“Missed Fortune” Financial Planning

Have you ever heard of this concept? I had a potential client contact me recently to get my take on whether “Missed Fortune” financial planning is as brilliant as its famed promoter (Doug Andrews) claims it is. Like many other financial advisors (and bloggers) I’m going to award Andrew’s concept a NO from my perspective. Granted, I’m sometimes referred to as a “conservative planner” but Andrew’s concepts seem more than risky–some are downright dangerous.

The quick summary: This concept is based on the premise that paying down your mortgage to eliminate debt isn’t necessarily the smartest money management technique. Rather, take either a line of credit against your home, or a second mortgage, and invest the money some place where it can produce returns. Your investment return is the spread between your interest rate on the home equity line of credit and the (presumably) higher return investing the money elsewhere. While the author often uses low-cost investment products as an example of where one might invest the money, you could be putting that money into any investment vehicle which you’re confident and comfortable with.
I will grant the strategy these three praises: it could, in theory, be a good decision for someone with an aggressive risk tolerance who believes that stock markets will continue their long-term history of positive returns. It could also be good for someone who can invest the money in themselves (for example a business of some sort) which they otherwise wouldn’t have the start-up capital for. I also think a careful application of insurance to the strategy could hedge the risk of loss-of-principal.
The giant question mark is whether the average person taking out a home equity line of credit can consistently earn a high enough return to pay back the interest costs, earn a profit, and sleep well at night. It is this “full cycle” which causes my hesitation to grant an approval. I think, especially in a rising interest-rate environment, these assumptions are quite dangerous. If the equity line (which is usually variable) costs you 7% and the market returns 8%, you’ve only made 1%. That assumes the advisor you’re working with isn’t taking too much of a bite from your invested capital. Using an expected return figure higher than 8% may be necessary to justify the concept. However, most advisors understand that using high figures (i.e. 12% or more) makes the illustration look better at the expense of unrealistic assumptions.
My advice is to keep a healthy balance between paying down your mortgage and investing your money in various other places. If you’re younger and oriented towards risk, you may want to play around with the equity in your home. If you’re older, looking towards retirement and very proud that you paid off your home, I’d steer clear of these “Missed Fortunes.” You might try setting up an automatic investment plan to utilize the capital you would have otherwise dedicated to paying back interest on the home equity line of credit.
Russell Bailyn
Premier Financial Advisors
14 E. 60th St. #402
New York, NY 10022
(212)752-4343 *31
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: NASD & SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

9 thoughts on ““Missed Fortune” Financial Planning”

  1. Russell-
    You may want to take a closer look at the book and the ideas presented. You seem to be forgetting that the equity line would have tax deductible interest. For someone in the 33% tax bracket, the line is really only costing 4.66%. With that in mind, couldn’t you provide many vehicles that would offer your clients a positive arbitrage in this situation?
    Also, the arbitrage is only one of three reasons it is recommended to pull trapped money in equity out of your home. The other two are liquidity and safety. Money tied up in equity is FAR from liquid. If an emergency were to come up, and a homeowner desperately needed the money in equity, they would need to apply for a loan and jump through those hoops. If the emergency was loss of a job, chances are, that person wouldn’t qualify for a loan. They would then need to sell their home to access their trapped equity. This money is also not as safe. If you get behind on payments, the bank will look to foreclose, and all equity could be lost. Banks will only look to sell the home for what they have invested, leaving the client with no home, no equity, and no cash.
    I personally have set this type of plan up for myself, and I advise all of my clients to look into it as well. You should definitely take a moment to read the book when you have time. Also, take a quick look at the article posted on my blog @ http://activerain.com/blogsview/55276/How-the-Affluent-Manage . A concept like this could completely change the way your clients perceive you.
    Chad Trease
    The Trease Group
    Wells Fargo Home Mortgage

  2. I think one of the biggest misconceptions about the missed fortune approach is that a client reads the book, doesn’t like the idea of using equity indexed contracts (either life insurance, CDs, index-linked corporate notes, or index annuities, etc.) and decides to use a direct investment in the market. On that note, I’d agree that it could turn out to be a risky proposition. Otherwise, I fail to see how this could be detrimental to a client’s financial health.
    Most folks are focusing on the interest rate rather than on what you pay on the mortgage vs. what you get after 20 years. This is definitely a slow and steady approach that always comes out ahead if implemented properly – properly being the key word.

  3. This strategy is basically doing for the individual what coporations and private equity are doing right now; leveraging their balance sheets. If there was ever a time to do this, it would be now while the yield differential between stocks (6.5%)and bonds (5%), is in favor or stocks. Everytime the differential has been greater then 1% in favor of stocks, stocks have risen over the next 12 months with an average return of 16%.

  4. A client of mine was sold this bill of goods. Took out an interest only home loan and extracted $90K to make premium payments on two indexed life policies with combined annual premiums of over $33K. If the 9.18% illustrated returns were realized, the premium payments would only have to be made for 5 years, so the 90K would take care of 3 years and the agents suggestion for years 4 & 5 were to take it out of the wife’s IRA (only $83K at present). Did I mention these people were 63 and 65, almost 66 years old?? Where are they going to come up with the money to make the premiums if the market does not deliver more than 9.18%?? Policies lapse and use all of their social security to pay the mortgage?
    If the desire to create a future income stream was the motive for the insurance, why not use a reverse mortgage on the house?

  5. Russell,
    The arbitrage set up by investing in a compounding tax free environment versus the payment of simple interest isn’t dependent upon a continually rising market although it is certainly helped by that. Further, if the “investment” is set up properly, there is no risk of negative returns.
    Have you checked out what the Federal Reserve Bank of Chicago had to say about the tradeoff between mortgage prepayments and investing http://www.chicagofed.org/publications/workingpapers/wp2006_05.pdf?
    The biggest issue is making sure that a homeowner can handle increased mortgage payments and this can be done by “repositioning” (paying off non deductible items like car loans) and looking at the effectiveness of saving in tax deferred vehicles like qualified plans and accounts versus the benefits of the higher mortgage deduction and investing not tax deferred but tax free.

  6. 2 unimportant points that you missed.
    1. Costs are tax deductible that means the net costs of funds borrowed are less expensive (and therefore are at a discounted rate from the actual mortgage rate.
    2. The concept is to put it in Index Life Insurance Contracts, backed by the claims paying ability of the insurance company. Not only this but because of the time value of money of the long-term contracts (investments the insurance company invests in) they are paying always (paying or crediting each year) more than the net cost of the mortgage.

  7. I do not agree with absolutely everything in the book, but I kinda agree on the concept. Here is my perspective:
    I have a mortgage of 280k which I refied recently at 5% interest rate. I am not paying any extra payment and I rather save it and invest it (all tax refunds, additional free money which others would use for principal, etc). My current investments are making me 12.35% annually, tax brake on the mortgage may reduce my interest down to +/- 3% with my current investments I think I would be able to pay the mortgage faster than by paying the principal every month. I agree on the concept that no matter what, your next bill will be due no matter how much you prepaid and that may kill your ownership during bad times. I agree on the concept when comparing two neighbors, both having 200k mortgage, one paying additional principal and having no savings other saving all extra money, so the situation may end up like this:
    Fist one having mortgage paid down to 100k and no savings, other paid down to 150k and having 50k in savings (in my case accumulating @ 12.35%) and suddenly they both lose jobs. First neighbor is screwed and foreclosed, other can continue paying off of his savings… Don’t you think?

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