Good Advice? You Decide!

Filed in archive Investing on January 14, 2006

Michael Weinstein of soundmoneytips.com recently blasted Money Magazine for
their atrocious advice to couple seeking counsel.

He says, "The latest edition of Money Magazine profiles a couple, 46 years old that together make $120k/year, have a $250k ARM mortgage, a $30k home equity loan, and $12k in credit card debt. The couple is very concerned about boosting their slim retirement savings; to this end, they'd like to leverage the equity on their LA home, which is now worth $1 million."

Here is the advice offered by CFA, Christopher] Van Slyke, "Take out a new $500k ARM mortgage, pay off the debts, then plow the remaining $200k into the U.S. stock market (80%) and bond funds."

"For them to catch up, they've got to be unconventional. Over time, their investments should grow by more than the interest rate" on their mortgage, which should be under 6 percent.

'Unconventional'?! How about 'betting the farm on a roulette spin coming up red'? Here's what could go wrong --- very badly wrong, with this new half-million dollar adjustable rate loan:

* The U.S. stock market doesn�t yield 7+% returns over the next two decades � an entirely possible scenario (see this chart).
* Inflation picks up, the Fed raises rates, and the couple�s ARM starts demanding 10+% interest.
* The LA housing market, currently red-hot, starts falling. According to the article, the couple �wants to sell the house in five to seven years.� The new half-million dollar loan squeezes their gains on that sale between the $500 and $1 million.
* One of the two loses his/her job. Try paying off a $500k mortgage at 6+% on one $60k income � while saving for retirement.

To offer the advice that was given, one would have to assume a perfect future with absolutely no bumps along the way. Historically there have been long seasons of stock market stagnation that, if it were to happen now, could devastate the finances of this couple. And the housing market has become like the internet of a few years ago where everybody believed it would just keep going up. When there is no explanation for why something is going up, we all need to be extremely careful in making decisions. The housing market on the west coast is in that place right now. The question is this: who is going to get caught with the house when the prices start going down?