investing? If there are any fixed-income investments in your portfolio, borrowing to buy them makes no sense because their returns are likely to be lower than what you’re paying in interest on the loan.
Sure, you can get a loan at 3 per cent today, but that rate will fluctuate over time. If the rate goes up 1 per cent, that’ll eat into whatever return projection you’ve been given. And it’ll eat into your cash flow — the money you’re using to have a life — unless you choose to sell some of your investments to cover the higher payments.
What happens if your home drops in value?
If you’re leveraging your home and your home goes down in value, it may no longer cover the line of credit you’re using to leverage your investments. You may be asked to pay more interest on the loan to cover the higher risk to the lender. Or your loan might be called, forcing you to sell your investments whether they’ve made money or not. Are you ready for the downside?
Plus, sticking $ 100,000 in the market all at once goes against the concept of “dollar cost averaging” — regularly buying a set amount of an investment (so you buy more when its value is low, and less when it is high).
You’re better off keeping your sticky fingers off your home’s equity. Instead, use the money you were going to cough up to repay the line of credit, and use that to invest monthly. Slowly but surely, you’ll build an investment portfolio without the potential downside of the whole plan going haywire.
If you’re wobbly on the math you’re being shown, if you’re not convinced this is the right tactic for you, if you’re being “sold” this idea, step away from the table and take some time to think. You should only use your home equity to invest if you are absolutely convinced you’ll make money. AB-so-LUTE-ly. Otherwise, you’re putting your home at risk for something you may not really understand.