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• W248161878 abstract "Abstract This study examines the impact of the single-family home on a family's optimal asset allocation decisions. Many researchers have studied individual investor portfolio allocations to stocks and bonds, but there has been little work examining how home ownership should affect those decisions. We believe the family home and any related financing should be considered part of the portfolio. Using a mean-variance utility function, we examine the effects of home ownership on optimal portfolio allocations to stocks and bonds. Failing to include the home and its financing can have a major impact on the optimal asset allocation strategy for a family. (C) 2003 Academy of Financial Services. All rights reserved. JEL classification: G11; D14 Keywords: Portfolio choice; Home ownership; Mean-variance optimization 1. Introduction Many researchers have studied individual investor decisions on how to allocate funds between stocks and bonds. Likewise, financial advisors provide generic recommendations regarding the proper mix of stocks and bonds at any given time based on the existing market conditions. For example, investors might be advised to hold 60% of their funds in stock and 40% in bonds. This study examines the impact of home ownership on these decisions. We employ the widely used concept of mean-variance analysis to determine the optimal asset allocations to stocks and bonds given general home ownership and mortgage loan scenarios. We also examine the case where the level of financing is allowed to vary and investors choose the optimal portfolio weights for stocks, bonds, and the mortgage loan. The idea of taking a broader prospective of what an individual investor's portfolio includes is proposed by Reichenstein and Delaney (1995), Scott (1995), and Reichenstein (1998). They note that financial assets such as stocks, bonds, and cash may only be a small part of the total portfolio. Black, Ciccotello, and Skipper (2002) suggest that financial decisions should be made based on the family's entire economic portfolio, including both assets and liabilities. Furthermore, they state that financial decisions should employ modern portfolio theory to select efficient portfolios based on the risk-return profiles of the economic assets. Fraser, Jennings, and King (2000) determine the value of Social Security wealth and add this important factor to the portfolio decision making process. We add to this line of work by looking at the ramifications of including the home as an investment asset. While there are many benefits to home ownership, we also consider the family home to be a key component of the investment portfolio. The family home is still the largest asset for many families, yet it is largely ignored when investment advice is handed out about the construction of a personal investment portfolio. Reichenstein (1998) argues that if retirement is the primary savings goal of the family, then the value of the family home should be considered part of the portfolio. We believe that any failure to consider the value of the family home in asset allocation decisions could lead to suboptimal choices. While the home investment should not be ignored, neither should the value of any mortgage loan used to finance the home. We follow Reichenstein's (1998) suggestion to treat the entire mortgage loan balance as essentially a negative bond. The mortgage loan taken out by the family is comparable to a company issuing a callable bond. The family is obligated to make fixed payments, but can call (prepay) the loan if they choose to sell the home or refinance at a later date. As we discuss later, treating the house as an asset and the mortgage as a liability is a superior approach to simply subtracting the mortgage loan amount from the real estate value and using a net equity figure for asset allocation decisions. The remainder of the paper is organized as follows: Section 2 reviews some of the literature related to general asset allocation with mean-variance analysis and the single-family home as part of the portfolio. …" @default.
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• W248161878 date "2003-10-01" @default.
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• W248161878 title "The Impact of the Single-Family Home on Portfolio Decisions" @default.
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