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By Christine Benz | 08-29-2012 01:00 PM

A Reverse-Mortgage Strategy to Complement Your Buckets

Professor and wealth manager John Salter outlines how retirees can put short-term cash to work in an HECM Saver reverse-mortgage product, though there are several risks to keep in mind.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Some new research suggests that retirees can be even more successful if they add a new type of reverse mortgage to their toolkits. Joining me to discuss this research is John Salter. He's assistant professor of financial planning at Texas Tech University.

John, thank you so much for being here.

John Salter: Thank you for having me.

Benz: John, your approach here, the one that you outlined with your co-authors, it begins with discussion of the bucketing strategy, and I know a lot of our Morningstar.com users have embraced bucketing when managing their retirement portfolios. And in its most simple form bucketing simply means that you set aside some cash to cover your near-term income needs, maybe two years or so. Then you have a separate long-term bucket for your more volatile asset classes your stocks and bonds. Your research, what you outlined in this paper, argues that maybe retirees should think about adding a third bucket that consists of this reverse mortgage product. Let's talk about how this whole thing works.

Salter: Sure. So, the idea came from sitting back thinking that the amount of cash that we hold also holds an opportunity cost, meaning if you take a two-year strategy--I'm going to hold two years' worth of my living needs in cash--that’s a fairly sizeable chunk of a portfolio that's not invested. So, we thought to ourselves is there a way that we can decrease that opportunity cost and allow more money to be invested to meet future goals.

On the other side, we know we keep the cash in order to not have to sell the portfolio during bear markets. They kind of work with each other, but is there a way to decrease the cash that we hold and get that same benefit from the bucket strategy. So we introduced the reverse mortgage in order to limit the amount of cash that we hold, and should we need to refill the cash when it runs out, we can borrow from the reverse mortgage.

Benz: So, are you taking cash lower than that two years' worth that you had run with as a baseline in the past?

Salter: We did. So we started, Harold Evensky, my co-author, kind of started this two-bucket strategy actually a while back, and at the time with the analysis two years made the most sense. We actually went down in our current analysis to six months; so it was a substantial decrease in the amount of cash being held.

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