Does paying off your mortgage affect your asset allocation?

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Does paying off your mortgage affect your asset allocation?

Postby ot1138 » Thu Apr 04, 2013 12:51 pm

I came into a windfall and instead of putting the money in my portfolio, I paid off my mortgage which was at 4.25%. Should this be considered in determining my bond allocation?

Eg: I'm not paying the 4.25% now, so that's effectively a fixed income investment over the remaining period of my former mortgage (26 years). Should I reduce my bonds from 35% to something smaller in light of that?
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Re: Does paying off your mortgage affect your asset allocati

Postby rkhusky » Thu Apr 04, 2013 1:25 pm

ot1138 wrote:I came into a windfall and instead of putting the money in my portfolio, I paid off my mortgage which was at 4.25%. Should this be considered in determining my bond allocation?

Eg: I'm not paying the 4.25% now, so that's effectively a fixed income investment over the remaining period of my former mortgage (26 years). Should I reduce my bonds from 35% to something smaller in light of that?


I would not consider it part of your AA. It's part of your net worth and affects how much income you'll need in retirement.
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Re: Does paying off your mortgage affect your asset allocati

Postby bobcat2 » Thu Apr 04, 2013 1:31 pm

Paying off your mortgage allows you to save more of your income, but keep the same standard of living. A good case can be made that it allows you to decrease the amount of risk in your portfolio, i.e. hold a higher percentage in bonds than before.

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Re: Does paying off your mortgage affect your asset allocati

Postby YDNAL » Thu Apr 04, 2013 1:37 pm

ot1138 wrote:I came into a windfall and instead of putting the money in my portfolio, I paid off my mortgage which was at 4.25%. Should this be considered in determining my bond allocation?

In the simplest sense, you have a new Balance Sheet with less Cash and less Debt. How this affects your AA (Stock/Bond split) should be driven by the new Ability & Need to take risk. A strong argument can be made that your Need to take risk is reduced (see below).

ot1138 wrote:Eg: I'm not paying the 4.25% now, so that's effectively a fixed income investment over the remaining period of my former mortgage (26 years). Should I reduce my bonds from 35% to something smaller in light of that?

It is only an investment IF you save it (and not blow it on annual trips to Vegas :D ).
  • This interest expense that you eliminated (as well as principal portion) is available cash flow that could/should be invested.
  • Since I believe you lowered Need to take risk - whether by investing the windfall directly or reducing debt as you did - you could increase Bonds in your current investable Assets.
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Re: Does paying off your mortgage affect your asset allocati

Postby The Wizard » Thu Apr 04, 2013 1:42 pm

My quick answer is: No, it should not affect your AA.

The longer answer is: you are now approaching the Boglehead rathole about what to do once you achieve your "number" since your monthly payments are now less (and your monthly savings possibly more). Some folks stay the course with their AA even though they have double the amount need to live on for next 40 years. Others "quit playing the game" once they've won.
Myself, I don't consider it a game and hence, I maintain my AA, adjusted incrementally for age...
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Re: Does paying off your mortgage affect your asset allocati

Postby harikaried » Thu Apr 04, 2013 1:55 pm

There was an interest post a few weeks ago asking about people's ratios of home equity to net worth:
viewtopic.php?f=2&t=112832

As you pay more principal towards your mortgage or pay it off, you increase the amount of home equity. So if you consider the house as part of your overall assets, a larger percentage is dedicated to the single property.
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Re: Does paying off your mortgage affect your asset allocati

Postby YDNAL » Thu Apr 04, 2013 1:56 pm

The Wizard wrote:.... your monthly payments are now less (and your monthly savings possibly more). Some folks stay the course with their AA even though they have double the amount need to live on for next 40 years. Others "quit playing the game" once they've won. Myself, I don't consider it a game and hence, I maintain my AA, adjusted incrementally for age.

I believe that it doesn't make sense to maintain the AA when personal circumstances change and/or financial goals are met... there is such thing as marginal utility of wealth (and all).

Here's what I'm talking about, ot1138 (OP).
Link - http://www.investmentadvisornow.com/inv ... edroe.html
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Re: Does paying off your mortgage affect your asset allocati

Postby Ketawa » Thu Apr 04, 2013 2:03 pm

harikaried wrote:As you pay more principal towards your mortgage or pay it off, you increase the amount of home equity. So if you consider the house as part of your overall assets, a larger percentage is dedicated to the single property.


I disagree with this. Your equity in your home does increase when you pay off a mortgage. However, the amount of your overall assets that is dedicated to your home has not changed. Brief example:

Before
$100k portfolio
$-50k mortgage
$100k home
$150k total

After
$50k portfolio
$100k home
$150k total

The mortgage balance and home value are not related except for the issue that the home is collateral for the mortgage, which only comes into play in a default.
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Re: Does paying off your mortgage affect your asset allocati

Postby pastafarian » Thu Apr 04, 2013 2:10 pm

YDNAL wrote:Here's what I'm talking about, ot1138 (OP).
Link - http://www.investmentadvisornow.com/inv ... edroe.html

Something about that URL keeps crashing Safari on my iPad. To the OP, paying off our mortgage did not cause us to alter our AA. But the tumult of 2008 caused us to make changes.
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Re: Does paying off your mortgage affect your asset allocati

Postby YDNAL » Thu Apr 04, 2013 2:21 pm

pastafarian wrote:
YDNAL wrote:Here's what I'm talking about, ot1138 (OP).
Link - http://www.investmentadvisornow.com/inv ... edroe.html

Something about that URL keeps crashing Safari on my iPad. To the OP, paying off our mortgage did not cause us to alter our AA. But the tumult of 2008 caused us to make changes.

It is a link to Buckingham Asset Management piece by Larry Swedroe from Thursday, 26 August 2010 and titled "How Do You Know When You Have Enough?" I believe Larry adapted some of this in a CBS Money Watch piece - I'll try to find that.

I just re-opened it and work just fine. Sorry!
Last edited by YDNAL on Thu Apr 04, 2013 2:22 pm, edited 1 time in total.
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Re: Does paying off your mortgage affect your asset allocati

Postby jsl11 » Thu Apr 04, 2013 2:22 pm

The amount of risk you should take is determined by your willingness, need, and ability to take the risk. Since you now have more money to invest, and lower expenses, your ability to take risk (higher percentage of stocks) has increased. However, your need to take that risk has decreased. Some people put more emphasis on ability, while others look at need as being the determining factor. I would suggest not to take any more risk than you need. Stocks are great when they are going up, as they have the last few years. However, I suggest recalling 2008 and how you felt about losing about half of the value of your stocks. Limiting risk is good if you can afford it.
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Re: Does paying off your mortgage affect your asset allocati

Postby YDNAL » Thu Apr 04, 2013 2:24 pm

YDNAL wrote:
pastafarian wrote:
YDNAL wrote:Here's what I'm talking about, ot1138 (OP).
Link - http://www.investmentadvisornow.com/inv ... edroe.html

Something about that URL keeps crashing Safari on my iPad. To the OP, paying off our mortgage did not cause us to alter our AA. But the tumult of 2008 caused us to make changes.

It is a link to Buckingham Asset Management piece by Larry Swedroe from Thursday, 26 August 2010 and titled "How Do You Know When You Have Enough?" I believe Larry adapted some of this in a CBS Money Watch piece - I'll try to find that.

I just re-opened it and work just fine. Sorry!

Here is the CBS piece (hope it works) - not the same, but the same message.
Link - http://www.cbsnews.com/8301-505123_162- ... tag=mwuser
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Re: Does paying off your mortgage affect your asset allocati

Postby The Wizard » Thu Apr 04, 2013 2:25 pm

YDNAL wrote:
The Wizard wrote:.... your monthly payments are now less (and your monthly savings possibly more). Some folks stay the course with their AA even though they have double the amount need to live on for next 40 years. Others "quit playing the game" once they've won. Myself, I don't consider it a game and hence, I maintain my AA, adjusted incrementally for age.

I believe that it doesn't make sense to maintain the AA when personal circumstances change and/or financial goals are met... there is such thing as marginal utility of wealth (and all).

Here's what I'm talking about, ot1138 (OP).
Link - http://www.investmentadvisornow.com/inv ... edroe.html

Yes, that link brings up exactly what I'm talking about. But the example of the 70-yr old couple whose investments went from $13M to $3M from 2000 to 2003 is instructive. That couple probably did NOT maintain an age-appropriate AA.

Here's another way of looking at my point. Let's say I'm living OK at age 65 with a $2M portfolio invested with a 50/50 AA. Now let's say a $2M windfall comes in and now I've got $4M invested, still at 50/50 AA, I claim I'm now LESS likely to be eating Alpo at age 85 than I was previously.
But if stock price fluctuations make one nervous, then by all means...
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Re: Does paying off your mortgage affect your asset allocati

Postby YDNAL » Thu Apr 04, 2013 2:35 pm

The Wizard wrote:Here's another way of looking at my point. Let's say I'm living OK at age 65 with a $2M portfolio invested with a 50/50 AA. Now let's say a $2M windfall comes in and now I've got $4M invested, still at 50/50 AA, I claim I'm now LESS likely to be eating Alpo at age 85 than I was previously.
But if stock price fluctuations make one nervous, then by all means...

In that sense, why not increase consumption 2-fold ? :)
  • Actually, a 65yo with $2 million can consume $60K+ annually and not be anywhere near Alpo territory in 20 (age 85), even 30 years.
  • Change in personal circumstances, from an additional $2 million, should shift the portfolio's goal from mostly consumption item to legacy for the most part. To each his/her own, right?
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Re: Does paying off your mortgage affect your asset allocati

Postby The Wizard » Thu Apr 04, 2013 2:40 pm

YDNAL wrote:...Change in personal circumstances, from an additional $2 million, should shift the portfolio's goal from mostly consumption item to legacy for the most part. To each his/her own, right?[/list]

Legacy, exactly right, whether charitable causes or grandchildren's college expenses.
So this is the thinking-split that each person has to decide about...
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Re: Does paying off your mortgage affect your asset allocati

Postby ot1138 » Thu Apr 04, 2013 3:05 pm

YDNAL wrote:
The Wizard wrote:.... your monthly payments are now less (and your monthly savings possibly more). Some folks stay the course with their AA even though they have double the amount need to live on for next 40 years. Others "quit playing the game" once they've won. Myself, I don't consider it a game and hence, I maintain my AA, adjusted incrementally for age.

I believe that it doesn't make sense to maintain the AA when personal circumstances change and/or financial goals are met... there is such thing as marginal utility of wealth (and all).

Here's what I'm talking about, ot1138 (OP).
Link - http://www.investmentadvisornow.com/inv ... edroe.html


So that's an interesting link because it illustrates that the mix between mortgage and equity doesn't really change anything. Assets - Liabilities remains unchanged so in effect, nothing has altered except that my future income is now increased by the amount of interest I no longer have to pay (and this has to be discounted for time and foregone tax deductions).

I currently could not live off of the interest safely (eg: 4% annual withdrawal) from my liquid assets, so I wouldn't consider myself "wealthy". From that standpoint, I should still be taking on enough risk to meet my goals. On the other hand, if I were to sell my house then I would be able to live off of the interest (although not live really well). So from that perspective, I should be taking less risk.

So it sounds like basically the answer is no, the bond portion of my portfolio isn't really affected by this. BTW, I have 35% in bonds (age 41).
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Re: Does paying off your mortgage affect your asset allocati

Postby Random Walker » Thu Apr 04, 2013 3:17 pm

For me a huge benefit of paying off the mortgage was psychological. With mortgage paid off, I felt more financially strong to withstand the ups and downs of an aggressive asset allocation.
To me it didn't really make sense to be paying higher interest on a mortgage than the bond portion of my portfolio was earning. Paid off mortgage builds financial muscles; increases the ability to take risk.

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Re: Does paying off your mortgage affect your asset allocati

Postby MrMatt2532 » Thu Apr 04, 2013 3:21 pm

Personally, I do account for a mortgage in my asset allocation and therefore I would say what you did does have an effect on your AA.

Without going into any math, essentially you have more ability to take risk now, but you also have less need to take risk, so it is not clear cut whether any change is warranted.
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Re: Does paying off your mortgage affect your asset allocati

Postby Blues » Thu Apr 04, 2013 3:57 pm

In my view, taking into consideration one's age, health and employment status, this quote from Larry is the crux:

However, the ability and willingness to take risk are only two of the three criteria for an investment policy. There is a third (often overlooked) criterion — the need to take risk. A great irony is that the very people with the most ability and willingness to take risk have the least need to take it.


Personally, I think this resonates quite well with Bill Bernstein's recent advice about having a "liability matching portfolio" (LMP) made up of safe investments which can accommodate your shortfall (after pensions, SS and other sources of guaranteed income) for a minimum of 20-25 years...and an auxiliary "risk portfolio" (RP) which addresses your future hopes, dreams and desires.

With that hybrid you can take care of "need" on the one hand...and "ability" and "willingness" to take on risk on the other. My two cents.
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Re: Does paying off your mortgage affect your asset allocati

Postby pastafarian » Thu Apr 04, 2013 4:18 pm

Blues wrote:In my view, taking into consideration one's age, health and employment status, [snip] My two cents.

So does the OP mark you down as Yes or No? :P Did you alter your AA when you paid off your mortgage?
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Re: Does paying off your mortgage affect your asset allocati

Postby Blues » Thu Apr 04, 2013 4:41 pm

pastafarian wrote:
Blues wrote:In my view, taking into consideration one's age, health and employment status, [snip] My two cents.

So does the OP mark you down as Yes or No? :P Did you alter your AA when you paid off your mortgage?


Yes. I've taken my own medicine and incorporated the advice summarized above into my own portfolio.
Since I have a pension, no debt and little need to take on (much) additional risk, I've reduced my equity exposure to 20-25% of my portfolio.

(Pastafarian, for the life of me I don't know why but for some reason replying to you makes me want jerk chicken tortellini for dinner. :oops: )
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Re: Does paying off your mortgage affect your asset allocati

Postby billyt » Thu Apr 04, 2013 4:45 pm

I am near retirement and am 40/60 stocks/bonds. I currently rent and am planning on buying a small home after retirement. Should I change my asset allocation after I buy the house?
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Re: Does paying off your mortgage affect your asset allocati

Postby grabiner » Thu Apr 04, 2013 7:26 pm

I would say that paying off a mortgage should affect your asset allocation because it eliminates certain fixed future expenses. Alternatively, you could have counted the mortgage as a negative bond in your allocation, and then it would cancel out if you sold bonds to pay it off.

Suppose that part of your asset allocation is a bond portfolio which will pay $20,000 per year for the next 10 years (an intermediate-term bond fund with about $160,000 would be a portfolio of this type), and you also have 10 years left on your mortgage with a $160,000 balance and payments due of $20,000 per year. You also have other investments, and the trade-off between risk and reward is acceptable for you.

Now, you decide to sell the bond portfolio to pay off your mortgage. Your risk and reward haven't changed; you got rid of matching payments and obligations. Therefore, your allocation shouldn't change; you got rid of $160,000 of bonds and $160,000 of negative bonds. If you view the mortgage as a negative bond, then your allocation didn't change.

The OP received a windfall, and that windfall itself hould have changed his asset allocation. The windfall might have led him to switch to a more conservative portfolio (if he planned to use it to retire early), or a more aggressive portfolio (if he now had more money than he needed for his own retirement, and was investing the windfall money for his own children).
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Re: Does paying off your mortgage affect your asset allocati

Postby Default User BR » Fri Apr 05, 2013 1:46 am

ot1138 wrote:I came into a windfall and instead of putting the money in my portfolio, I paid off my mortgage which was at 4.25%. Should this be considered in determining my bond allocation?

I don't think so.


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Re: Does paying off your mortgage affect your asset allocati

Postby LH » Fri Apr 05, 2013 5:19 am

You went from having actual bonds- negative bond (aka mortgage) = "total bonds"

to

just having bonds=bonds.

This has likely (depending on the relative size), substantially increased your bond holdings.

Therefore, you can decrease your bonds, and increase stocks.

Now, this is to the extent that

1)It does not increase your capitulation risk
2)that it affects the riskness of your portfolio significantly.

The whole mortgage as a negative bond is one way of looking at it, but a mortgage is not in fact a negative bond. One does not rebalance the mortgage, and even with the mortgage, one can still rebalance the with FULL amount of the bonds present.

ie, if you have 100K mortage, and 100K bonds, you have ZERO net bonds to one way of looking at it..... BUT, if you have 100K morgage, 100K stocks, and 100K bonds, in a 50/50 stock bond split, and the stock market drops 50 percent, well, you can STILL rebalance with the bonds, buy buying stocks low to the tune of 25K, and selling the bonds(likely high if in a bond fund, or non ibond, as price would likely go up) high to the tune of 25K, resulting in
75K bonds, 75 K stock...... this even though, you have "zero net bonds" since 100K mortage=-100K bond. -100K+actual 100K bond= zero....

So, you still have bonds in reality. You can still rebalance.

so..... the answer is yes, it does influence my way of thinking about risk. To me, it means any given portfolio is LESS RISKY, than a portfolio with a mortgage.

By owning home, you have less need of cash flow, your minimum level you need is easier to achieve safely, therefor can take more risk. Also, house worth is usually less volatile than the stock market. A house is bond like to some extent (a zero return bond, a house can be considered about equal to an ibonds zero real return, not here, do not conflate it, I am talking about the house equity ONLY=ibond like, ie both home and current ibonds expectantly hold thier real value..... I am not talking about the mortage, the mortage is more akin to a bond with actual return by paying it off, ie a mortage =negative bond)

Home ownership affects risk qualitatively, not quantitatively that I can ascertain.

Net Worth is the big picture..... Your asset allocation is just one piece of that.

Its risk to NET WORTH, that you really care about. In the end, its net worth you can buy snickers bars, medical care, etc. with.

The money you put into your home, does not fall into a conceptual black hole.


2)Another way of looking at this is leverage.

A mortage is leverage

Leverage = risk.

No leverage = less risk.

So, by that rubric, paying off your mortage, has decreased your risk. Qualitatively, then, you can increase your stock risk.... and still have the same risk you had before to some extent at least.
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