Forbes: reverse mortgage can ‘neutralize’ portfolio risk

A Home Equity Conversion Mortgage (HECM) has the potential to “neutralize” any risk found in a senior’s portfolio, but it has the best potential to accomplish this goal when paired with another financial instrument like an annuity. This is according to a new piece in Forbes by Jack Guttentag, aka the “Mortgage Professor.”

“A major weakness of the HECM reverse mortgage program is that it is a stand-alone,” Guttentag says. “Potential synergies from integrating HECMs into retirement plans have been ignored. This article provides one illustration. It shows how a HECM can be combined with an annuity to neutralize the high risk that accompanies a high-yield asset portfolio.”

Guttentag then posits a hypothetical scenario involving a senior who is advised to change the composition of her portfolio.

“Consider Mary who is retiring at 62 with a house worth $500,000 and a financial asset portfolio worth $1 million, 75% of which is in common stock,” Guttentag says. “Her financial advisor has recommended that she rebalance her asset portfolio so that common stock accounts for 25% of the total, an action that would reduce the risk of a major shortfall at the cost of a lower expected return.”

Historic median rates of return help to indicate that “Mary” should avoid her prior portfolio dynamic, Guttentag says.

“By shifting her portfolio to 25% stock, the bad-case would rise from minus 2.7% to positive 2.8%,” he explains. “The cost of that reduction in risk is a decline in the median return from 9.5% to 6.1%.”

A reverse mortgage would allow “Mary” to retain a 75% stock level in her portfolio with its higher probable return while “neutralizing” the less desirable outcome, Guttentag says.

“[A reverse mortgage] does this with a HECM credit line which is accessed only if needed to retain the spendable funds that would occur with the median rate of return,” Guttentag says. “The chart indicates that when risk is ignored, the longer deferment period generates more spendable funds.”

The potential benefits of a HECM credit line can be applied to several different scenarios, all while maintaining access to a source of funds that is deployable when needed to stabilize a senior’s existing portfolio, Guttentag says.

“The bad case is a very low probability event,” he explains. “In the likely event that it doesn’t occur, the HECM credit line could be used for any other purpose, or not used at all. Maintaining an unused credit line is costless.”

Guttentag has described a reverse mortgage/annuity combination in several previous columns, including one from April 2021 which said that a change in the Federal tax code to eliminate taxes on annuity payments that had been wholly funded with reverse mortgages could serve as a potential answer to help ensure greater longevity from a retirement portfolio.

Read the column at Forbes.

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