I was talking with an attorney the other day about different investing strategies & different ideas for how to build wealth. I explained my dislike for any debt and how I'm working to eliminate my mortgage and remain debt free. He had a different opinion & told me that the majority of his net worth is from real-estate and that he has always carried a significant amount of debt in his life to invest in different real-estate projects. He even made the comment that if you pay your house off, "you have this huge asset sitting there doing nothing for you."
That got me thinking that he is technically correct in that if you own your home, it's providing you a basic necessity but you're not necessarily using it in any way to generate/build wealth. That also got me thinking about how most people lose money trying to time the market and even more people lose significant amounts of money by panicking & selling during a recession. If however you stay in the market, you'll recover all your losses once it recovers. Additionally, if you had a stack of cash sitting outside of the market, you could invest during a recession and make some excellent returns. Obviously, having cash outside of the market is losing value though and so most people don't have a significant amount except for their emergency fund which wouldn't be smart to invest.
But what about using the equity in your home to invest during a recession? Let's say you have $50,000 in equity that you could pull in the form of a home equity loan with today's rate of 5.75% on a 20-year term would have payments of $351/month.
I did a quick review of the last 5 major recessions and found that the average decline was 40% and the average duration was 22 months:
1973-74 (48% - 645 days)
1976-78 (19% - 531 days)
1980-82 (27% - 622 days)
2000-02 (49% - 929 days)
2007-09 (57% - 517 days)
Let's say hypothetically in the future, you wait until the market declines 25%, and then you take out a home equity loan of $50,000. You set a buy order to deploy $10,000 (20% of your total funds) when the market hits a 30% decline from its most recent peak. Once that executes, you set another buy order to deploy another 20% of your funds if the market hits a 35% decline. Again for a 40% decline. And again for a 45% decline. And lastly one for a 50% decline until all your money is deployed. If you take out the home equity loan and the market never drops to 30%, you simply pay off the home equity loan and move on.
Since the average duration of a recession is 22 months and let's say you took the loan out a quarter of the way though (month 6), you would have to pay roughly 16 months worth of P&I payments on your home equity loan ($5,616) but wouldn't the upside potential be tremendous?? Once the market fully recovers, you could sell everything, payoff the home equity loan, repay yourself the P&I that you've paid those 16 months, pay taxes and pocket the rest. Or you could just sell enough shares to payoff the home equity loan, repay yourself the P&I that you've paid those 16 months, pay taxes and let the balance of the shares stay in the market since we would more than likely be at the start of a bull run.
There could be some risk if you only got to deploy one stage of capital though since a 30% gain on your first $10k wouldn't cover the cost of carrying the whole $50k home equity for 16 months. Maybe it would be better to deploy 50% of your capital at the 30% decline mark and then dollar cost average the rest of the way down? If the market didn't drop further, you would still have the balance of the home equity loan to sit on until the market recovered and then pay it off completely. Maybe toss it in a money market account to earn a little bit of interest while you wait for the market to recover.
Two major factors before I'd even consider doing something like this:
1. I'd only consider investing in a total stock market index fund and not ever any individual company stocks
2. I'd only consider this if your free cash flow can more than adequately cover the cost of the home equity loan. For instance, my personal budget has free cash flow every month of about $1,500 which is more than 5 times the cost of the home equity loan so there's very limited chance that the home equity loan would cause any stress on my monthly budget.
Any thoughts/comments on this hypothetical situation?
Update: Added chart illustrating what I proposed in this post using actual data from Great Recession.