« Blog of the Week – No. 8 | Main | Financial Planning for Generation X »
Mortgage Your Retirement
By JLP | November 14, 2005
DISCLAIMER: The following IS NOT a recommendation.
The November 14th, 2005 issue of Forbes has an article titled “Mortgage Your Retirement,” written by Yale Law School professors Ian Ayres and Barry Nalebuff. The article is interesting in that the authors think that people should try to diversify across both assets classes and time. Come again?
Most people are familiar with the diversification of asset classes which is the principle of not putting all your eggs in one basket. However, most people are not familiar with the concept of diversification across time. The best way to understand time diversification is through an example. Say you invest $100 each year for three years. You have $100 invested in year one, $200 in year two, and $300 in year three. According to the authors, you have too much exposure to year three and not enough to year one.
The only way around this particular lack of diversification is to use margin. In other words, borrow money, invest it today, and then pay back the loan. It makes sense on paper but seems a little dubious over the long run. Why? Because of market fluctuations. If you borrow money to invest and the market goes down, you will be faced with margin calls, which will require you to put up more of your own money. If you don’t have the money, the brokerage firm will sell your assets until your losses are covered. This doesn’t seem like a good way to save for retirement.
In theory, the idea makes some sense but in reality could be a nightmare. The best suggestion I have is to start saving when you are young and invest all through your life. As you approach retirement, lighten up on the stock portion of your portfolio so that if the market drops your retirement plans won’t be in jeopardy.
I’m curious to know what you think. Please read the article listed above and then tell me what you think.
Topics: Retirement Planning | 2 Comments »
November 15th, 2005 at 6:58 pm
This does seem like a weird concept. They mention that people do it all the time with real estate. Maybe I’m understanding it wrong, but there are no margin calls in real estate. If your house drops in value, the bank doesn’t call in the loan and make you sell your house, do they? As long as you keep making your mortgage payments you get to keep living there.
But then again, buying stocks on margin isn’t the only way to borrow to invest. If we’re talking about young people that wouldn’t have home equity to borrow against, I’m not sure how else they would borrow that money but say they (stupidly) took out a cash advance on a credit card to buy stocks. Theoretically, you could be paying off part of the balance on the credit card every month whether or not the stocks lost value. But I can’t say I’d want to take that route myself! All in all it sounds like a pretty stupid idea to me. Of course you are imbalanced over time, as the whole point is to have more money that you started out with!
November 15th, 2005 at 7:06 pm
JLP, what are your thoughts on Warren Buffet’s strategy of not diversifying, but making sure you really understand what you’re investing in. I think his mentor (Graham?) is the one that said you can identify a company where you are virutally guaranteed a profit. That thought intrigues me – and I wanted to get your opinion.