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ram
Joined: 01 Jan 2008
Posts: 102
Location: Midwest
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 Posted: Sun Nov 29, 2009 8:42 pm Post subject: Does mortgage prepayment equal bond investment |
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My wife recently went to full time work and our family income increased by 84000/year post tax. When she was working part time our savings/expenses were-
Both 401K -- -------------33000
Both traditional IRA------10000 ( not eligible for Roth)
529 for 2 kids ------------ 6000
Retirement accounts ----19000 (employer paid)
Taxable savings ------- 12000
Mortgage and RE taxes 27000 ( 15 yr, 4.5 % fixed)
When she was part time we saved 20% in bonds (16000/Yr) and 80% in stocks (64000). All bonds are tax sheltered. Our asset allocation is stock /bond = 90/10% at present. Plan is to increase bond allocation by 2.5 % each year from my present age of 45 so that by age 65 I am 60 bonds/40 stock.
We are bogleheadish in our lifestyle. 65000 out of the 84000 additional income is now paid as mortgage prepayment. At this rate the mortgage will be paid in 2.5 yrs. Neither of the 2 kids are in college now and both will be in 2.75 yrs. I will want to have the mortgage paid by then.
At present I am investing 100% in stocks
Question 1. Is it reasonable to assume that my obligation to invest in bonds as dictated by my asset allocation is fulfilled by mortgage prepayment?
Question 2. Should I actually pull money out of my meagre bond savings and buy stocks. Asset allocation dictates this if we assume that a dollar of mortgage prepayment equals a dollar of bond investment.
Another point to note- The intt rates will likely rise in 2.5 yrs and bond rates would have dropped. By then I would have paid up my mortgage and will be ready to buy bonds again.
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Ram
Last edited by ram on Sun Nov 29, 2009 9:16 pm; edited 1 time in total |
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DSInvestor
Joined: 04 Oct 2008
Posts: 2564
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| Posted: Sun Nov 29, 2009 9:03 pm Post subject: |
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401k max is 16.5K per person or 33K/yr. Are you prevented from maxing out 16.5K each?
I would not consider the mortgage prepayments as bond purchases. When the debt is gone, how much in bonds will you have if you buy 100% stocks for a few years? 5%, 6%? I suspect you may bond allocation may be below target.
If anything, the mortgage is a negative bond. If you have 100K bonds and have a 100K mortgage, I'd argue that you have no net allocation to bonds at all. |
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ram
Joined: 01 Jan 2008
Posts: 102
Location: Midwest
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| Posted: Sun Nov 29, 2009 9:15 pm Post subject: |
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| DSInvestor wrote: | 401k max is 16.5K per person or 33K/yr. Are you prevented from maxing out 16.5K each?
When the debt is gone, how much in bonds will you have
If anything, the mortgage is a negative bond. |
DS Investor- My mistake 33 K is being invested in 401K.
- I will have about 5% in bonds in 2.5 yrs.
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Ram |
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DSInvestor
Joined: 04 Oct 2008
Posts: 2564
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| Posted: Sun Nov 29, 2009 9:24 pm Post subject: |
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| ram wrote: | | DSInvestor wrote: | 401k max is 16.5K per person or 33K/yr. Are you prevented from maxing out 16.5K each?
When the debt is gone, how much in bonds will you have
If anything, the mortgage is a negative bond. |
DS Investor- My mistake 33 K is being invested in 401K.
- I will have about 5% in bonds in 2.5 yrs. |
You're currently 90/10 and looking to be 82.5/17.5 in 3 yrs, right?
If your purchases will take you down to 5% bonds, you'll need to triple your bond allocation from 5% to 17.5%. If you buy more bonds with your new contributions to keep you close to desired allocation you can avoid big moves in 3 yrs. If you're nervous about rising interest rates, you can consider short term bond funds. |
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ram
Joined: 01 Jan 2008
Posts: 102
Location: Midwest
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| Posted: Sun Nov 29, 2009 9:45 pm Post subject: |
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[quote="DSInvestor"]mortgage is a negative bond.
Lets assume my total assets(disregarding mortgage) are 500K as of today
Bonds +50 K
Negative Bonds ( mortgage) -200K
Stocks +450K
--------------- Total +300K.
After 2.5 years
Bonds +50 K
Negative Bonds (mortgage) 0 K
Stocks +650 K
----------------- Total +700K
Thus I have gone from -150 K bonds to +50 K bonds, i.e. I have bought bonds of 200K while investing 200 K in stocks.
Previously I had less than 0% in bonds and now I have 7% which is certainly in line with my 2.5% per year of additional bond allocation.
Based on what you say I seem to be doing the right thing. ( Is retiring a negative bond not same as adding a positive bond)
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Ram |
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DSInvestor
Joined: 04 Oct 2008
Posts: 2564
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| Posted: Sun Nov 29, 2009 9:58 pm Post subject: |
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| ram wrote: | | DSInvestor wrote: | | mortgage is a negative bond. |
Lets assume my total assets(disregarding mortgage) are 500K as of today
Bonds +50 K
Negative Bonds ( mortgage) -200K
Stocks +450K
--------------- Total +300K.
Net bond position is -150K.
Desired bond position is 10% or 30K. You're 180K short on bonds.
After 2.5 years
Bonds +50 K
Negative Bonds (mortgage) 0 K
Stocks +650 K
----------------- Total +700K
Net bond position is 50K
Desired bond position is 17.5% or $122,500. You're 72K short on bonds.
Stocks are high by 72K.
Thus I have gone from -150 K bonds to +50 K bonds, i.e. I have bought bonds of 200K while investing 200 K in stocks.
Previously I had less than 0% in bonds and now I have 7% which is certainly in line with my 2.5% per year of additional bond allocation.
Based on what you say I seem to be doing the right thing. |
The mortgage prepayments get rid of the negative bond but you're still short on the bond allocation. If you buy both stocks and bonds while you prepay the mortgage, you'd keep the portfolio closer to desired AA. Instead of buying 200K stocks over the next 2.5 years, you can buy 130K stocks and 70K bonds to stay closer to desired AA. |
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sommerfeld
Joined: 12 Dec 2008
Posts: 754
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| Posted: Mon Nov 30, 2009 5:46 pm Post subject: |
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| ram wrote: | Thus I have gone from -150 K bonds to +50 K bonds, i.e. I have bought bonds of 200K while investing 200 K in stocks.
Previously I had less than 0% in bonds and now I have 7% which is certainly in line with my 2.5% per year of additional bond allocation.
Based on what you say I seem to be doing the right thing. |
The trick is to compare apples & apples -- if you want to view the mortgage as a negative bond, describe your asset allocation accordingly. As described above, you are levered up to an asset allocation of 150% stock, -50% bond, and will shift to a less risky 93%/7% allocation as you retire the negative bond.
| Quote: | | (Is retiring a negative bond not same as adding a positive bond) |
there's one way it's better than adding a positive bond: it is zero risk to you, whereas any real bond you buy will have some inherent risk.
(all this assumes you have a fully funded cash emergency fund, of course). |
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ram
Joined: 01 Jan 2008
Posts: 102
Location: Midwest
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| Posted: Tue Dec 01, 2009 12:16 am Post subject: |
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[quote="sommerfeld"]The trick is to compare apples & apples -- if you want to view the mortgage as a negative bond, describe your asset allocation accordingly. As described above, you are levered up to an asset allocation of 150% stock, -50% bond, and will shift to a less risky 93%/7% allocation as you retire the negative bond.[quote]
Thanks. I am reassured that I am moving to a less risky position. Assuming that in case of job loss we will stop the extra payment for mortgage we have 12 mo of emergency funds, our both jobs are stable and we can survive on any one salary.
However as DS investor has pointed out I need to put some money in real bonds as well.
Question- Is it OK to put it in 1 yr CD instead of a bond fund?
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Ram |
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