Equity harvesting

There’s a phenomenon that I have seen mentioned in more than one place: equity harvesting.

The fundamental concept is the get your hands on the equity in your home and put it to good use. Certain articles seem to restrict the application to buying cash value life insurance. But for me, I prefer to look at everything in terms of capital and cash flows. When you get a one-time burst of money, that is extra capital. When you purchase a dividend paying stock, a renal property, or another device that pays monthly, quarterly, or annual money, that’s a cash flow.

Basically, fetching the equity from your home (which is paying you nothing in monthly cash flows) and using it buy a cash flowing stock can definitely grow your net worth. There is risk involved. This usually involves some type of mortgage such as a HELOC or a home equity loan (haven’t seen any other way to access home equity). Then the money is invested elsewhere and you must now pay off the debt you incurred.

The risk is whether or not you can pay off the debt. The risk is whether your investment will make money. If you bought stocks for dividends, there is risk in whether or not your stocks will stop paying dividends. I put the balance of my HELOC into Vanguard Natural Resources. Essentially, my stock pays me 9% in dividends and I turn around and use it to pay off my 4% HELOC. I pocket the 5% difference, and over the long term, when the debt is paid off, I will then pocket the entire 9%.

What are some other risks? If prime interest rises, then my carrying costs for the debt will go up. Right now it’s pegged at PRIME-0.25% with a minimum of 4%. Prime would have to go up to 4.5% before I would see a change. NOTE: This has nothing to do with the secondary mortgage market. Lending rates have gone up, but PRIME has not.

What have I done to mitigate the risk? Surprisingly, I bought even more Vanguard stock. I am actually earning dividends above and beyond what the balance of the HELOC would earn, which means I am paying off the debt faster. If PRIME rises enough that I can no longer pay off the debt (which would have to be pretty big), I can always sell part of the position and simply pay off the remaining debt.

The other risk is the chance that Vanguard Natural Resources stops paying a dividend or cuts it. To impact my strategy, they would have to make a significant cut. If that happens, I can still sell the stock and pay off the debt. Of course, such a move would probably have catastrophic impact to the stock price, but since I own a considerably bigger position than the debt, I could still make it out alright. But I don’t really expect this. Vanguard has done a great job at actually growing their holdings, acquiring new oil and natural gas reserves, and increasing their dividend payouts since its inception. You can say “past performance is no guarantee of future returns”, but past performance of this company shows that management is doing a good job.

When I read articles about equity harvesting, they aren’t lukewarm. Many tend to drip with derision, accusing insurance agents of ripping people off. I’m not doing anything like that. I wasn’t sold this idea by some shady agent. Instead, I learned about the value of arbitrage, dividend investing, and viewing everything through a lens of capital and cash flows. It allowed me to break out of the conventional investing molds many people find themselves in, and to apply this tactic to grow a new cash flow that will certainly be useful in the years to come.

And guess what I plan to do when my HELOC expires in ten years? I will most certainly investigate the rates and options, and look into doing it again!

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