The conventional advice in asset allocation is to allocate about 5-10% of your portfolio to Real Estate. A home is clearly Real Estate. So can an investment in your home be considered as your RE portion of your asset allocation?
Author Larry Swedroe covers this in his book, “The Only Guide You’ll Ever Need for the Right Financial Plan…”
A primary residence is clearly real estate, but it is very undiversified real estate. First, it is undiversified by type. There are many types: office, warehouse, industrial, multi-family residential, hotel, and unimproved land. Owning a home provides exposure to just the residential component of the larger asset class of real estate. Even by excluding multi-family residences, it is only exposure to the single-family component. Second, a home is undiversified geographically. Home prices might be rising in one part of the country and falling in another. Third, home prices may be more related to an exposure to an industry than to real estate in general. For example, in the 1980s, home prices in Texas and in oil-producing regions in general collapsed when oil prices collapsed. One’s home provides some exposure to real estate but not diversified exposure.
A home is a very different financial asset. You cannot perform the normal portfolio maintenance tasks such as rebalancing and tax management. While clearly an asset with value that should appear on the balance sheet and be considered a possible source to fund future cash-flow needs (through a reverse mortgage or sale), it should be excluded from consideration when thinking about asset allocation.
But according to Swedroe, a mortgage on the home should be considered in the asset allocation as a negative fixed-income allocation (because you, as the owner, have borrowed money instead of lending money).
A mortgage (or any other form of debt) should be considered as negative exposure to fixed-income assets and treated as such in the asset-allocation picture. For example, if you are holding a $200,000 mortgage and have $200,000 of fixed income assets, your fixed-income allocation is zero, not $200,000.”
I understand the reasoning but it does seem like I am taking only one side of the equation into account here. To be fair, Swedroe does recommend considering all other non-tradeable financial assets like home equity and insurance when considering your risk profile.
For now, I am sticking to the default posture of ignoring both sides of the equation (Happily, home prices in our neighborhood are still above where we bought it). But a broader model that takes these other factors into account would be nice. An possible approach is described by Ashvin Chhabra in “Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors“. Maybe a post for another day …