Should My Home Equity Be Working for Me?

Q: Hi Jeff, I have been considering using a portion of the equity in my home and investing in managed growth funds that have been averaging over the the last ten years 12%+. I have a current rate of 6.25% on my mortgage. I'm still working and bring in enough income to pay my mortgage now, but I would like to retire within the next 5 years.

I have heard of "Equity Stripping", and "Equity Repositioning" and have long thought the equity in your home should be working for you instead of sitting idle earning 0%. If the funds are managed properly and watched carefully, wouldn't this be a smart way of liquifying your assets if needed? What are your thoughts?

A: I am not a big fan of this for several reasons...

First, this is basically arbitrage. You are borrowing money at one rate, paying interest on it and hoping to earn more than that by investing it in something else. Your borrowing rate would probably be 6.25% or higher. The higher the rate the more difficult arbitrage is to do.

Also, those most successful at arbitrage are ones that are able to lock in the transactions from the start, so they know exactly what the result is. For instance, arbitrage is done between the underlying stocks that make up certain ETFs and the ETF. Utilizing computerized trading, arbs invest large amounts of money to make a small amount but they doing it many, many times.

In your plan, you have no way of knowing what you will earn. It doesn't matter what a fund has averaged in the last ten years, there's no guarantee it will do that in the next 10 years. If it was that simple, everyone would be investing in those funds. For instance, Clipper is a mutual fund that had outstanding long-term records. By all accounts it should have done great. Then it was sold to a larger mutual fund company and it's performance changed.

So there is a lot more risk doing this than you think. A LOT more.

Second, you mentioned that you are still working to bring in enough to pay your mortgage now. That sounds like it's a stretch to pay your current mortgage (unless I'm misunderstanding you). That increases the risk even further because you probably don't have enough income to cover the additional payment on the equity you pull out and invest. That means you would have to take from the investment each month. Doing so reduces the probability of success.

Your posted comments on this and other questions are welcome.
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