Tip For Ignoring Bad Advice In Money Magazine
The latest edition of Money Magazine profiles a couple, 46 years old, that together make $120k/year, have a $250k ARM mortgage, a $30k home equity loan, and $12k in credit card debt. The couple is very concerned about boosting their slim retirement savings; to this end, they'd like to leverage the equity on their LA home, which is now worth $1 million.
Here comes some -- in our opinion -- highly irresponsible advice from a CFA who suggests this 'extreme makeover' (Money's phrase): Take out a new $500k ARM mortgage, pay off the debts, then plow the remaining $200k into the U.S. stock market (80%) and bond funds:
"This is very aggressive," says [the CFA, Christopher] Van Slyke. "For them to catch up, they've got to be unconventional. Over time, their investments should grow by more than the interest rate" on their mortgage, which should be under 6 percent.
'Unconventional'?! How about 'betting the farm on a roulette spin coming up red'? Here's what could go wrong -- very badly wrong -- with this new half-million dollar adjustable rate loan:
* The U.S. stock market doesn't yield 7+% returns over the next two decades -- an entirely possible scenario (see this chart).
* Inflation picks up, the Fed raises rates, and the couple's ARM starts demanding 10+% interest.
* The LA housing market, currently red-hot, starts falling. According to the article, the couple 'wants to sell the house in five to seven years.' The new half-million dollar loan squeezes their gains on that sale between the $500 and $1 million.
* One of the two loses his/her job. Try paying off a $500k mortage at 6+% on one $60k income -- while saving for retirement.
Forgot to mention - the husband says he's 'risk averse when it comes to playing with the stability of our lives.' Not exactly a good fit with the CFA's advice.
How about this approach -- sell the house. Retire the debts. Take the remaining $700k and put away a big chunk for savings (invested not only in the US stock market). Then buy a more modest home, or rent until the housing market settles down.
(Hat tip: Barry Ritholtz' readers)
Comments
Wow...I agree with you 100%. That advice sounds a little irresponsible and I am suprised to see that it made it into Money Magazine.
I saw this article also and wrote about it here.
I agree with you completely, it is horrible advice and it is irresponsible of Money to even print it.
As much as I think parts of California would be cool to live in, and as much as I think some of the jobs that would be available in LA would be awesome to have, I also think [much of] California's housing market, taxation system, etc. can really milk a family that doesn't have a ton of money or how to handle the amount of money they do have. Chances are, this couple would be better off leaving their "better" jobs in LA and their "better" home for something comparable in another state. Even if they couldn't find anything as good financially, their dollar might go further in multiple areas.
The advice the CFA gave is...absolutely mind boggling. I would never tell this to anyone, save maybe a single person who was willing to risk it. You most certainly don't give that sort of advice to a family who is somewhat codependent. What happens to the wife and child when the father has some medical expenses, or what happens when some medical expenses come up for the child? Any number of naturally random incidents could totally ruin an already-risky setup such as the one suggested. I agree with your recommendations.
I think someone has to redefine the meaning of expert. Imagine what will happen to the couple of they follow the advice?
If I may suggest taking a look at this site go2self.org/stop. It provides simply budgeting tools & techniques and training in progressive stages according to the wants and needs of the user.
Site also provides advanced budgeting and leveraging techniques and systems that anyone can implement without the aid of experts.
Thank you!!
Even better -- sell the house, retire the debts, move out of CA to someplace a lot cheaper (like eastern TN), buy a house every bit as good as their current house, or better, free and clear.
My company explicitly prohibit recommending borrow money (home equity) to invest in stocks.
What about using home equity to pay off mortgage, in full, years ahead of schedule, without budget cuts, without lifestyle cutbacks, without increasing income and without biweekly payments?
Has been done by myself and hundreds of others.
SELF, could you please explain using home equity to pay off a mortgage? Wouldn't you need to take out another loan or line-of-credit at a higher interest rate to pay off the 1st mortgage?
The easy answer is to use continually use a HELOC as a very short term leveraging mechism w/ self imposed 7,15 or 30 day terms (after all it is a line of credit). Leveraging involves a disclipline using a combination of payment shifftng techniques, similar to invesment houses sweeping their funds into higher yielding accounts for a short term, in the case of debt funds are swept to less costly debt accounts to pay off costlier debt.
Caution: Do not let rates be the sole factor is debt cost. Time is what really compounds cost.
Bad Real-Estate Advice
I promise this will be the last article with “bad” in the title in a while. There is never a shortage of bad financial advice though, in fact sometimes I feel like the majority of the advice out there is bad advice. Here is an excellent ex...
But at least Money magazine was smart enough to list this site as one of the best blogs from the financial front in their April edition. They're also pretty negative about the risky financial setup of the family in "One Family's Finances".