In theory, this has ambiguous effects on asset allocation. On the one hand, housing is a risky and illiquid asset. Having a lot of housing wealth therefore reduces your ability to take risks in other spheres, and so you should own fewer shares. On the other hand, though, greater housing wealth means you are richer and - in some circumstances - richer people are better able to take risk. This suggests the proportion of your financial wealth you can invest in shares should be higher.
So, which effect dominates? It depends. Researchers in the US have found that higher mortgage debt is associated with lower shareholdings while higher housing equity is associated with higher. But the two effects are of roughly equal size, so that having a $10,000 more expensive house and a $10,000 bigger mortgage has no net effect on the share of equities in financial wealth.
However, things are different in France. Researchers there have found that the wealth effect is stronger than the mortgage effect, so shareholdings rise if both house prices and mortgage debts rise.
This reminds us that economics is not like physics. There are no deep, constant parameters. But what can explain the difference between the US and France? There are two things, both relevant to UK investors.
One is that the costs of moving house - such as stamp duties and lawyers' fees - are greater in France than in the US, which means that fewer Frenchmen than Americans move.
This matters. If you intend to move house, you should own fewer shares and more cash than if you intend to stay put. This is because shares are a poor hedge against your future housing spending; if they fall, you might lose your chance of getting your dream home. If, however, you already have your dream home, this consideration doesn't apply, and so you can own more shares.
But only up to a point. Owning lots of shares exposes you to the risk of having to sell your home if your equity portfolio does really badly. And being a forced seller is something to avoid; many nice houses are on the market at reasonable prices because their owners' businesses got into trouble.
Another consideration is that there's a third asset to consider - human capital, or earning power. If you have job security - as Frenchmen have to a greater extent than Americans - you can afford to take on more financial risk. By contrast, if your job is insecure you face the danger that you might suffer a loss not just on your human capital, but on your house too - if, say, a major local employer closes. This argues for having more cash as protection against this double blow.
All this implies that the relationship between your housing wealth and your equity allocations should vary from person to person, dependent upon a few questions such as:
■ Are you hoping to trade up? If you are, you should own fewer shares than someone who's happy where they live. The exception to this is those who are hoping that big rises in shares will enable them to get a big house. But this is a strategy only for the brave.
■ Does increased wealth make you feel able to take more risk? If so, then a big house should be accompanied by more shareholdings.
■ How safe is your job? The safer, the more you're able to bear equity risk.
There's something else here, says Harvard University's Raj Chetty. His research implies that the rise in mortgage debt in the 2000s caused people to own fewer shares. It thus contributed to lower share prices. By the same token, if households reduce their mortgage debt, this might eventually lead to higher share prices.
