Treat your mortgage as a "negative exposure" to bonds?

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Treat your mortgage as a "negative exposure" to bonds?

Postby Compounding » Wed Jan 30, 2013 2:43 pm

I was wondering how many of you out there treat your mortgage as a negative exposure to your allocation to fixed-income assets, as Larry Swedroe suggests doing (he references this issue on page 67 of The Only Guide for the Right Financial Plan book). In reality, do you actually treat your mortgage balance as negative fixed-income in your asset allocation picture?

In theory and on paper, I can understand the logic of such a recommendation - a mortgage is very much like a "negative bond" with coupon payments going out each month. However from a practical perspective, I think this would be hard to implement and maybe overthinking things a little bit. Mortgages are typically a few hundred thousand dollars - so by definition anyone starting out or with modest investable assets is essentially shut out from equities by following this rule. For example if I have a $200k mortgage balance, I'll need $200k in bonds just to "offset" that negative bond exposure before I can start thinking about equities in my AA. It just doesn't seem practical. Even a million dollar portfolio with a 60/40 AA of stocks/bonds and a $200k mortgage balance would be altered to dramatically: $200k would be "put aside" in bonds to offset the negative bond exposure of the mortgage, leaving $800k and thus $480k in equities and $520k in bonds ($200k plus 40% of $800k). Not exactly 60/40 risk.

Intuitively is seems like overkill. If I was forced to follow this rule in gun-to-my-head fashion, I would probably rent so I wouldn't have to endure the "investment penalty" of having a mortgage. And yes, one has the option to pay off the mortgage prior to investing, but at today's low mortgage rates (especially after-tax), I'm guessing it makes sense for many to invest in the market and let the mortgage roll on.

I'm a big fan of Larry Swedroe and agree on most everything in his books - so I wanted to get your thoughts on this exception.

- Brian
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Random Musings » Wed Jan 30, 2013 2:52 pm

Simply put, I considered my mortgage a negative bond since in my case, I could either have paid the house off immediately or took out a loan. The loan gave me a little more liquidity so I went that route and ultimately paid off the mortgage fairly quickly.

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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Random Walker » Wed Jan 30, 2013 4:04 pm

I agree with the OP,
Perhaps is just a function of perspective. I too can see why formally the mortgage is a negative bond. If I were young and in accumulation phase with mortgage payments and investment savings coming from current income, I think I would tend to ignore this way of looking at things. For an older retiree with little or no income relative to assets understanding this formal view I think is very important. Under this circumstance the stock bond mix relative to the mortgage is much more significant.

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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby sesq » Wed Jan 30, 2013 4:08 pm

Not sure if you saw this thread:

viewtopic.php?f=10&t=109784

I am new here, but it seems to be this negative exposure analysis pushes one towards looking at AA on ones entire net worth vs just the retirement plan. Logically it makes sense to net like:like assets and debts.

In my case when I look at my retirement I am 85/15 (s/b) and I wonder if I should buy more bonds (age 40). If I layer in the mortgage against bonds I am 62/-31/69 (s/b/re). If I only look at RE equity then I am 62/11/26 (s/b/re). The weird thing is since my house is getting re-fi'd at 2.625% 5/5 Arm, I am leaning towards moving more into the market. I was originally planning to pay off the mortgage in 2014, now I am leaning towards 2016, and allocating more of my surplus to my kids 529 plans and restarting backdoor Roth's. I am comfortable with the Arm since I have some company stock that vests in the near term (before the rate lock expires) that is driving my savings & investing train.

Maybe I should be buying bonds with my shifted investments with the expectation that the bond funds will exceed my 2.625% mortgage (probably not hard to do in tax advantaged accounts vs deductible debt). Of course that is the opposite of the conclusion of the guy in the thread I linked.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby 555 » Wed Jan 30, 2013 4:24 pm

It could be argued, to the contrary, that if your mortgage has higher interest than your bonds, then you shouldn't own any bonds until you pay off the mortgage.

If you take the totality of all your current and future assets and liabilities, then think of that as a round hole, while percentage-based asset allocation is a square peg.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby interplanetjanet » Wed Jan 30, 2013 4:42 pm

I think that looking only at the mortgage can be a mistake.

Typically a mortgage is not acquired in isolation, a piece of property comes along for the ride. By buying, you are avoiding rent and future increases in rent - the closest analogy that comes to mind easily is that the property can be seen a bit like an inflation-adjusted pension with a cash-out feature, though the cash-out is wildly variable depending on the market. It seems likely that this "pension" could be seen as offsetting the negative bond of a mortgage, though to what degree no doubt depends on the specifics.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby jdilla1107 » Wed Jan 30, 2013 5:14 pm

555 wrote:It could be argued, to the contrary, that if your mortgage has higher interest than your bonds, then you shouldn't own any bonds until you pay off the mortgage.


+1.

Doing so creates negative cash flow. Borrowing at 3% and loaning at 2% is the opposite of what you want to be doing.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Dogs » Wed Jan 30, 2013 5:20 pm

555 wrote:If you take the totality of all your current and future assets and liabilities, then think of that as a round hole, while percentage-based asset allocation is a square peg.


I wholeheartedly agree with this. I am a new investor and there is literally no way to include any aspect of my two rental properties in my AA without being forced to sell them. Any rule is going to be riddled with exceptions. You also can't rebalance properly with a house. It doesn't fit. I would personally treat a mortgaged house in terms of income, not as an asset, but the only hard and fast rule I can imagine being applied to the mortgage is to not consider it as part of your AA.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby jhd » Wed Jan 30, 2013 5:53 pm

For me, the key is that a mortgage is directly offset by a place to live. It's not JUST a negative bond in isolation... it's a negative bond that substitutes for the expense of paying rent somewhere. If I rent a house for $1500/month and then decide to buy with a mortgage payment of $1500/month, why would my long-term asset allocation change?

Look at two scenarios:

A. Rent
$500K in assets, 70%/30% target allocation, $0 mortgage ($0/month payment), $1500/month rent:
$350K stock, $150K bond

B. Mortgage
$500K in assets, 70%/30% target allocation, $250K mortgage ($1500/month payment), $0/month rent:
$350K/$150K or $175K/$325K?

If bond rates are low, mortgage rates should be low too. So at least in theory, one should make the same decision if bonds are paying 2% and mortgage rates are 3.5% than they would if bonds are paying 6% and mortgage rates are 7.5%.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby bpp » Wed Jan 30, 2013 6:14 pm

jdilla1107 wrote:
555 wrote:It could be argued, to the contrary, that if your mortgage has higher interest than your bonds, then you shouldn't own any bonds until you pay off the mortgage.


+1.

Doing so creates negative cash flow. Borrowing at 3% and loaning at 2% is the opposite of what you want to be doing.


This is what has finally driven me to start including the mortgage as a negative bond in my allocation calculations. Of course, doing so makes one's bond percentage much lower, or even negative. What I am doing is defining a new glide path from where I am with my new, lower effective bond allocation, that takes me to the same place at retirement I originally wanted to be under the old way of accounting.

So original situation:
x% in bonds, with a 1%/year glide path, aiming at hitting 50% at age 60, and a mortgage that I want to have paid off by then.
(Plan to stay at 50% from age 60 onwards.)

New situation: y% in bonds (y < x), with a higher %/year glide path, still aimed at hitting 50% at age 60. Any bonds that pay less than the mortgage get cashed out (except for an emergency fund allotment) and put into mortgage prepayment. When my spreadsheet says it is time to buy bonds to stay in balance, then put new money into either bonds or mortgage prepayment, depending on which gives the higher yield at the time.

So if the stock market climbs, new money gets directed to the mortgage (or bonds, if they start yielding higher rates than the mortgage). If it falls, new money goes into stocks.

I do not include real estate or imputed rent in the asset allocation calculation.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Rick Ferri » Wed Jan 30, 2013 6:28 pm

I refinanced twice in the past 6 years. Now I'm at 3.12% on a jumbo. My real interest expense is 0%Net of taxes and inflation.

Yes, you've got to take advantage of that free mortgage put to make up for low interest rates on investments.

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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby stemikger » Wed Jan 30, 2013 6:30 pm

I am having a hard time with this technical stuff, but i I just paid off my mortgage and my house is worth roughly $350,000 and my entire portfolio is worth $325,000 with a 60/40 stock bond AA, do I now go 90/10 or 80/20. What if I don't have the risk tolerance for 90/10 or 80/20?
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Rick Ferri » Wed Jan 30, 2013 6:33 pm

Nothing wrong with paying off your house before retiring. I intend to do that as well. There is a warm and comfy about having no dept that a little extra interest income doesn't make up for. Don't go over your comfort level on an allocation just because you have no debt or the whole thing blows up.

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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby retiredjg » Wed Jan 30, 2013 6:35 pm

555 wrote:It could be argued, to the contrary, that if your mortgage has higher interest than your bonds, then you shouldn't own any bonds until you pay off the mortgage.

Some people do see it that way. But if you applied the same argument to stocks, wouldn't that mean you shouldn't own any stocks during a crash? But here, we mostly tell people to buy stocks during a crash, not sell. I know this is not a perfectly clean comparison, so you don't have to point that out. But this argument does deserve some consideration.

If the "mortgage as a negative bond" thinking makes sense to you and feels right to you, do it. But I don't think anyone else should be following that advice just because some smart financial guy discusses it in a book. If it doesn't feel right in your gut, you may not make it through a market crash cause that mortgage may not feel so bond-like when your portfolio is taking a dive.

"If you need to ask, don't go there" applies to a lot of things in life. I think this is a good example. Some people will immediately resonate with the mortgage as negative bond approach and it is probably fine for those folks. Others will wonder and ask, either silently or openly, what others think of it. I suspect those folks probably shouldn't go there.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby jdilla1107 » Wed Jan 30, 2013 6:44 pm

retiredjg wrote:
555 wrote:It could be argued, to the contrary, that if your mortgage has higher interest than your bonds, then you shouldn't own any bonds until you pay off the mortgage.

Some people do see it that way. But if you applied the same argument to stocks, wouldn't that mean you shouldn't own any stocks during a crash?


I don't follow this analogy at all. Do you mean because stocks will have a low earnings yield during a crash? Unlike bonds, stocks have potential for far more than the earnings they generate in a particular time period and this is a huge difference. Bond upside is capped.
Last edited by jdilla1107 on Wed Jan 30, 2013 7:52 pm, edited 1 time in total.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby jdilla1107 » Wed Jan 30, 2013 6:52 pm

Rick Ferri wrote:I refinanced twice in the past 6 years. Now I'm at 3.12% on a jumbo. My real interest expense is 0%Net of taxes and inflation.


And risk free bonds are negative real after taxes and inflation which is still cash flow negative. I guess if you hold no treasuries and have all of your bonds in tax sheltered accounts, you could approach cash flow neutral.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby am » Wed Jan 30, 2013 7:45 pm

Kind of silly if you ask me to lend money to the gov., corporations etc. at 1.6% via TBM when you have a mortgage that is higher in %? Is it not a no brainer to first pay off mortgage before lending money at a lower rate? I agree with the concept of a negative bond. That is why I payed off my mortgage this week. It hit me all of a sudden. Plus, the market is at near highs and I am afraid that this could be the last opportunity for a while to do this given that I sold some stocks to do this.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby FinancialDave » Wed Jan 30, 2013 8:03 pm

Most people have enough trouble trying to figure out a simple Asset Allocation -- why muck it up throwing something irrelevant into the mix!

By the way, except occasionally in the short term, I don't lend money to anyone, especially at rates available today, as there is no income in doing so.

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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Dogs » Wed Jan 30, 2013 8:35 pm

am wrote:Kind of silly if you ask me to lend money to the gov., corporations etc. at 1.6% via TBM when you have a mortgage that is higher in %?


When stocks decline you can't pull money back out of your mortgage to buy stocks without taking out another loan with interest, and if you did that, why pay it off in the first place?
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby momar » Wed Jan 30, 2013 10:08 pm

am wrote:Kind of silly if you ask me to lend money to the gov., corporations etc. at 1.6% via TBM when you have a mortgage that is higher in %? Is it not a no brainer to first pay off mortgage before lending money at a lower rate? I agree with the concept of a negative bond. That is why I payed off my mortgage this week. It hit me all of a sudden. Plus, the market is at near highs and I am afraid that this could be the last opportunity for a while to do this given that I sold some stocks to do this.

My mortgage is for 30 years and will stay at the same low, low rate for all 30 years no matter where treasuries go.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby dharrythomas » Wed Jan 30, 2013 10:37 pm

I never really think about the mortgage as 'negative exposure' to bonds.

I think of a mortgage as just like any other kind of debt (clearly there are tax differences). It is a fixed expense that has to be paid regardless of cash flow. It adds risk and stress to finances. With no debt, you can survive with less income and your personal finances become more 'anti-fragile'.

When I do the math on the potential furlow for federal employees, it is clear to me how much risk not having paid off the mortgage adds. :oops:

There may not be a real difference in the concepts except that I haven't quantified the magnitude of the additional risk.

Good Luck

Harry
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby momar » Wed Jan 30, 2013 10:54 pm

dharrythomas wrote:I never really think about the mortgage as 'negative exposure' to bonds.

I think of a mortgage as just like any other kind of debt (clearly there are tax differences). It is a fixed expense that has to be paid regardless of cash flow. It adds risk and stress to finances. With no debt, you can survive with less income and your personal finances become more 'anti-fragile'.

When I do the math on the potential furlow for federal employees, it is clear to me how much risk not having paid off the mortgage adds. :oops:

There may not be a real difference in the concepts except that I haven't quantified the magnitude of the additional risk.

Good Luck

Harry

So would someone who is furloughed rather have paid off their mortgage, or would they rather have that money
in liquid assets which can be used to pay their monthly mortgage and buy food?
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Wed Jan 30, 2013 11:00 pm

FinancialDave wrote:Most people have enough trouble trying to figure out a simple Asset Allocation -- why muck it up throwing something irrelevant into the mix!

Because it's not irrelevant, hence the question and discussion. Having a mortgage exposes you to greater risks as you are leveraged.

momar wrote:
am wrote:Kind of silly if you ask me to lend money to the gov., corporations etc. at 1.6% via TBM when you have a mortgage that is higher in %? Is it not a no brainer to first pay off mortgage before lending money at a lower rate? I agree with the concept of a negative bond. That is why I payed off my mortgage this week. It hit me all of a sudden. Plus, the market is at near highs and I am afraid that this could be the last opportunity for a while to do this given that I sold some stocks to do this.

My mortgage is for 30 years and will stay at the same low, low rate for all 30 years no matter where treasuries go.

You could buy a 30 year individual bond and say the same thing about it.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby stemikger » Thu Jan 31, 2013 12:47 am

Rick Ferri wrote:Nothing wrong with paying off your house before retiring. I intend to do that as well. There is a warm and comfy about having no dept that a little extra interest income doesn't make up for. Don't go over your comfort level on an allocation just because you have no debt or the whole thing blows up.

Rick Ferri


Thanks Rick.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Thu Jan 31, 2013 2:00 am

Compounding wrote:I was wondering how many of you out there treat your mortgage as a negative exposure to your allocation to fixed-income assets

I do not. Nor do I count my home equity as anything. Or my pension value. Or my future Social Security. None of that is considered part of my asset allocation.


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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby grakster » Thu Jan 31, 2013 2:03 am

To me It makes more sense to think of my mortgage as an annuity rather than a negative bond. When it's paid off, it's like getting a check that covers my housing expenses every month for the rest of my life. Beyond just that cozy feeling, having that permanent reduction in expenses seems essential in order for me to ever retire.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Thu Jan 31, 2013 2:06 am

dharrythomas wrote:I think of a mortgage as just like any other kind of debt (clearly there are tax differences). It is a fixed expense that has to be paid regardless of cash flow. It adds risk and stress to finances. With no debt, you can survive with less income and your personal finances become more 'anti-fragile'.

I disagree, because you had you use your liquid funds to achieve this. While you have less cash flow needs (assuming staying in that house is what you need), your money that you have to pay it is tied up. The mortgage only needs to be paid out in small bits over time. You took a multiple of all those bits and sunk it at once. Yes, the mortgage is covered, but the liquidity is not there for other expenses either.


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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby LH » Thu Jan 31, 2013 2:17 am

am wrote:Kind of silly if you ask me to lend money to the gov., corporations etc. at 1.6% via TBM when you have a mortgage that is higher in %? Is it not a no brainer to first pay off mortgage before lending money at a lower rate? I agree with the concept of a negative bond. That is why I payed off my mortgage this week. It hit me all of a sudden. Plus, the market is at near highs and I am afraid that this could be the last opportunity for a while to do this given that I sold some stocks to do this.



You have to smear it over time.

Say you have a 30 year mortgage,100K, at 4 percent, and are in the 25 percent tax bracket. After tax, its a 3 percent loan for 30years.

Now, you can pay off that loan sure, and get the 3 percent now, but what you give up, is the use of that 100K over 30 years.

Its the 30 years that is key. The time behavior/compounding real behavior of the money over that whole time.

So say interest rate on bonds are 1 percent now, ok pay off the mortgage entirely with 100K over 2 years, you win? 3 percent rate of return....

But say then for then next 28 years, the interest rate jumps up to 7 percent, and inflation to 5 percent. You did not win. You would have been much better off, keeping that low 30 year loan, and paying it back it hugely inflated dollars.

1)mortgage take place over time, 30 years are available.

2)Mortgages are leverage on your whole portfolio/existance/spending. Everything from the house, to your stocks/bonds, to your snickers bar you eat, is leveraged by that mortgage.

3)Mortgages/debt, are a great inflation hedge.

Really why humans pay off mortgages now, is for the same reason they sell stocks when they are low/cheap(feel risky), its that mortgages are cheap(feel risky) as they have been, so naturally humans desire to flee them. Simple buy high, sell low herd financial behavior.

Expectantly, a mortgage now is free money, free leverage. Its the kind of situation, where a guy in econ 101 class in 2030(most likely/expectantly), will read about and go, hey, I would load the heck up. What were those primitives thinking?

I find it really behaviorally hard to keep my mortgage, whats left of it, myself. I would say not a week goes by, without me thinking I should can it entirely over next few years. I also sometimes think of buying apple or facebook too : )

right now, my mortgage is 8 percent leverage on my portfolio (discounting the snicker bar side of things), expectantly free.... Its simply minimally evening out my consumption/production time curve via my very loose Zvi Bodie understanding.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby bpp » Thu Jan 31, 2013 4:48 am

Dogs wrote:
am wrote:Kind of silly if you ask me to lend money to the gov., corporations etc. at 1.6% via TBM when you have a mortgage that is higher in %?


When stocks decline you can't pull money back out of your mortgage to buy stocks without taking out another loan with interest, and if you did that, why pay it off in the first place?


Not an issue for someone who rebalances by directing new funds and reinvesting dividends.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby momar » Thu Jan 31, 2013 7:42 am

MrMatt2532 wrote:
momar wrote:
am wrote:Kind of silly if you ask me to lend money to the gov., corporations etc. at 1.6% via TBM when you have a mortgage that is higher in %? Is it not a no brainer to first pay off mortgage before lending money at a lower rate? I agree with the concept of a negative bond. That is why I payed off my mortgage this week. It hit me all of a sudden. Plus, the market is at near highs and I am afraid that this could be the last opportunity for a while to do this given that I sold some stocks to do this.

My mortgage is for 30 years and will stay at the same low, low rate for all 30 years no matter where treasuries go.

You could buy a 30 year individual bond and say the same thing about it.

I guess, but why would I want to lend money on a 30 year note for historically low rates? These situations are the opposite of each other.

Its possible rates never go above my mortgage over the next 30 years, I suppose. Of course, I am investing in equities in lieu of paying off/down my mortgage. I also get the benefit of having that money liquid instead of tied up in a house.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby magician » Thu Jan 31, 2013 10:48 am

momar wrote:
MrMatt2532 wrote:
momar wrote:
am wrote:Kind of silly if you ask me to lend money to the gov., corporations etc. at 1.6% via TBM when you have a mortgage that is higher in %? Is it not a no brainer to first pay off mortgage before lending money at a lower rate? I agree with the concept of a negative bond. That is why I payed off my mortgage this week. It hit me all of a sudden. Plus, the market is at near highs and I am afraid that this could be the last opportunity for a while to do this given that I sold some stocks to do this.

My mortgage is for 30 years and will stay at the same low, low rate for all 30 years no matter where treasuries go.

You could buy a 30 year individual bond and say the same thing about it.

These situations are the opposite of each other.

So you, for one, do believe that having a mortgage is having a negative exposure to bonds.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby kenyan » Thu Jan 31, 2013 11:06 am

Random Musings wrote:Simply put, I considered my mortgage a negative bond since in my case, I could either have paid the house off immediately or took out a loan. The loan gave me a little more liquidity so I went that route and ultimately paid off the mortgage fairly quickly.

RM


This is the case where I think it makes sense.

When the mortgage is a huge percentage (or larger than) of one's liquid retirement assets, however, I just think you're making the situation too complicated. I can't rebalance it, I can't put it - or something equivalent - in my Roth or 401k, and including it as an asset in the retirement allocation forces one to be excessively conservative in liquid accounts, restricting their growth potential. Then again, I'm someone who prefers to "bin" accounts that are dedicated for different goals, and the mortgage/house have no effect (at this point) on my retirement investing. I'm sure purists could tell me exactly where my logic fails, but I don't see the sense in including a mortgage in my retirement AA - it would force me to own nothing but bonds just to get toward zero percent bonds.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Compounding » Thu Jan 31, 2013 12:48 pm

retiredjg wrote:If the "mortgage as a negative bond" thinking makes sense to you and feels right to you, do it. But I don't think anyone else should be following that advice just because some smart financial guy discusses it in a book. If it doesn't feel right in your gut, you may not make it through a market crash cause that mortgage may not feel so bond-like when your portfolio is taking a dive.

"If you need to ask, don't go there" applies to a lot of things in life. I think this is a good example. Some people will immediately resonate with the mortgage as negative bond approach and it is probably fine for those folks. Others will wonder and ask, either silently or openly, what others think of it. I suspect those folks probably shouldn't go there.


As the OP, I think this quote sums up these kind of issues where there might not be a "right" answer, just one based on circumstances and individuals. If it doesn't make sense to you and in your gut you just can't get behind the logic of it, then perhaps you shouldn't do it - because it dramatically lessens the chance of you staying the course and committing long term. I think the whole mortgage as negative bonds is a classic example of this in my case. With the various posts it all seems to be a matter of perspective regarding how exactly a mortgage should be viewed - from a negative bond to an annuity to just another expense to an inflation-hedge. None of these views are necessarily "wrong".

Many have indicated that you shouldn't invest in bonds at today's low rates until paying off a mortgage. Unless you are 100% equities (which few are) - doesn't that rule prohibit you from investing in stocks as well? I mean, you can't have a 80/20 AA and not invest in bonds. Basically its like saying you have a choice between 100% equity AA OR paying off your mortgage in full. Shouldn't I be comparing my mortgage to the entire portfolio, since that's where the money I would've has used to pay off the mortgage is going?

Also, I think there is a difference between how you treat a mortgage that is a primary residence or an investment property. Perhaps the investment property should be negative/positive bond-like depending on the rental income, but a house you live in is simply an expense much like rent is, except with certain tax and equity-building advantages. After all, you must rent or own (or live with parents :shock: ), thus that should be your comparison. And yes, a mortgage is a liability on the balance sheet, but its not like other consumer loans and not like the loan an entity makes when it puts out a bond at auction. Those loans must be paid back in full with all principal and interest paid (ideally!) - but a mortgage has a sort of "out" clause: I can always sell the home for around its market value and eliminate the loan (assuming I'm not underwater). You have no such "out" with credit card, student loan, car loan, or bond debt (unless perhaps if the bond is callable). My point is that the primary mortgage has much different characteristics than bonds that make calling it a "negative bond" seem imprudent. At least in my case.

- Brian
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby jdilla1107 » Thu Jan 31, 2013 1:19 pm

Compounding wrote:Many have indicated that you shouldn't invest in bonds at today's low rates until paying off a mortgage. Unless you are 100% equities (which few are) - doesn't that rule prohibit you from investing in stocks as well? I mean, you can't have a 80/20 AA and not invest in bonds. Basically its like saying you have a choice between 100% equity AA OR paying off your mortgage in full. Shouldn't I be comparing my mortgage to the entire portfolio, since that's where the money I would've has used to pay off the mortgage is going?
- Brian


I think you are making a mistake in thinking that an AA of 100/0 is always more risky than 80/20. For example, an 80/20 of $80,000 in stocks with $20,000 in bonds is more risky than 100/0 of $30,000 in stocks. (The other money could be in your mortgage as an example.)

As opposed to "I want to be 80/20", you can ask yourself how much money you would be willing to risk for a 50% loss.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby 555 » Thu Jan 31, 2013 2:01 pm

Compounding, jdilla1107 please edit your posts. You are quoting me as saying things that other posters said. :annoyed
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Compounding » Thu Jan 31, 2013 2:13 pm

555 wrote:Compounding, jdilla1107 please edit your posts. You are quoting me as saying things that other posters said. :annoyed


My apologies - its been corrected. The person I quoted was responding to your quote -and the quote within the quote was overlooked.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby YDNAL » Thu Jan 31, 2013 2:38 pm

Compounding wrote:I was wondering how many of you out there treat your mortgage as a negative exposure to your allocation to fixed-income assets,...

A successful investor once said... "The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective." - Warren Buffett

I choose to invest MY fixed-income Assets according to my need.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby mchop » Thu Jan 31, 2013 3:37 pm

Thank you LH. Your explanation while considering the time value of money resonated with me.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby YDNAL » Thu Jan 31, 2013 5:16 pm

mchop wrote:Thank you LH. Your explanation while considering the time value of money resonated with me.

I agree.

I have a tendency to bypass prior posts and address the original poster, so I missed LH's fine post.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Rodc » Thu Jan 31, 2013 5:20 pm

interplanetjanet wrote:I think that looking only at the mortgage can be a mistake.

Typically a mortgage is not acquired in isolation, a piece of property comes along for the ride. By buying, you are avoiding rent and future increases in rent - the closest analogy that comes to mind easily is that the property can be seen a bit like an inflation-adjusted pension with a cash-out feature, though the cash-out is wildly variable depending on the market. It seems likely that this "pension" could be seen as offsetting the negative bond of a mortgage, though to what degree no doubt depends on the specifics.



Yes, thinking of a mortgage an an anti-bond in isolation is like looking at a bond as a cost and ignoring the interest and value returned when it matures or you sell it.

And unlike a bond you can't easily rebalance in and out.

To me it just seems to needlessly complicate things with no real benefit from doing so.

I don't have a problem if someone wants to do this, but I don't bother.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Thu Jan 31, 2013 9:31 pm

LH wrote:Expectantly, a mortgage now is free money, free leverage. Its the kind of situation, where a guy in econ 101 class in 2030(most likely/expectantly), will read about and go, hey, I would load the heck up. What were those primitives thinking?

As a younger person, I have a high stock allocation despite having a mortgage (and being leveraged). However, I wouldn't say that this is free leverage, as I am paying interest on the loan...
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby dharrythomas » Thu Jan 31, 2013 9:46 pm

momar,

I personally would rather have a paid off house. We're not anywhere close to maxed out on house payments based on current salary, but required monthly income drops alot without that payment.

We don't have car loans and don't carry a credit card balance. The intent is to pay cash for everything.

It is not the path that a that will maximize the mean/median end result in a monte carlo simulation, but to use a Warren Buffett analogy it 'minimizes my odds of multiplying by zero.'

Many people lie to themselves about how much risk they are taking. Bad things tend to happen to individuals at the same time that bad things are happening in the economy. Don't forget that when bad things happen the multiplier effect of the leverage is just as powerful on the way up as it is on the way down. It is much harder to get into financial trouble if you don't have debt (not impossible but much harder).

My wife thinks I'm too risk adverse but humors me because I sleep better with less stress and even with additional savings without the payment there is more cash flow available for her to do with as she wishes.

Good Luck.

Harry
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby docneil88 » Thu Jan 31, 2013 9:56 pm

Rodc wrote:And unlike a bond you can't easily rebalance in and out [of a mortgage].

To me it just seems to needlessly complicate things with no real benefit from doing so [i.e. viewing a fixed rate mortgage as a negative bond].

Hi Rodc, If you have the cash for a partial prepayment of a mortgage, it's easy to make such a prepayment, thereby rebalancing out of your mortgage/negative bond position. (Edit to add: most mortgages do not carry a prepayment penalty.)

The idea of a (fixed rate) mortgage as a negative bond seems simple enough to me. But more importantly, it captures a key fact: if you have a mortgage and interest rates go way up, the value of that mortgage to you will go way up because your payments will not increase, yet you can make your payments with inflated dollars. Whereas, if you had a 15- or 30-year bond and interest rates go way up, the value of that bond will go way down. Best, Neil
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Blue » Thu Jan 31, 2013 10:23 pm

There seems to be a general consensus that interest rates can only go up and thus many have mentioned the benefit of locking in long-term fixed mortgage rates.

This seems to me a form of market timing implicitly denying the possibility of an extended period of flat rates or deflation.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby freebeer » Thu Jan 31, 2013 10:39 pm

Blue wrote:There seems to be a general consensus that interest rates can only go up and thus many have mentioned the benefit of locking in long-term fixed mortgage rates.

This seems to me a form of market timing implicitly denying the possibility of an extended period of flat rates or deflation.


In the case of deflation you can a) refinance or b) use the implicit "put" option and walk (if you are in a no-recourse state). So I don't think it's necessarily market timing.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby zebrafish » Thu Jan 31, 2013 11:52 pm

dharrythomas wrote:I think of a mortgage as just like any other kind of debt (clearly there are tax differences). It is a fixed expense that has to be paid regardless of cash flow. It adds risk and stress to finances. With no debt, you can survive with less income and your personal finances become more 'anti-fragile'.


This is the only comment in this thread that makes any sense to me.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby zebrafish » Fri Feb 01, 2013 12:16 am

LH wrote:Say you have a 30 year mortgage,100K, at 4 percent, and are in the 25 percent tax bracket. After tax, its a 3 percent loan for 30years.

Now, you can pay off that loan sure, and get the 3 percent now, but what you give up, is the use of that 100K over 30 years.

Its the 30 years that is key. The time behavior/compounding real behavior of the money over that whole time.

So say interest rate on bonds are 1 percent now, ok pay off the mortgage entirely with 100K over 2 years, you win? 3 percent rate of return....

But say then for then next 28 years, the interest rate jumps up to 7 percent, and inflation to 5 percent. You did not win. You would have been much better off, keeping that low 30 year loan, and paying it back it hugely inflated dollars.


All the above is true, but no one knows the what the future holds. And people tend to be very optimistic about the future. So, you can leverage to invest, but it may take a long time to come out ahead if something bad happens along the way on the investment side (risk). Also, if you can pay off the mortgage in a small period of time, once you don't have a mortgage, you can direct more of your cash flow towards investing. So, I'm not convinced having a mortgage is the greatest thing since sliced bread. I'm not sure leveraging will come out ahead in every scenario.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Fri Feb 01, 2013 12:57 am

docneil88 wrote:The idea of a (fixed rate) mortgage as a negative bond seems simple enough to me. But more importantly, it captures a key fact: if you have a mortgage and interest rates go way up, the value of that mortgage to you will go way up because your payments will not increase, yet you can make your payments with inflated dollars. Whereas, if you had a 15- or 30-year bond and interest rates go way up, the value of that bond will go way down. Best, Neil

But if you truly believe that, then you have to buy an equivalent amount of bonds to counteract the negative bond and get you to the desired asset allocation. Which brings me to the main reason that it falls apart for me. People with substantial mortgages would need to have all or nearly all their investments in bonds and no stocks at all until their portfolio grew and mortgage shrank to the point where the bond allocation was satisfied.

I think the simplest thing is to not regard the mortgage or the home as an investment at all.


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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Fri Feb 01, 2013 1:01 am

Blue wrote:There seems to be a general consensus that interest rates can only go up and thus many have mentioned the benefit of locking in long-term fixed mortgage rates.

This seems to me a form of market timing implicitly denying the possibility of an extended period of flat rates or deflation.

It's certainly a possibility. But if rates stay flat, then you lose very little. The difference between the return you get with bonds and that of prepaying are a matter of a point or so. And you're probably still getting a small benefit of paying with inflated money, even though in that scenario one would expect inflation to stay low.

The mortgage is a cheap hedge against rising rates and inflation.


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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Fri Feb 01, 2013 1:06 am

zebrafish wrote:
dharrythomas wrote:I think of a mortgage as just like any other kind of debt (clearly there are tax differences). It is a fixed expense that has to be paid regardless of cash flow. It adds risk and stress to finances. With no debt, you can survive with less income and your personal finances become more 'anti-fragile'.


This is the only comment in this thread that makes any sense to me.

Sorry, but I think it's inconsequential. Would this sort of hand-wringing be going on about someone who rents? They also have a monthly expense that has to be paid regardless of cash flow. They lose their place to live if it's not paid. All the same risk and stress, without even the inflation control of a mortgage.

It's as I have said, this is for most here this is NOT a financial question but an emotional one. For some reason they feel "safer" with their money tied up in one illiquid asset. I don't personally see it, but if it makes them feel better there's no real answer.


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