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

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

Postby LH » Fri Feb 01, 2013 3:17 am

YDNAL wrote:
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.


Thanks guys much appreciated,

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

Postby LH » Fri Feb 01, 2013 3:27 am

MrMatt2532 wrote:
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...


Over 30 years, if after tax your interest rate is 3 percent, its "expectantly free in real terms".

A lot is happening inside that preceding quote (not that I said exactly that maybe, but just quote to set off what I am saying now). Nominal vs real. Time value of money. Implicit referral to the average inflation rate, and taking that to be the expectant average rate going forward. 3.2 is one quoted inflation rate from my memory. If all thats the case over 30 years, the loan is cost free in real terms over time. Also, even if the 100k is expectantly free, you have to have the 100K invested in something that beats inflation, so scratch TIPS for now for instance.

If Japan 1990-2013, deflation to what maybe 1 percent average inflation? (I forget)..... happens going forward, not free, and you would have paid a real cost.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Fri Feb 01, 2013 8:55 am

LH wrote:
MrMatt2532 wrote:
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...


Over 30 years, if after tax your interest rate is 3 percent, its "expectantly free in real terms".

A lot is happening inside that preceding quote (not that I said exactly that maybe, but just quote to set off what I am saying now). Nominal vs real. Time value of money. Implicit referral to the average inflation rate, and taking that to be the expectant average rate going forward. 3.2 is one quoted inflation rate from my memory. If all thats the case over 30 years, the loan is cost free in real terms over time. Also, even if the 100k is expectantly free, you have to have the 100K invested in something that beats inflation, so scratch TIPS for now for instance.

If Japan 1990-2013, deflation to what maybe 1 percent average inflation? (I forget)..... happens going forward, not free, and you would have paid a real cost.

Ok this is fine and I agree with it. Still, this really has nothing to do with the question in my opinion. What you are doing is basically just making a case for taking on debt is all.

The whole point to me is that is that if I have a 30 year mortgage at 3% and I can buy a 30 year bond at 3%, adding money towards either of the two assets essentially does the same thing regardless of what inflation does in the future.

The other point is that it's about controlling risk. If my only assets are stocks and bonds, 50k in stocks, 50k in bonds, I have some expectation regarding my portfolio's risk/return (a 50/50 stock/bond portfolio). If my stocks lose 10k, then I will have lost 10%. Now if I also have a 50k mortgage, then my total portfolio will actually behave as a 100/0 stock/bond portfolio and if stocks lose 10k, then I will have lost 20%.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Fri Feb 01, 2013 9:11 am

Default User BR wrote:
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.


Brian

It doesn't fall apart, but it does expose a problem with the traditional approach if you were to include debt as a negative bond. The point of including the debt is that it reveals your true allocation to stocks/bonds. For many young investors with debt, this means they are highly leveraged in stocks and have some amount of negative bonds. Again, this doesn't necessarily mean they should be paying off their mortgage and not buy stocks, it just means they are taking more risk than they may have thought otherwise. Also, I agree the simplest solution is to ignore it, but I don't think this is correct either as having debt means leverage/less bonds/more risk.

I agree if one were to do this, there is an issue with choosing and applying an asset allocation. Not to toot my own horn, but this exact issue is what got me thinking about a more elegant way to apply an asset allocation considering all your assets (such as debt). I talk about this is another thread: viewtopic.php?f=10&t=109504&p=1592012#p1592012
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Rodc » Fri Feb 01, 2013 9:14 am

The other point is that it's about controlling risk. If my only assets are stocks and bonds, 50k in stocks, 50k in bonds, I have some expectation regarding my portfolio's risk/return (a 50/50 stock/bond portfolio). If my stocks lose 10k, then I will have lost 10%. Now if I also have a 50k mortgage, then my total portfolio will actually behave as a 100/0 stock/bond portfolio and if stocks lose 10k, then I will have lost 20%.


I suggest percent here is the wrong measure. You have the same real dollar loss either way. That is all that matters.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Harold » Fri Feb 01, 2013 9:43 am

Really up to personal preference whether to treat your mortgage as a "negative exposure" to bonds – but in reality it is that way.

For most people, borrowing to buying a home is a huge deal. Promising a lender a stream of payments, with their being able to take your home if you don’t fulfill that promise has a pretty significant effect on your financial picture. I like to think of what we would consider a very financially responsible 25-year-old with $10K in retirement savings (80/20 stock/bond) and $20K in cash, who decides to buy a $100K home with 20% down. Afterwards, he has a $100K home, $8K in stocks, $2k in bonds, and -$80K in mortgage. Yet we still say he’s prudently following an 80/20 asset allocation as if that $8K in stock is all the risk he is taking? His whole financial picture has changed – if he makes 10 years of mortgage payments and runs into hard times, he could lose his mortgage payments, his down payment, and his home (and he’ll have paid his tax/insurance/repair/lawncare/etc/etc “rent” for that whole decade on top of that).

What’s really happening is that you’re leveraging to buy a home, and every dollar you decide to invest rather than paying down the loan is money you’ve borrowed to invest (similarly with every other spending choice you make with that dollar). That could be fine, but what it really means is that rather than some neat 80/20 asset allocation – it’s more like 140/-40 or some other ratio representing that you’ve borrowed to invest. Not that that’s necessarily a bad thing, and there have even been recommendations for young people to do precisely that. But there are a lot of people unwittingly doing it. (For example, there was a guy posting just the other day who wanted to pay off his mortgage by selling his bonds, but was afraid he’d be in a more risky 100/0 position “after” paying off his mortgage – led to the totally wrong conclusion by excluding his mortgage.) Rather than the negative bond idea “forcing” someone with an 80/20 allocation to avoid buying stocks – it should “force” him to realize that the 80/20 notion is an artifice that may or may not be useful or appropriate for reality.

The concept isn't an irrelevant complicating factor, it's a relevant clarifying factor. Up to the individual whether it serves his needs, but for asset allocation to have any concrete meaning he should consider the impact.

About a couple of other topics mentioned:

- Some say the mortgage has use as an inflation hedge. It's certainly true that the mortgage can serve as an option, the cost being the interest being paid -- and a well thought out investment plan could include options. But it may well be an option of no ultimate value. If there were any degree of certainty about it, some serious arbitrage would currently be going on, and serious lenders surely wouldn't be lending at a guaranteed loss.

- For those equating mortgage to rent, I have only this to say:
http://www.bogleheads.org/forum/viewtopic.php?f=2&t=100993
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Grt2bOutdoors » Fri Feb 01, 2013 9:52 am

If one is fortunate enough to have substantial positive cash flow after all expenses and normal retirement investment, they should then compare the alternative use of the money. If the choice is to place it in a fund or savings account paying less than the mortgage rate, that is a short to intermediate losing proposition. Paying down the mortgage will result in a higher after-tax return.

There are advocates for investing all disposable income as in theory, a properly diversified portfolio will almost always come out ahead. The problem is life is not theoretical, there are many obstacles and if you make the wrong choices as Harold indicated in this and past threads, you can lose what may be your biggest asset.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Fri Feb 01, 2013 10:14 am

Rodc wrote:
The other point is that it's about controlling risk. If my only assets are stocks and bonds, 50k in stocks, 50k in bonds, I have some expectation regarding my portfolio's risk/return (a 50/50 stock/bond portfolio). If my stocks lose 10k, then I will have lost 10%. Now if I also have a 50k mortgage, then my total portfolio will actually behave as a 100/0 stock/bond portfolio and if stocks lose 10k, then I will have lost 20%.


I suggest percent here is the wrong measure. You have the same real dollar loss either way. That is all that matters.

You may have missed my point. Let's take a different approach.
Here's another example:
Person 1:
100k stocks
Person 2:
100k stocks
100k bonds
100k debt
Person 3:
50k stocks
50k bonds

Assume all else is equal. These three investors all have the same total value: 100k.

The traditional approach would say person 2 and 3 had the same asset allocation. In fact, it is person 1 and 2 have the same asset allocation.

If stocks lose 10%, portfolios 1 and 2 lose 10%, and portfolio 3 loses 5%. Therefore, portfolio 3 has the least risk as a 50/50 portfolio, whereas portfolios 1 and 2 are 100/0 portfolios.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby YDNAL » Fri Feb 01, 2013 1:00 pm

.
viewtopic.php?f=2&t=100993
I never saw the thread in Non-Investing subforum linked by Harold. I would like to address that.
  • A mortgage note requires payment of principle + interest - so the only "expense" is the interest portion. (see more on this later)
  • A house comes with other expenses - taxes, insurance, regular upkeep, maintenance, to name a few.
  • The TOTAL of interest + other expenses should equate Rent for the same property. If it does, great! If it doesn't, you are paying too much "to own" this property.
  • Now, regarding paying-back the principle, during Inflationary periods you are paying back with deflated dollars over the long-term; while the Asset Value may well keep-up with Inflation.

There are 2 different questions to address in this thread, IMO.
1. What is a mortgage note?
2. What role does it play in Net Worth and Asset Allocation?

A mortgage note is a financial obligation (Liability) to pay back the principle borrowed to the lending instituion. Certainly, the lending institution is in business to make money, so they charge you interest (expense to you) to lend you the money.
  • So, the mortgage note (Liability) = negative Net Worth.
  • You don't acquire this negative Net Worth unless you are buying an Asset to collatelarize it (positive Net Worth). Those who insist to include this Liability should also then include the Asset when doing financial computations.
  • Neither the mortgage note nor Asset can be used to rebalance other Savings. So, my suggestion is to invest these Savings based on your overall willingness, ability, and need to take risk and to stop fretting over all the other nonesense.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby 555 » Fri Feb 01, 2013 1:21 pm

All these percentages depend heavily on choice of what to include in the numerator and denominator. People are talking about the signifance of a mortgage as part of ones financial picture, but human capital (one's future income) is generally even far bigger in magnitude. Repeating my earlier post

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.

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.


Forget about percentage-based asset allocation in the context of your entire financial picture. It's too simplistic of a concept. What you need is a mathematical model that helps you make decisions about what to do with any discretionary money (or at least in the absence of a model, at least figure out what kinds of decisions could make sense).
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Fri Feb 01, 2013 1:42 pm

555 wrote:All these percentages depend heavily on choice of what to include in the numerator and denominator. People are talking about the signifance of a mortgage as part of ones financial picture, but human capital (one's future income) is generally even far bigger in magnitude. Repeating my earlier post

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.

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.


Forget about percentage-based asset allocation in the context of your entire financial picture. It's too simplistic of a concept. What you need is a mathematical model that helps you make decisions about what to do with any discretionary money (or at least in the absence of a model, at least figure out what kinds of decisions could make sense).

I think I agree with you regarding factoring in human capital. I think a percentage based approach is ok if you include human capital in the total, or the denominator as with everything else (stocks+bonds/bond equivalents+human capital-debts). The idea is I choose how much of my total assets (including human capital) that I want to expose to stock risk vs bond risk. I recommended a model on these forums with these ideas in mind. I remember you posting in one of the threads but I didn't remember you agreeing with the ideas.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby bdpb » Fri Feb 01, 2013 2:58 pm

MrMatt2532 wrote:If stocks lose 10%, portfolios 1 and 2 lose 10%, and portfolio 3 loses 5%. Therefore, portfolio 3 has the least risk as a 50/50 portfolio, whereas portfolios 1 and 2 are 100/0 portfolios.


I think you missed Rodc's point.

Person 1 and 2 lose 10k in dollars and person 3 loses 5k in dollars. Person 3's portfolio is not less risky because it is 50/50, but because it only had 50k at risk in stocks.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Fri Feb 01, 2013 3:32 pm

bdpb wrote:
MrMatt2532 wrote:If stocks lose 10%, portfolios 1 and 2 lose 10%, and portfolio 3 loses 5%. Therefore, portfolio 3 has the least risk as a 50/50 portfolio, whereas portfolios 1 and 2 are 100/0 portfolios.


I think you missed Rodc's point.

Person 1 and 2 lose 10k in dollars and person 3 loses 5k in dollars. Person 3's portfolio is not less risky because it is 50/50, but because it only had 50k at risk in stocks.

To not confuse things further, Rodc was replying to a different example and not the one you are talking about. In the example Rodc was replying to, the amount in stocks was 50k for both cases.

Back to this most recent example: yes, person 3 allocated 50k out of 100k total towards stocks...aka a 50/50 stock/bond asset allocation. Person 1 and 2 allocated 100k out of 100k total towards stocks...aka a 100/0 stock/bond asset allocation. Really there is nothing to argue here. They have the same total amount of assets, and investors 1 and 2 have a larger percent, yes percent, in stocks...

You can divide or multiply the values of the assets in the portfolio by 10 or 99 for all it matters. The point is that person 1 and 2 (including debt) are exposed to a 100/0 portfolio and person 3 is exposed to a 50/50 portfolio. If you can't see that debt affects risk we have a problem....
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Fri Feb 01, 2013 4:50 pm

Harold wrote:For most people, borrowing to buying a home is a huge deal. Promising a lender a stream of payments, with their being able to take your home if you don’t fulfill that promise has a pretty significant effect on your financial picture.

How is that any different than renting? You have to live somewhere, and most of the time it's not free. And if you don't pay, you get asked to leave. The fact that the mortgage is only part of the overall cost of living in the house is irrelevant.

I'll say again, does someone who rents have a negative bond? Why not? Because it isn't broken into principal and interest? It's still a monthly payment due to live there.


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

Postby MrMatt2532 » Fri Feb 01, 2013 5:02 pm

Default User BR wrote:
Harold wrote:For most people, borrowing to buying a home is a huge deal. Promising a lender a stream of payments, with their being able to take your home if you don’t fulfill that promise has a pretty significant effect on your financial picture.

How is that any different than renting? You have to live somewhere, and most of the time it's not free. And if you don't pay, you get asked to leave. The fact that the mortgage is only part of the overall cost of living in the house is irrelevant.

I'll say again, does someone who rents have a negative bond? Why not? Because it isn't broken into principal and interest? It's still a monthly payment due to live there.


Brian

I'll give you my argument. We all need shelter. We basically have two choices. Either buy a house and pay it's associated costs (utilities, repair,home insurance ...) or pay rent and it's associated costs (utilities,renter insurance,...). These are the choices we have. These are consumption choices. I can either choose as a consumer to buy a house or pay for rent. That's it.

As to whether or not I need to get a mortgage for buying a house is a separate issue. If you do need to take out a mortgage then you should treat it as a negative bond, all the other stuff is a consumption choice.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Rodc » Fri Feb 01, 2013 5:13 pm

To not confuse things further, Rodc was replying to a different example and not the one you are talking about. In the example Rodc was replying to, the amount in stocks was 50k for both cases.


Yes. Thank you.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby wshang » Fri Feb 01, 2013 6:31 pm

I think MrMatt is on to something here. There is a difference between those of us who are retired and those in accumulation phase. For the former, it is a simple matter to liquidate enough assets to buy the home outright. Of course, the problem then is one has to generate sufficient income, pay the tax on the income, then pay the PI. Intrinsically inefficient, kinda like high-turnover in a mutual fund. One is doing fine if the TIMING is correct. That is, figuring in the government distortion of the normal functioning market by the tax subsidy, whether the after tax payment of interest is less than inflation. Of course that goes away later as the mortgage matures. BH's are against trying to time the market? How about timing the Fed's distortion of long-term interest rates?

For those in accumulation phase, it is the foregoing of possible capital (non home equity appreciation) in the hopes of inflation. Let me remind the forum that the 30 year mortgage is an invention of the Federal government and before the depression, it made little sense for the banking industry or consumer to have a loan of that duration. Market distortions imply the true cost is actually more. One desires now, what cannot be afforded unless leverage is employed.

So, in fact, one is making a political bet (albeit probably not a bad one), using leverage and a market timing bet. All three strategies not typically Bogleheadish.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Harold » Fri Feb 01, 2013 7:16 pm

Default User BR wrote:
Harold wrote:For most people, borrowing to buying a home is a huge deal. Promising a lender a stream of payments, with their being able to take your home if you don’t fulfill that promise has a pretty significant effect on your financial picture.

How is that any different than renting? You have to live somewhere, and most of the time it's not free. And if you don't pay, you get asked to leave. The fact that the mortgage is only part of the overall cost of living in the house is irrelevant.

I'll say again, does someone who rents have a negative bond? Why not? Because it isn't broken into principal and interest? It's still a monthly payment due to live there.


Brian

If you lapse on your rent payments – you need to find a new place to live.

If you default on a mortgage, you lose your home asset, your down payment, all the mortgage payments you’ve made – and you need to find a new place to live.

With renting there’s no long-term commitment whatsoever (can move to a cheaper place, can move in with family, sleep on someone’s couch). With a mortgage, you’ve entered into an agreement to make a set amount of payments at a certain interest rate – just as the bond issuers do for the bonds you buy.

Besides, rent doesn’t have a thing to do with a mortgage payment. See explanations above, or the thread I linked to earlier
http://www.bogleheads.org/forum/viewtopic.php?f=2&t=100993
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby dharrythomas » Fri Feb 01, 2013 8:43 pm

Harold » Fri Feb 01, 2013 9:43 am

Really up to personal preference whether to treat your mortgage as a "negative exposure" to bonds – but in reality it is that way.


A very clear explanation, thanks.

I came to the same end result without quantifying the changes to my financial situation.

Leverage adds risk, whether it is a margin loan, mortgage, student loan, car loan, or credit card. Clearly the risk are different depending on the type of leverage and just as clearly many people ignore the amount of risk they are living with. If you concentrate your risk on the equity side, your net worth can’t go below zero.

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

Postby Tonen » Fri Feb 01, 2013 10:32 pm

In Australia at least this is simply answered, as the situation shouldn't arise for a prudent investor. Mortgage interest costs receive no tax relief, so return on investment has to be quite a bit higher than mortgage interest rates to break even. Even in these unusual times of low interest, the prudent approach is pay off your mortgage before voluntarily investing.

And in maybe I missed it somewhere above, but a mortgage liability in any case is offset by an asset - the house. A bond is an asset with no liability. Any similarities are tenuous. If you are to use an analogy of a mortgage as a negative bond, the logic should extend to then considering a paid-off house as being a bond. It is important to account for the risks of leverage inherit in a mortgage, but the bond-analogy thing I don't think is helpful
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Harold » Sat Feb 02, 2013 12:03 pm

dharrythomas wrote:A very clear explanation, thanks.

I appreciate your comment.
Tonen wrote:a mortgage liability in any case is offset by an asset - the house. A bond is an asset with no liability. Any similarities are tenuous. If you are to use an analogy of a mortgage as a negative bond, the logic should extend to then considering a paid-off house as being a bond. It is important to account for the risks of leverage inherit in a mortgage, but the bond-analogy thing I don't think is helpful

Well yes, if you take out a loan you have a liability. It doesn't automatically or inherently take on the characteristics of what you initially borrowed to buy or what you used as collateral though.

Maybe you had enough cash to buy the house, but got a mortgage anyway so you could buy a pile of Hello Kitty toasters -- once you've paid off the mortgage, the toasters don't become bond-like. Similarly if you used your Les Paul guitar collection as collateral, the guitars don't become bond-like once the loan is repaid.

The reason people use the bond analogy is because with a mortgage, you promise a defined stream of payments to the lender -- just as a bond issuer promises a defined stream of payments to you when you buy a bond. And the stream of payments owed by a mortgage-holder directly reduce the stream of payments they would receive from the bonds they buy. This observation has a definite impact on their financial picture (along with the consequences if they choose not to make their promised payments).

Some people find being aware of that helpful, some don't ...
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Sat Feb 02, 2013 12:10 pm

MrMatt2532 wrote:I'll give you my argument. We all need shelter. We basically have two choices. Either buy a house and pay it's associated costs (utilities, repair,home insurance ...) or pay rent and it's associated costs (utilities,renter insurance,...). These are the choices we have. These are consumption choices. I can either choose as a consumer to buy a house or pay for rent. That's it.

As to whether or not I need to get a mortgage for buying a house is a separate issue. If you do need to take out a mortgage then you should treat it as a negative bond, all the other stuff is a consumption choice.

What is the difference? Why is one a bond and the other a consumption item? In either case you owe a steady payment to continue to live in the place you want. Again, why is the rent not a bond? Why should the mortgage be considered in the asset allocation and the rent not?


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

Postby Default User BR » Sat Feb 02, 2013 12:16 pm

Harold wrote:If you lapse on your rent payments – you need to find a new place to live.

If you default on a mortgage, you lose your home asset, your down payment, all the mortgage payments you’ve made – and you need to find a new place to live.

That's totally irrelevant to the question. You "lost" all the rent as soon as it was paid. You are also making the assumption somehow that there isn't equity in the house and that it can't be sold for more than the outstanding balance. In some case that will be the case, other times not. But regardless, in either case you can view it as a zero when you stop paying. Rent or mortgage, you leave.

Trying to blend in the mortgage you pay with whatever equity and "imputed rent" and all the other stuff that comes with it into investing just makes no sense to me. The only sensible thing is to exclude it from asset allocation. That means that it is not a negative bond. The house is not an investment at all. It is shelter that you have worked a long-term payment plan for.


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

Postby MrMatt2532 » Sat Feb 02, 2013 12:29 pm

Default User BR wrote:
MrMatt2532 wrote:I'll give you my argument. We all need shelter. We basically have two choices. Either buy a house and pay it's associated costs (utilities, repair,home insurance ...) or pay rent and it's associated costs (utilities,renter insurance,...). These are the choices we have. These are consumption choices. I can either choose as a consumer to buy a house or pay for rent. That's it.

As to whether or not I need to get a mortgage for buying a house is a separate issue. If you do need to take out a mortgage then you should treat it as a negative bond, all the other stuff is a consumption choice.

What is the difference? Why is one a bond and the other a consumption item? In either case you owe a steady payment to continue to live in the place you want. Again, why is the rent not a bond? Why should the mortgage be considered in the asset allocation and the rent not?


Brian

I consider a house and rent as consumption items for the same reasons that food, clothing, electricity, water, and so on are all considered consumption items. They are things we pay for and consume regularly. You could consider the house as a prepaid shelter whereas with rent we pay for it regularly. Of course there are still the everyday costs such as maintenance, utilities, insurance, and so on.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Harold » Sat Feb 02, 2013 12:30 pm

Default User BR wrote:
Harold wrote:If you lapse on your rent payments – you need to find a new place to live.

If you default on a mortgage, you lose your home asset, your down payment, all the mortgage payments you’ve made – and you need to find a new place to live.

That's totally irrelevant to the question. You "lost" all the rent as soon as it was paid. You are also making the assumption somehow that there isn't equity in the house and that it can't be sold for more than the outstanding balance. In some case that will be the case, other times not. But regardless, in either case you can view it as a zero when you stop paying. Rent or mortgage, you leave.

Trying to blend in the mortgage you pay with whatever equity and "imputed rent" and all the other stuff that comes with it into investing just makes no sense to me. The only sensible thing is to exclude it from asset allocation. That means that it is not a negative bond. The house is not an investment at all. It is shelter that you have worked a long-term payment plan for.


Brian

Brian, for both the homeowner and the renter, "rent" is lost as soon as it is paid, as I alluded to at the bottom of my post. Further, I haven't ignored "equity" in the home -- the home has been purchased, the buyer owns it, it's an asset of his and I never said otherwise. You have been presented with coherent descriptions and totally logical counters to your objections. And every single item I have mentioned is relevant.

You don't want to view it this way, and that's fine -- but there's no argument to be had.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby wshang » Sat Feb 02, 2013 1:46 pm

I think there is another aspect from which to consider the question. Suppose some entity allowed you to purchase all of your healthcare needs, housing and utilities in perpetuity for a fixed sum now and you could easily afford and had the funds in your savings. Presuming you thought it was a fair price and allowed you to plan with less certainty into the future, then it would make perfect sense to accept. (I guess most in retirement would accept this proposition if the time value of money was taken into consideration.)

On the other hand, if you were in accumulation phase (you might earn more in the future), or had the penchant or somehow thought you could predict and time the market into the future, then you might decline the proposition. This is in essence how to frame the "negative exposure" question in my mind.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Harold » Sat Feb 02, 2013 2:19 pm

wshang wrote:I think there is another aspect from which to consider the question. Suppose some entity allowed you to purchase all of your healthcare needs, housing and utilities in perpetuity for a fixed sum now and you could easily afford and had the funds in your savings. Presuming you thought it was a fair price and allowed you to plan with less certainty into the future, then it would make perfect sense to accept. (I guess most in retirement would accept this proposition if the time value of money was taken into consideration.)

On the other hand, if you were in accumulation phase (you might earn more in the future), or had the penchant or somehow thought you could predict and time the market into the future, then you might decline the proposition. This is in essence how to frame the "negative exposure" question in my mind.

As interesting as the idea is, and as illustrative of one's risk acceptance/aversion it would be, the relationship of a mortgage is much simpler than that.

Someone has made the decision that he wants to own a home; that is, part of your first paragraph (and only the asset part of the housing portion, since he's still got his tax/insurance/etc. "rent"). He either doesn't have the cash for the purchase, or doesn't want to part with it, so he borrows -- receiving a lump sum in exchange for a promise to make set payments.

Once that's been done, the new homeowner looks at his financial landscape and sees a home, his various other assets/liabilities, and a defined set of mortgage payments. No theory or speculation is required -- it is what it is. The question is only whether one chooses to consider that set of mortgage payments when he is making risk or investment decisions or not. Some choose not to, but for most people it's a very big thing to dismiss.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby market timer » Sat Feb 02, 2013 3:13 pm

To say that a mortgage is not a negative bond, because it was used to acquire a house, is akin to saying credit card debt is not a negative bond, because it was used to acquire some other stuff. Both mortgage and credit card debt are negative bonds. It is helpful to be able to separate conceptually debt used to acquire an asset from the asset itself, or else you might end up paying more in interest than needed.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby davidlukewilcox » Sat Feb 02, 2013 3:43 pm

My post will probably be glossed over, but I feel that it provides a new insight into the discussion.

If we're going to include our mortgages as a negative bond (which I agree with since it is a fixed payment out every month), then we should also include our jobs as a positive bond (since it is a fixed payment in every month). You could find a particular amount of money and invest it in some bond such that you would be indifferent between your salary and the fixed income from that bond. What more, this bond grows yearly, more than by inflation for most people.

In my case, I make close to 8,000 per month or 96,000 per year. This is fixed income, or otherwise could be treated as a bond. Let's assume that my salary grows by 4.5% per year (not out of the ordinary in my field). Let's also assume that the inflation grows at 3% per year and I end up working for 40 more years (I'm near the beginning of my career). This would add up to about $10 million in earnings over my career, or adjusted for 3% inflation, $3.1 million today. If I consider my future working years, I have a $3.1 million bond. I have a mortgage balance of $160k, so if we subtract out the negative bond, then I am actually holding $2.94 million in bonds.

All I'm saying is that to be fair, you should include all payments into and out of your accounts. I do agree that the mortgage is a negative bond to the same token that earnings are a positive bond.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby YDNAL » Sat Feb 02, 2013 3:58 pm

market timer wrote:To say that a mortgage is not a negative bond, because it was used to acquire a house, is akin to saying credit card debt is not a negative bond, because it was used to acquire some other stuff. Both mortgage and credit card debt are negative bonds. It is helpful to be able to separate conceptually debt used to acquire an asset from the asset itself, or else you might end up paying more in interest than needed.

This issue is NOT (also a zillion other threads alike) a definition contest.... class, lets define a mortgage note.

The issue is how to treat a mortgage note in allocating other investable (liquid) Assets. The simplistic example, as MrMatt provided, goes something like this:
MrMatt2532 wrote:Here's another example:
Person 1:
100k stocks
Person 2:
100k stocks
100k bonds
100k debt
Person 3:
50k stocks
50k bonds

Assume all else is equal. These three investors all have the same total value: 100k.

No, all else is not equal and these investors "all [insert: DON'T] have the same total value: $100K."
  • Person 2, we can safely assume, has invested $25K (20% downpayment) in a $125K home - minimally, that is.
  • The question then become how to account for all Assets and all Liabilities (basically Net Worth) and, yes, human capital, in Asset Allocation decisions.
  • Later in life, a person additionally is more likely to own an Asset (such as a home) without leverage, has a Pension, SS benefits, etc. that ALL become factors in determining Ability and Need for risk.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Sat Feb 02, 2013 4:10 pm

YDNAL,

Yes, in fact all else is equal. When I say all else is equal that's exactly what it means. You could pretend none of the three people own a house, or you could pretend they all own 100k house. or any other scenario you think up. The idea is besides the amount of stocks, bonds, and debt, all else is equal. It's a simple idea really.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Sat Feb 02, 2013 5:06 pm

davidlukewilcox wrote:My post will probably be glossed over, but I feel that it provides a new insight into the discussion.

If we're going to include our mortgages as a negative bond (which I agree with since it is a fixed payment out every month), then we should also include our jobs as a positive bond (since it is a fixed payment in every month). You could find a particular amount of money and invest it in some bond such that you would be indifferent between your salary and the fixed income from that bond. What more, this bond grows yearly, more than by inflation for most people.

In my case, I make close to 8,000 per month or 96,000 per year. This is fixed income, or otherwise could be treated as a bond. Let's assume that my salary grows by 4.5% per year (not out of the ordinary in my field). Let's also assume that the inflation grows at 3% per year and I end up working for 40 more years (I'm near the beginning of my career). This would add up to about $10 million in earnings over my career, or adjusted for 3% inflation, $3.1 million today. If I consider my future working years, I have a $3.1 million bond. I have a mortgage balance of $160k, so if we subtract out the negative bond, then I am actually holding $2.94 million in bonds.

All I'm saying is that to be fair, you should include all payments into and out of your accounts. I do agree that the mortgage is a negative bond to the same token that earnings are a positive bond.

David, what you are talking about is human capital. And this is the main reason for high stock allocation when young and low allocations when high. It is an important consideration to asset allocation, but unneeded for the basic idea that debt should be treated as a bond. My only thing I would nitpick is that I think you should only consider the amount of your human capital that will go towards savings, and not to also include the amount that will go towards consumption. IE maybe an investor makes 100k, pays 80k towards taxes and consumption items and then has 20k to invest. Only the streams of 20k should be included.

Here is a post I made recently that brings all these ideas together in a unified model: viewtopic.php?f=10&t=109504
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Rodc » Sat Feb 02, 2013 6:20 pm

Harold wrote:
Default User BR wrote:
Harold wrote:If you lapse on your rent payments – you need to find a new place to live.

If you default on a mortgage, you lose your home asset, your down payment, all the mortgage payments you’ve made – and you need to find a new place to live.

That's totally irrelevant to the question. You "lost" all the rent as soon as it was paid. You are also making the assumption somehow that there isn't equity in the house and that it can't be sold for more than the outstanding balance. In some case that will be the case, other times not. But regardless, in either case you can view it as a zero when you stop paying. Rent or mortgage, you leave.

Trying to blend in the mortgage you pay with whatever equity and "imputed rent" and all the other stuff that comes with it into investing just makes no sense to me. The only sensible thing is to exclude it from asset allocation. That means that it is not a negative bond. The house is not an investment at all. It is shelter that you have worked a long-term payment plan for.


Brian

Brian, for both the homeowner and the renter, "rent" is lost as soon as it is paid, as I alluded to at the bottom of my post. Further, I haven't ignored "equity" in the home -- the home has been purchased, the buyer owns it, it's an asset of his and I never said otherwise. You have been presented with coherent descriptions and totally logical counters to your objections. And every single item I have mentioned is relevant.

You don't want to view it this way, and that's fine -- but there's no argument to be had.


If I rent I "lose" the rent every month to the same extent that if I have a mortgage I "lose" the interest payment. Money gone, though I do get a place to live. That much is a wash to the extent that in the early years interest is often in the ball park of rent (Only very roughly of course).

If I can't make my house payment I can sell my house for much more than I owe. I am not upside down, not by a long shot and in addition that house has appreciated by more than 100% over the last 20 year I have had it. If I have to sell in a hurry I may have to sell for less than I like, but I will walk away with a nice wad of cash, and I will have enjoyed the shelter for 20 years. Indeed I might decide I no longer want to bother with the upkeep or want to live in the burbs, I might decide to sell my house and go rent an apartment in the city. That would result in the same outcome. The reason why I want out has no bearing on the issue. So certainly not universal that losing the means to pay the rent results in all those losses you list.

It is certainly possible to get in a situation where you can no longer pay the mortgage and house value is down and you will lose money. The risk is real, but I don't think is well captured in the above quote. When you buy a house, like any investment, you take risk which may or may not show up, and you have some chance of making money. Unlike most investments, with a house you get a nice steady stream of returns in the form of a place to live. As time goes on the odds of the house value dropping below the purchase price goes down, and the interest payments (ie "rent") goes down as well which increases the odds of buying a house being worthwhile. People who expect only keep a house for a few years take on the greatest risk (or unexpected get forced out in a few years).
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Harold » Sat Feb 02, 2013 9:29 pm

Rodc wrote:
Harold wrote:
Default User BR wrote:
Harold wrote:If you lapse on your rent payments – you need to find a new place to live.

If you default on a mortgage, you lose your home asset, your down payment, all the mortgage payments you’ve made – and you need to find a new place to live.

That's totally irrelevant to the question. You "lost" all the rent as soon as it was paid. You are also making the assumption somehow that there isn't equity in the house and that it can't be sold for more than the outstanding balance. In some case that will be the case, other times not. But regardless, in either case you can view it as a zero when you stop paying. Rent or mortgage, you leave.

Trying to blend in the mortgage you pay with whatever equity and "imputed rent" and all the other stuff that comes with it into investing just makes no sense to me. The only sensible thing is to exclude it from asset allocation. That means that it is not a negative bond. The house is not an investment at all. It is shelter that you have worked a long-term payment plan for.


Brian

Brian, for both the homeowner and the renter, "rent" is lost as soon as it is paid, as I alluded to at the bottom of my post. Further, I haven't ignored "equity" in the home -- the home has been purchased, the buyer owns it, it's an asset of his and I never said otherwise. You have been presented with coherent descriptions and totally logical counters to your objections. And every single item I have mentioned is relevant.

You don't want to view it this way, and that's fine -- but there's no argument to be had.


If I rent I "lose" the rent every month to the same extent that if I have a mortgage I "lose" the interest payment. Money gone, though I do get a place to live. That much is a wash to the extent that in the early years interest is often in the ball park of rent (Only very roughly of course).

If I can't make my house payment I can sell my house for much more than I owe. I am not upside down, not by a long shot and in addition that house has appreciated by more than 100% over the last 20 year I have had it. If I have to sell in a hurry I may have to sell for less than I like, but I will walk away with a nice wad of cash, and I will have enjoyed the shelter for 20 years. Indeed I might decide I no longer want to bother with the upkeep or want to live in the burbs, I might decide to sell my house and go rent an apartment in the city. That would result in the same outcome. The reason why I want out has no bearing on the issue. So certainly not universal that losing the means to pay the rent results in all those losses you list.

It is certainly possible to get in a situation where you can no longer pay the mortgage and house value is down and you will lose money. The risk is real, but I don't think is well captured in the above quote. When you buy a house, like any investment, you take risk which may or may not show up, and you have some chance of making money. Unlike most investments, with a house you get a nice steady stream of returns in the form of a place to live. As time goes on the odds of the house value dropping below the purchase price goes down, and the interest payments (ie "rent") goes down as well which increases the odds of buying a house being worthwhile. People who expect only keep a house for a few years take on the greatest risk (or unexpected get forced out in a few years).

1) I used the word default intentionally. Of course one wouldn't be foreclosed on if he chooses to sell his home and pay off his mortgage.

2) A homeowners "rent" is far more than interest payments on his mortgage. Actually, I often don't even include interest when I'm calculating a homeowners "rent" (rather considering it borrowing costs, since homeowners who acquire other assets while maintaining a mortgage have a cost of borrowing to do so).
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Sun Feb 03, 2013 2:59 am

Harold wrote:Brian, for both the homeowner and the renter, "rent" is lost as soon as it is paid, as I alluded to at the bottom of my post. Further, I haven't ignored "equity" in the home -- the home has been purchased, the buyer owns it, it's an asset of his and I never said otherwise. You have been presented with coherent descriptions and totally logical counters to your objections. And every single item I have mentioned is relevant.

Obviously I disagree. I think your arguments amount to hand-waving. You want it to be a certain way, so you ignore the logical inconsistencies of trying to include a mortgage as a negative bond in the investment portfolio. It just makes little to no sense when you really look at the ramifications. Furthermore, any other required outflow such as rent could be included with as much justification, yet you want to ignore that.

Harold wrote:You don't want to view it this way, and that's fine -- but there's no argument to be had.

Why, because you don't want it? Sorry, it doesn't work that way.


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

Postby YDNAL » Sun Feb 03, 2013 8:45 am

MrMatt2532 wrote:YDNAL,

Yes, in fact all else is equal. When I say all else is equal that's exactly what it means. You could pretend none of the three people own a house,....

You just made-up your own thread since this thread deals with a mortgage note in AA decisions.
Compounding (OP) wrote:Subject: Treat your mortgage as a "negative exposure" to bonds?


MrMatt2532 wrote:Here's another example:
Person 1:
100k stocks
Person 2:
100k stocks
100k bonds
100k debt
Person 3:
50k stocks
50k bonds

Assume all else is equal. These three investors all have the same total value: 100k.

MrMatt2532 wrote:.... or you could pretend they all own 100k house.

Persons 1 & 3 then have $100K additional Net Worth -- NOT "all have the same total value: $100K".... flawed thinking!

MrMatt2532 wrote:The idea is besides the amount of stocks, bonds, and debt, all else is equal. It's a simple idea really.

It is so simple, yet you still get it wrong!
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Sun Feb 03, 2013 12:28 pm

YDNAL,

I don't know what to say. As market timer pointed out, it is important to separate the debt from the asset itself. You seem to be trying to confuse the situation by adding a house to some of the people and not the others when I clearly say all else is equal.
market timer wrote:To say that a mortgage is not a negative bond, because it was used to acquire a house, is akin to saying credit card debt is not a negative bond, because it was used to acquire some other stuff. Both mortgage and credit card debt are negative bonds. It is helpful to be able to separate conceptually debt used to acquire an asset from the asset itself, or else you might end up paying more in interest than needed.

Let me try to make my example clear one more time for you:
Person 1:
100k stocks
0k bonds
0k debt
Person 2:
100k stocks
100k bonds
100k debt
Person 3:
50k stocks
50k bonds
0k debt

Now, I didn't mention the house value, and that is important because it doesn't matter to make the point and in fact it only needlessly complicates things. Also, as you can see I used keyword debt instead of mortgage: this is important because it doesn't matter where the debt came from as long as all else is equal. If you'd like we can use 2 cases. Case 1 where they all own a house worth 125k and case 2 where they all do not own a house. In case 1: their net worth is 225k. In case 2: their net worth is 100k. This isn't complicated at all: net worth equals stocks+bonds+house-debt. For the case 1 where they all own a house you can pretend persons 1 and 3 paid off their mortgage. In case 2 you can pretend person 2 has a school loan that he isn't done paying it off. In the end of the day, all those details complicate things and again it doesn't matter how they acquired the debt or if they have a house as long as all else is equal.

My answer to the OP is that yes you should treat your mortgage (or any debt) as negative exposure to bonds and this example I make is my demonstration as to why it's important. The traditional approach would look at person 2 and 3 and say that they each have a 50/50 stock bond portfolio so that they both have a conservative portfolio. In reality, person 1 and 2 both have a 100/0 stock bond portfolio and it is only person 3 that has a 50/50 stock bond portfolio. This demonstrates that if you don't include debt as negative bonds, your portfolio may be actually riskier than you thought. As Harold mentioned: whether or not you treat your debt as a negative bond doesn't really matter, in reality it is one...
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby sls239 » Sun Feb 03, 2013 1:09 pm

It doesn't make sense to do that when talking about the basic rules of thumb (like age in bonds).

The reason it doesn't make sense to do so is that a mortgage is an alternative to rent and of the two, the mortgage - (assuming you are mortgaging something similar to what you would rent) is less risky over the long term. The basic rules of thumb don't count the risks of renting, and therefore shouldn't include the (lesser) risks of a mortgage either.

Rules of thumb are about market risks, they cannot take into account all personal risks. I mean if a mortgage is a negative bond, then what the hell would having a child be?

With that said, when you have money to allocate, paying down the mortgage is definitely an option which deserves to be compared to other options available in terms of market risk.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby YDNAL » Sun Feb 03, 2013 2:07 pm

MrMatt2532 wrote:YDNAL,

I don't know what to say. As market timer pointed out, it is important to separate the debt from the asset itself. You seem to be trying to confuse the situation by adding a house to some of the people and not the others when I clearly say all else is equal.

No, MrMatt, you are "confusing the OP's situtation."
Compounding (OP) wrote:Treat your mortgage as a "negative exposure" to bonds?

Unless you can obtain a mortgage note without "a house" as collateral, there is nothing else to discuss. And certainly your "example" and conclusions are wrong.
Last edited by YDNAL on Sun Feb 03, 2013 2:09 pm, edited 1 time in total.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Default User BR » Sun Feb 03, 2013 2:08 pm

I just don't see how anyone can run a scenario and seriously want to consider a mortgage a negative bond for investing purposes[1]. Let's look at something:

1. A house with a mortgage of 100k.
2. About 300k in 401(k) and IRAs, no taxable money (so nothing that can be "thrown at" the mortgage).

So, what is the portfolio? If the mortgage is a negative bond, then it has to be included in the portfolio as a negative asset. So is the portfolio size 200k? If the person desires a 70/30 asset allocation, does that mean 140k stocks, 60k bonds? Then in reality your accounts hold 140k stocks and 160k bonds.

It gets worse if the holdings are equal to or less than the mortgage. Then you have people holding no stocks at all for protracted periods. In particular you have young people avoiding the market at the best time for them to be in it, all in the name of servicing the "negative bond".

I will say a final time[2], the only thing that makes sense from an investing standpoint is to separate the home-owning situation, which includes the equity, the mortgage, the taxes and insurance (more required payments BTW), etc. from the portfolio. Just as you would for renting.


1. I am not now nor have I been talking about the mortgage from a view outside of the investments. If it's not included in the portfolio, then I don't care what you call it. Call it George if you want.

2. I mean this, if the examples don't make sense to people then I don't feel I can explain my point any better, so further contributions would be pointless.

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

Postby magician » Sun Feb 03, 2013 2:14 pm

YDNAL wrote:Unless you can obtain a mortgage note without "a house" as collateral, there is nothing else to discuss. And certainly your "example" and conclusions are wrong.

When you buy a house and take out a mortgage you have an asset (the house) and a liability (the mortgage). Liabilities can be considered negative assets. Whether it's a good idea to consider the mortgage a negative asset seems to be a good debate topic; it certainly seems that there is something to discuss.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby magician » Sun Feb 03, 2013 2:17 pm

Default User BR wrote:I just don't see how anyone can run a scenario and seriously want to consider a mortgage a negative bond for investing purposes[1]. Let's look at something:

1. A house with a mortgage of 100k.
2. About 300k in 401(k) and IRAs, no taxable money (so nothing that can be "thrown at" the mortgage).

So, what is the portfolio? If the mortgage is a negative bond, then it has to be included in the portfolio as a negative asset. So is the portfolio size 200k?

Only if the value of the house is $0.

If its value were, say, $150k (a more likely scenario), then the portfolio size is $350k: $300k in the 401(k) plus $50k in equity in the house.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Sun Feb 03, 2013 2:19 pm

Default User BR wrote:I just don't see how anyone can run a scenario and seriously want to consider a mortgage a negative bond for investing purposes[1]. Let's look at something:

1. A house with a mortgage of 100k.
2. About 300k in 401(k) and IRAs, no taxable money (so nothing that can be "thrown at" the mortgage).

So, what is the portfolio? If the mortgage is a negative bond, then it has to be included in the portfolio as a negative asset. So is the portfolio size 200k? If the person desires a 70/30 asset allocation, does that mean 140k stocks, 60k bonds? Then in reality your accounts hold 140k stocks and 160k bonds.

Yes this is all correct thinking.

I agree there are issues with young investors/investors where mortgage is greater than other assets. Again, I will bring up my other thread that tries to address this issue: viewtopic.php?f=10&t=109504

sls239,
You are right there are issues often when considering basic rules of thumb such as 'age in bonds' with considering mortgage as negative bonds. In this case the issue is with the simple formula 'age in bonds' and not with the fact that debt is like negative bonds. Again, see my above thread.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby magician » Sun Feb 03, 2013 2:23 pm

MrMatt2532 wrote:
Default User BR wrote:I just don't see how anyone can run a scenario and seriously want to consider a mortgage a negative bond for investing purposes[1]. Let's look at something:

1. A house with a mortgage of 100k.
2. About 300k in 401(k) and IRAs, no taxable money (so nothing that can be "thrown at" the mortgage).

So, what is the portfolio? If the mortgage is a negative bond, then it has to be included in the portfolio as a negative asset. So is the portfolio size 200k? If the person desires a 70/30 asset allocation, does that mean 140k stocks, 60k bonds? Then in reality your accounts hold 140k stocks and 160k bonds.

Yes this is all correct thinking.

The part about the portfolio being worth $200k is not correct thinking.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Sun Feb 03, 2013 2:30 pm

magician wrote:
MrMatt2532 wrote:
Default User BR wrote:I just don't see how anyone can run a scenario and seriously want to consider a mortgage a negative bond for investing purposes[1]. Let's look at something:

1. A house with a mortgage of 100k.
2. About 300k in 401(k) and IRAs, no taxable money (so nothing that can be "thrown at" the mortgage).

So, what is the portfolio? If the mortgage is a negative bond, then it has to be included in the portfolio as a negative asset. So is the portfolio size 200k? If the person desires a 70/30 asset allocation, does that mean 140k stocks, 60k bonds? Then in reality your accounts hold 140k stocks and 160k bonds.

Yes this is all correct thinking.

The part about the portfolio being worth $200k is not correct thinking.

Sure it is. Depends what you consider as part of the portfolio. In this case I'm not considering the value of the house.

Without the house, holding 140k stocks and 160k bonds and 100k in debt leads to a 140 in stocks and 60k in bonds or a stock/bond portfolio of 70/30.

With the house, say valued at 125k, then the total value is 300-100+125=325. Now the portfolio is 140k in stocks, 60k in bonds, and 125k in real estate. This would be a 43%/18.5%/38.5% in stocks/bonds/real estate.

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

Postby magician » Sun Feb 03, 2013 2:34 pm

MrMatt2532 wrote:
magician wrote:
MrMatt2532 wrote:
Default User BR wrote:I just don't see how anyone can run a scenario and seriously want to consider a mortgage a negative bond for investing purposes[1]. Let's look at something:

1. A house with a mortgage of 100k.
2. About 300k in 401(k) and IRAs, no taxable money (so nothing that can be "thrown at" the mortgage).

So, what is the portfolio? If the mortgage is a negative bond, then it has to be included in the portfolio as a negative asset. So is the portfolio size 200k? If the person desires a 70/30 asset allocation, does that mean 140k stocks, 60k bonds? Then in reality your accounts hold 140k stocks and 160k bonds.

Yes this is all correct thinking.

The part about the portfolio being worth $200k is not correct thinking.

Sure it is. Depends what you consider as part of the portfolio. In this case I'm not considering the value of the house.

How do you justify including the liability without including the asset that that liability was incurred to purchase? That seems . . . well . . . bizarre.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Rodc » Sun Feb 03, 2013 2:36 pm

I don't know why one would invent something like an anti-bond (negative bond). A mortgage is not an anti-bond, it is not liquid for one thing. If one wants to consider a mortgage in their asset allocation fine. But you don't have to invent something that is not really correct. Just include it as what is actually is.

But if you want to complexify things it seems you should do a complete job. Consider all assets and liabilities. If you have a mortgage, you also have a house (condo, etc). Count them both. If this is the path and you own your house outright then you still include it. You might also want to consider your human capital though that is a rather uncertain thing for most of us.

For the vast majority of people, I confess I don't see the practical benefit. Just decide how much stock market risk you are willing to take (and the need to make mortgage payments might be part of that) and pick an asset allocation.

Frankly we have only the crudest understanding of risk and return going forward. No one can really estimate the optimal stock/bond spit to better than maybe +/-10% no matter how fancy they get. No one knows what the expected real returns from stock is to better than +/- a couple of percent at best (and what they actually get they far less knowledge of).

What is being discussed here is way out in the noise.

My feeling is that going down this sort of path is wasted energy at best. If you keep it simple you are less likely to do something goofy.
Last edited by Rodc on Sun Feb 03, 2013 2:37 pm, edited 1 time in total.
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby MrMatt2532 » Sun Feb 03, 2013 2:36 pm

magician wrote:How do you justify including the liability without including the asset that that liability was incurred to purchase? That seems . . . well . . . bizarre.

Again: simple answer as previously talked about. I consider the home a consumption item, not an investment. Now, as I've demonstrated you can include the home in the portfolio if you really want, the choice is yours!
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby Rodc » Sun Feb 03, 2013 2:39 pm

MrMatt2532 wrote:
magician wrote:How do you justify including the liability without including the asset that that liability was incurred to purchase? That seems . . . well . . . bizarre.

Again: simple answer as previously talked about. I consider the home a consumption item, not an investment. Now, as I've demonstrated you can include the home in the portfolio if you really want, the choice is yours!


Well, if you can invent something like an anti-bond and consider your mortgage to be such a fictitious thing, I suppose you can define your house to be consumption item as well. :)
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Re: Treat your mortgage as a "negative exposure" to bonds?

Postby YDNAL » Sun Feb 03, 2013 2:45 pm

magician wrote:
YDNAL wrote:Unless you can obtain a mortgage note without "a house" as collateral, there is nothing else to discuss. And certainly your "example" and conclusions are wrong.

When you buy a house and take out a mortgage you have an asset (the house) and a liability (the mortgage). Liabilities can be considered negative assets. Whether it's a good idea to consider the mortgage a negative asset seems to be a good debate topic; it certainly seems that there is something to discuss.

The partial quote above has nothing to do with a Liability as reduction of Net Worth - something I addressed previously here and other similar threads.
  • BTW, there is no such thing as "negative Asset" - even in cases, as in recent history, of a mortgage note (Liability) that exceed a house's (Asset) fair market value.
  • Negative Net Worth... sure.
    Assets - Liabilities = Net Worth

The partial quote addressed a previous poster's attempt to exclude the Asset - as if a mortgage note exists while the Asset doesn't exist.
YDNAL wrote:
MrMatt2532 wrote:YDNAL,

.... You seem to be trying to confuse the situation by adding a house to some of the people and not the others when I clearly say all else is equal. (my emphasis)

No, MrMatt, you are "confusing the OP's situtation."
Compounding (OP) wrote:Treat your mortgage as a "negative exposure" to bonds?

Unless you can obtain a mortgage note without "a house" as collateral, there is nothing else to discuss. And certainly your "example" and conclusions are wrong.
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