Let's now turn to how a home is financed.

If a home is financed with a fixed-rate mortgage, that mortgage effectively is a short (negative) bond position, and should be considered as such when looking at the overall portfolio. The fixed rate on the mortgage does provide inflation protection. A fixed rate mortgage also has a put feature. If interest rates decline, the put (putting the mortgage back to the lender by paying it off) allows the borrower to refinance the mortgage at the current rate. This provides protection against falling interest rates (for those on fixed incomes) and deflation. If a home were financed with an adjustable rate mortgage, the risk picture would be considerably different. Therefore, it is very important that investors consider how a home is financed in developing an asset allocation strategy.

09/21/2000

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