Use Real Estate Equity To Generate Reliable Income For You, Not The Securities Salesman
- How leveraging equity near retirement is a gain for the salesman and a risk for you.
- Why it doesn't make sense to increase your risk profile at an older age.
A reader asks, “I'm 61 nearing retirement and a lot of financial gurus say I should leverage my rental property equity to buy stocks, real estate, etc., for retirement. Is it a good idea?”
There are two answers to that question – the scientific answer and the realistic answer…
The scientific answer is that you should do whatever provides the highest after tax return net of all fees and expenses.
Science says that if leveraging up provides a higher return then it's theoretically a better choice; however, THERE IS A HUGE DIFFERENCE BETWEEN SCIENTIFIC THEORY AND ACTUAL PRACTICE.
I'm not a big fan of anyone nearing retirement re-leveraging equity to be reinvested in volatile assets (like stocks) for the following reasons…
- Financial leverage is the only form of leverage that cuts both ways. It makes the good times great, and the bad times unbearable.
- Re-leveraging real estate equity will incur lots of fees and expenses creating an immediate loss. This might be good for the salesman in search of commissions pitching the idea, but it all comes out of your pocket, creating a net negative investment return before you ever get out of the starting gate.
- Increased leverage raises your interest carrying costs and debt to equity ration thus increasing your risk of financial failure because you have less room for error. Your additional investments must provide a compounded (not average) return in excess of interest costs and expenses before ever adding a dime to your pocket. Most people lack the investment skill to reliably achieve that goal.
Actual practice shows there are historical time periods where a high leverage strategy would have worked out well, but there are historical time periods where it would have been a miserable failure.
Whether it works to your advantage or not is completely dependent on future asset returns, which is unknowable.
The only thing you know for sure is your risk profile and expenses will increase, but you can't know if your future returns will increase as well (no matter how much the salesman pitches you with historical return evidence to support his ideas).
The whole problem with this strategy is two pronged: future returns are unknowable but your interest costs will absolutely increase.
Unless you can forecast expected returns to exceed interest costs reliably and with a strong degree of confidence, then you have no basis for increasing your risk through leverage.
In fact, I'm hard pressed to think of a circumstance where I would implement such a strategy in my own portfolio.
It generally doesn't make sense to re-leverage your rental real estate equity and increase your risk profile as you near retirement.
Your retirement objective should be sustainable cash flow in excess of expenses that adjusts for inflation – not maximum wealth. Real estate equity provides the former and leverage is targeted for the latter.
The pitch to apply high leverage strategies primarily exist because salesman are highly motivated to earn double commissions both on the mortgage refinance, and on the reinvestment of the proceeds from the refinance into other assets.
It's a double-down for the salesman… but a high risk play for the retiree.
Others may disagree, but that's my two cents worth.
What do you think? Tell us in the comments section below…
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