BBCW, I have to politely disagree with you on this one.
I think investment properties should be set aside from a “110 minus your age” portfolio (or a glide-slope portfolio like you prefer); and primary residences shouldn’t be counted as investments at all.
Now, we could just wave all that away and pretend that important wealth doesn't exist. But I don't like that idea. Doing that would mean, among other things, that an otherwise similarly situated family that buys a 4 bedroom condo compared to another family that buys a 2 bedroom HDB (3 room unit) would be taking equal total investment risks (in allocation percentage terms) if all other savings were invested in the same way. And that's just not right. There really is more stock-like risk for Family #1 compared to Family #2.
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OK, fast forward, and now we're getting near retirement. So the "Vanguard model" suggests a 30-70 split when the couple (let's suppose) hits age 65 (for example, as a classic/traditional retirement age). And let's suppose home equity represents 50% of total household wealth, still. Thus, even if the entire other half of total household wealth shifted to bonds, Vanguard's "rule of thumb" 30-70 split can never be achieved, not with this level of home equity. Is *that* a problem? Maybe, maybe not. At that point you can simply say, "Well, I'm not going to sell my home, and I still think it's the right size. And I feel comfortable with keeping 15% of my total wealth in stocks and the rest in bonds by the time I hit age 65."
Hmmm. So I’ve had a think through this, and I have to disagree on a couple of fundamental points.
Firstly, don’t write off the value of simplicity. The good thing about the 110-minus-your-age rule is that it’s dead easy to follow, so it encourages people to get started with investing rather than being intimidated by decision-making before they even start.
A primary residence is different from other assets, because people’s behavior around selling it is very different. If you own stocks, bonds, or investment properties, you can sell them to pay for expenses (say, when you retire). But a primary residence is not something you can sell, except in the most extreme circumstances. You might downsize when you retire, or you might sell it and rent if you’re desperate for cash—but realistically, a primary residence is not an “investment asset”.
If it’s not something you can sell and take profit on, it doesn’t really belong in an investment portfolio.
On the second point, the problem with investment properties in a “110-minus-your-age” portfolio is that they tend to be levered. That means you need to think about: do you just count the equity, or do you count the total notional value? And how do you take account of the loan itself: that sort of offsets the interest on the bond side of your portfolio?
Unlevered vs levered positions are best kept separate.
Separately, to engage with your thought about what happens in the glide path: don’t forget that the equity in the house will increase as you pay down the loan. It seems like we both agree that there’s a situation where the house equity could completely eat up the “stock” allocation, meaning that the only liquid asset that people hold is bonds—but that doesn’t seem good to me.
Firstly, it makes it pretty much impossible to rebalance, because all of the “risky” assets are locked up in a form that can’t be easily sold. And secondly, it means that when our family wants to draw down to cover their retirement expenses, they have to either draw down from their bonds (so their portfolio gets riskier)... or sell their house. Both of those seem like bad options.
It’s better to keep it simple and keep properties out of the equation.
I assume emergency cash and daily funds are counted under bond-like bucket?
Definitely not. Your emergency fund and your day-to-day cash are completely separate from your investment portfolio; they don’t get counted at all.
In terms of counting the property value, do you just count the owner equity portion (net of loans), or the full market value of the property? For example, a $200k property that you still owe $100k on. Should I count the full $200k? Logically, I should since I have full exposure in it?
Yeah, this is a surprisingly difficult question to answer. It’s the equivalent of having a fairly chunky margin loan on a large equity position.
This is why I’d keep investment properties separate from a “110 minus your age” portfolio. If you keep the property and its loan in a separate pile (even if it’s just in your mind), you can pay more attention to questions like “is the property covering the cost of the mortgage?”.
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