If you’re a home owner, you’ve seen your property values increase a lot in the last 5 years or so. In some cases more than double. The house that you paid $250,000 for a few years back, is now worth $500,000.
However, f you’re paying attention to the reports that are coming out these days, you’re also aware that the housing market is slowing down and in many cases property values are slipping too.
A few weeks ago, I was at a presentation given by Craig Alexander who is an economist with the TD Bank. In that presentation he gave us all kinds of information about the economy, and where we are heading in the next year or so. One thing he said caught my attention, and got me thinking.
He said that stock markets are a leading indicator of the real economy. What that means is that you will see a decline in the stock markets, generally 3 to 6 months, ahead of a decline in the economy. Then, you will also see the stock market turn around, 3 to 6 months, ahead of an economic turn around.
He also went on to say that real estate generally follows economic cycles. It doesn’t create economic cycles. In other words, when the economy is strong, like it has been in the last few years, you’ll see an increase in real estate values. Not the other way around, where increases in real estate values do not result in a stronger economy.
So a normal cycle like this. Stock market declines, economy declines, real estate declines, stock market recovers, economy recovers, real estate recovers. If you can recognize the cycle, you can position yourself to take advantage of these same cycles.
We have seen the stock market decline, some people are saying we have hit the bottom. I don’t know about that, only time will tell. But let’s say for arguments sake that we are close to the bottom of that cycle.
Economic growth is also on the decline, we are just beginning to see real estate decline.
Some people are saying to sell our homes right now, and downsize, or rent. Get out of the real estate market before it crashes. Well that doesn’t make a lot of sense. You still have to live somewhere. Besides, it’s expensive to sell a house, in realtor and legal fees. Plus you’d have to take time away from work to pack up your household, and move to a new home, resulting in lost income.
Then what would you do with all of the money that you have left over after you sold your home? For most people this just doesn’t make sense.
There’s a better way to protecting your wealth, and for most people it requires outside of the box thinking.
Let’s say that you own a home valued at $500,000 and you have a mortgage on that house of $200,000. That means you have about $300,000 in equity tied up in real estate.
First, apply for a Home Equity Line of Credit (HELOC) for up to 80% of the value of your home, or $400,000. If you’ve got good credit, you can still get one, for now. By doing this, you’ve essentially locked in access to this money. Without the HELOC, you run the risk of losing access to that equity when the real estate market takes a downturn.
Next, take some of that available credit of $400,000 to pay off your mortgage of $200,000, this strategy alone will save you hundreds of dollars a month in interest costs. In most cases, this will be done automatically by the bank when you register take out the HELOC.
Finally, take that $200,000 in available equity that’s left after you’ve paid off your mortgage and move it to a money market account. It was money that was tied up in your house, and at risk of going down in value. You’ll have to pay some interest to access this money. But, that interest is tax deductible because you are borrowing money for investment purposes.
I wouldn’t advise you to leave the money in the low return money market account. This is simply a place to park your money while we go through this rough patch in the equity markets. But, over the next few months you want to use a dollar cost averaging approach to moving that money into a balanced portfolio of mutual funds.
That way you don’t put all of your money into your portfolio at once. We could still see a decline in stock prices. But, you do want to start putting yourself in a position to take advantage of the recovery in the stock markets.
Over a period of a few months you have your equity moved to an asset that was depressed in value, and now is in a position to go up in value. You have essentially done what all smart investors do, move money from assets that are at the top of their price cycle, to assets that are at or near the bottom of a price cycle.
I have to say that this strategy is not recommended for everyone. There is a risk that the mutual fund portfolio will not perform as expected, and go down in value, in the short term. Any strategy that borrows money for investment purposes is generally advised for people that have a 10 year or longer time frame, and have the risk tolerance to see their investments go up and down in value. But, for the right person, this is a sound strategy to protect, and create wealth.
Remember, the equity markets are a leading indicator of economic cycles, so they will turn around before the economy turns around, and the economy will turn around before housing turns around. Over time you have protected your wealth, and put yourself in a position to take advantage of the market and economic upswings.
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Rolf Issler is a licensed Insurance Advisor and Mutual Funds Representative with World
Financial Group. The information contained is for eductaion and entertainment purposes only.
