Monday, November 17, 2008

Mortgage and Retirement

Ian Ayres, the Yale Economist, is always coming up with ideas that make me think. In a recent Forbes article he proposed mortgaging your retirement. As he points out to purchase a house you typically put down anywhere from 5% -20%, and you buy the asset all at once. But in your retirement you only put down a little bit at a time. Typically you put more money in when you are older and less when you are younger. Ayres points out that this means that you are not spreading out your risk over time, you want to purchase more retirement funds when you are young and less when you are old.

He proposes that you purchase what is called a life cycle account. When you are in your twenties you buy on the margin, by basically buying a mortgage on stocks with 50% down. Gradually over time you reduce this 2/3 down by 40, until you start repaying your retirement mortgage in your 50s. Ayres tested this model using data for each age group going back to 1913 and found using past data that it outperformed the standard retirement plan (of buying stocks young and bonds old) and never returned less than 2.5%.

I have to say though I’m skeptical. For three reasons, first past performance does not indicate future returns as they say. I’m also curious about the general equilibrium case. If all young people start buying stocks on margin, will the cost of borrowing to purchase stock increase, could this wipe out the gains Ayres sees? Finally, I don’t fully understand the mechanics of it, it seems to me that a lot could go wrong, what if you start to earn less in your 50s, its harder to retire earlier or maybe not. What if you get disabled do you still owe your retirement debt?

Ayres is a smart guy though, so I’ll be curious to follow this. If it’s a good idea some financial company will offer it (although if it is a bad idea that might happen too).

h/t Dan Rothschild for passing on the idea
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1 comment:

Erik_Simpson said...

I see the article is from 2005. I doubt Forbes would print it now, since today's is precisely the environment that illustrates the primary risk of this approach, which is that it allows your retirement savings to bankrupt you. We now have whole communities with underwater mortgages. Newer homeowners have the most leverage on their mortgages. As bad as their situation is now, how bad would it be if they were facing margin calls on their retirement savings as well? With the market down about 50%, a 200% investment in stocks would have produced some ferocious margin calls by now, I think.