How Should You Consider Your Home in Your Retirement Calculations?

Fans of the Fool come in all varieties, but you all have one thing in common: You're thinking ahead with an eye toward a comfortable retirement -- hence your interest in building up a solid portfolio of stocks. But there's one giant asset in many of our portfolios that we're somewhat confused about how to treat in when doing retirement math: our homes.

In this "What's Up, Bro" segment from the Motley Fool Answers podcast, hosts Alison Southwick and Robert Brokamp consider how you might best use your home as a store of value while you're still storing yourself in it, and some ways to let its worth be reflected in your choices during your golden years.

A full transcript follows the video.

This video was recorded on Feb. 20, 2018.

Alison Southwick: So, Bro, what's up this week?

Robert Brokamp: Well, as you may know, or may not, how to factor your home into a retirement plan has long been a conundrum among retirement planning experts. On the one hand, for most Americans, their home is their biggest asset, so you'd think you should somehow factor that into your retirement plan.

On the other hand, it's also a roof over your head, and it hasn't always been easy to turn your house into cash, and you don't want to play it too crazy. You want to protect it, so a lot of folks have said to leave it completely out of your retirement plan.

People don't know exactly what to do with it, but a couple of articles I read, recently, provided what I thought were some interesting ideas of how to factor it into your overall financial plan. The first article was published on MarketWatch.com from Mark Hulbert. The title gives you a clue, and that is "Owning a home can give you a place to hide from a bear market for stocks." This was published in January. It's sort of an update of an article he has published, previously, and I mentioned it in a previous episode.

Hulbert looked at data from the Case-Shiller Home Price Index to basically look at how residential real estate performed during the 20 bear markets since 1952. And what he found was there's only two examples of when housing prices also went down along with stocks, and one of those was only 0.4% decline.

The other one was the one that happened during the Great Recession and it was a doozy, but on average, home prices go up when stocks go down. In fact, the Case-Shiller Index actually goes up a little more during bear markets in stocks than it does during bull markets in stocks.

Now, what about that most recent example? Does that mean that things have changed in the relationship between the stock market and the housing market? Hulbert asked Robert Shiller, who is the co-creator of the Case-Shiller Index. He said, "No, that was probably an anomaly and going forward, this relationship between housing prices holding up during bear markets and stocks is probably going to hold true."

Another interesting thing that Hulbert pointed out was that housing prices are pretty positively correlated to inflation. In other words, owning a house is an inflation hedge, as well. In his article he suggested the way to factor this into your portfolio would to be buy ETFs that focused on the construction industry, which is kind of an interesting idea.

But I think just owning a home and making it a goal to pay it off before you retire is another way to get these same benefits. By having it paid off or mostly paid off by the time you retire, you built up that equity so that you can access it in retirement by using either a home equity line of credit or, more commonly, a reverse mortgage to use it during a bear market in stocks, so you don't have to sell stocks when they're down, or if you have a big-ticket emergency like healthcare, or something like that.

Now, what most financial planners do recommend is that you don't rely on your home equity unless you absolutely need it, which brings us to the next article that I read. It was a study in the Journal of Financial Planning by three folks: Peter Neuwirth, Barry Sacks, and Stephen Sacks.

I won't go into all the details, but they essentially argue that retirees should consider tapping their home equity early in retirement, especially for the many Americans who are house rich but cash poor. By using their home equity, they rely less on their portfolios and that gives their investments more time to grow.

Perhaps the most interesting takeaway they offer is an alternative to the classic 4% rule. For those who know, that's how much you should be able to spend your first year of retirement. You look at just the value of your portfolio -- your IRAs, 401(k)s and things like that -- not your house -- take 4% of that, and that's how much you can spend in your first year of retirement. Then you adjust that dollar amount every year for inflation.

They suggest that what you should do is take the value of your portfolio, and the value of your home equity, and divide that by 30. From a percentage point, that's 3.3%, so it's a smaller percentage, but of a much bigger pie for most people, and they think that's actually a better guideline for how much you should be spending, and you should be incorporating that home equity into your regular spending and retirement.

It's an intriguing idea. It's slightly controversial. I'm sure many people in the financial planning community will be debating it, but I still think it's a very interesting way to incorporate home equity into your portfolio value when you think about how much you can spend in retirement.

The bottom line is this. Among three of the bigger events that can derail your retirement, one is a bear market in stocks, inflation, or unexpected big-ticket expenses, and as a hedge against all those three your house is a pretty good bet.