Pennsylvania Investment Observer

Looking for Commissionable Dollars

by Daniel J. Nestlerode

The investment industry evolved over the years to its current state, charging commissions for transactions. In this way, investors paid as they placed their money into stocks, bonds or mutual funds or converted their investments back into cash. For decades, this was the only way that Wall Street worked and it still is one of the most familiar business models: brokers get paid when you trade. Whether your investment account grew over the years or generated excess income for you was different matter. If you traded, the broker won. You won if you selected the correct investments and/or bought and sold correctly.

In recent years, with real estate prices soaring and the stock market going through an extended bear market, some enterprising brokers and brokerage firms have discovered that clients have large pools of underutilized assets. Many investors own their own homes. Furthermore, over the years the value of their real estate has grown in value. Back in the nineteen fifties, my father bought a fifty acre tract on Little Pine Creek for about $12,000. Recently, a half-acre lot was sold not far from our property for $118,000. If you do the math, our fifty-acre tract would be worth a great deal of money. Enterprising brokers looking for commissionable dollars are looking for potential clients who would turn some of their unrealized appreciation in their real estate into other investments. The process involves mortgaging the original real estate, getting a lump sum of money from your friendly mortgage banker and turning the check over to your investment broker. If your investment broker is really good at his business, his company will also offer the mortgage services to you, probably at a reduced fee. If you follow this process, your investment broker now has a sizeable chuck of cash to invest and charge commissions upon. Many enterprising brokers have collected fees for placing mortgages and there will be commissions from the investments that are sold to you.

Is this a good deal for you? In many cases, this arrangement is a prescription for financial trouble for you. You have taken an asset that you own, probably one with no mortgage, and placed a lien on the property that requires periodic payments. Further you have taken the borrowed money and purchased investments that are probably not guaranteed as to repayment of interest, dividends (which are never guaranteed) or principal to offset the mortgage. So you have sharply increased your investment risk, or what I call the likelihood of an adverse financial outcome. If you understand the downside of this transaction and invest appropriately, then you can minimize the possibility that Murphy (the Irish fellow related to the whatever can go wrong usually does go wrong notion) will visit your portfolio. Alas, many investors only understand the downside of an investment strategy after it has gone wrong, much to their regret.

If an enterprising investment broker approaches you with such an arrangement as I have described above, I suggest that you hang up the phone, not respond to the email or show him the door. He is looking for fees, probably double fees, on the same money. There are times when it might be advisable to convert part of the equity you have in your real estate into other working investments. However, I recommend that you proceed very cautiously and carefully with such arrangements. It is distressing to lose money in an extended bear market like the one we have just be through. It would be downright awful to lose a big piece of your investment portfolio and your home because you mortgaged it to stretch for larger dollar returns.

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