Stocks have soared in value the last several years, and a dangerous investment strategy is creeping back into the market: financial advisors may soon recommend that clients tap the equity in their home to buy stocks.
Proven disastrous for thousands of investors in the crashes of 2000 and 2008, this so-called strategy posits that investors can take advantage of a rising stock market and pull cash out of their homes via a low interest home equity loan. They then plow those loan proceeds into the stock market and get fat and happy from the returns and dividends.
It sounds enticing, particularly as the broad stock market continues to crest near record highs and record low interest rates crimp the returns on traditional savings products like bank CDs.
The recent disastrous history of this strategy, however, shows that the risks are clearly not worth the benefits. During and after the tremendous tech stock bubble in 1998-2000, investors employed a similar strategy. Many ended up with tremendous debts and even lost their homes as stock prices sharply plummeted during the bursting of the bubble.
Similar stories came to light after the crash of 2008, often made worse because they were orchestrated by scam artists who used clients' cash from home equity loans to fund Ponzi schemes that promised yields two to three times the rate of the new mortgage payment. The conman's pitch was simple and effective for retirees looking for income. Refinance your home equity loan, give me the cash, and I will generate enough of a return so you can make the mortgage payment and have enough to live comfortably.
Following the 2000 tech bubble and crash, FINRA (previously NASD), the investor protection unit, warned brokerage firms against recommending or facilitating investments of liquefying home equity. According to FINRA's warning from 2004, it believed that a "recommendation for a homeowner to liquefy home equity for investments poses significant and unique risks for investors", including that the investor "may lose his or her home." According to FINRA, if the investment fails to earn the necessary rate of return, the investor "may be unable to meet his or her mortgage obligations and default on the mortgage."
FINRA also warns that "if the value of an investment decreases, as can happen with many investments, the investor may need to sell his or her investments to protect his or her home and limit further losses."
Unfortunately, this recent history hasn't prevented some financial advisers and business journalists from proposing it could be useful to tap into your home equity.
For example, Jonathan Yates, a Benzinga staff writer, penned a recent article entitled "3 Reasons to Tap into Home Equity to Buy Stocks." Yates posits that "buying stocks with the proceeds of a home equity loan diversifies the portfolio" of the investor. Yates suggests that "there are many stocks that have dividend yields higher than mortgage rates" and that as a result, investors can "practice a form of interest arbitrage."
He also argues that "stocks are much more liquid than real estate" and that it is a "wise financial move to convert illiquid assets into ones that can be sold when needed."
Unfortunately, Yates, and many financial advisors, don't discuss the tremendous risks investors are taking when they engage in tapping home equity for stock purchases. This is an ultra-high risk strategy that has destroyed the most valuable asset of many Mom and Pop investors: their homes.
In the recent past, investors have watched years of home equity wiped out after weeks of a rapidly declining stock market. Stay away from this strategy.
Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.