Blogs & Comment

Do homeowners need more bonds?

Professor Milevsky discourses in his new book on the need to diversify financial portfolios with respect to holistic balance sheets. But what about the house you own: should it be included on your holistic balance sheet? And should you diversify your financial portfolio with respect to that asset as well?
I havent found much discussion so far on this facet in Milevskys book even though it would seem to be a logical extension of the main thesis.
I have also wondered about this in the past. To wit: many homeowners have financial portfolios with high allocations to stocks. That seems rather undiversified given both house values andstocks are similarly affected by the state of the economy. For example, if you have been laid off in a recession and are facing the prospect of selling your house at a loss, your portfolio is likely to be way down too.
Shouldnt homeowners with financial portfolios perhaps have higher allocations to bonds and GICs for the sake of diversification? Having wondered about this in the past and wondering if Professor Milevsky would extend his holistic balance sheet thesis in this direction — I asked him if it would be useful to include ones home as an asset and if so, should the owner have a higher allocation to bonds?
His response was in the affirmative. To quote:
Most certainly. Even if you have no intention of ever selling your house, and plan to be carried out feet first at the end of the lifecycle, you should still include this asset on the personal balance sheet. More importantly, your mortgage is a NEGATIVE holding of bonds (you issue the bond to the bank) and hence your RRSP and other retirement investments should take into account this “short” position…At the very least you want to make sure that if you have a substantial portion of your personal holistic balance sheet in home equity, that your RRSP is light on highly-correlated REITS…
So, one shouldnt necessarily have a large allocation to stocks just because they are young. If they own a house and want to diversify with financial assets, they may need a high allocation of bonds to avoid overexposing their net worth to economic fluctuations. Of course, there is also an interaction with the homeowners human capital to consider; if it was very bond-like, then a high bond allocation may not be required.
A final note: Canadians are used to having house prices go up, and managed to get through the last recession with that impression in tact. So many homeowners in Canada will likely continue with high allocations to stocks. But as the U.S. experience of the past two years demonstrates, there is nothing guaranteed about house prices always going up.