How to treat a mortgage in context of long term investment

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kiddoc
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How to treat a mortgage in context of long term investment

Post by kiddoc » Wed May 02, 2018 8:47 pm

Previously, we established that a mortgage is essentially a negative bond with a negative yield = mortgage interest rate for the duration of the mortgage Mortgage: negative yield bond

So how do people treat a mortgage when deciding about investments in taxable accounts? My mortgage interest rate is 3.875%. Because of the higher standard deduction, I cannot itemize and will get no tax benefit (for at least as long the current rules are in place). Does this mean that any new investment into an asset class with an expected 15 year return less than 3.875% should go to paying off the mortgage instead?

Since money is fungible, it almost feels like when I am investing in bonds, I am borrowing money at 3.875% to invest at 2.5-3.5%. On the other hand, the liquidity and re-balancing benefits of bonds in a portfolio cannot be under-stated. :annoyed

This only applies to taxable accounts. Retirement account contributions will remain unchanged.

Edit: If it helps, 403b and backdoor Roth IRA (him and her) are being fully funded. No access to HSA. Marginal tax rate: fed 24% state 5%
"The four most dangerous words in investing are: 'this time it's different.'" - Sir John Templeton

runner540
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Re: How to treat a mortgage in context of long term investment

Post by runner540 » Wed May 02, 2018 10:18 pm

If you are investing in taxable while holding a mortgage at 3.875%, you are indeed betting that your aftertax rerurns will be higher than 3.875% (you're paying the mortgage with after tax dollars).

EHEngineer
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Re: How to treat a mortgage in context of long term investment

Post by EHEngineer » Wed May 02, 2018 11:47 pm

kiddoc wrote:
Wed May 02, 2018 8:47 pm
Does this mean that any new investment into an asset class with an expected 15 year return less than 3.875% should go to paying off the mortgage instead?

Since money is fungible, it almost feels like when I am investing in bonds, I am borrowing money at 3.875% to invest at 2.5-3.5%. On the other hand, the liquidity and re-balancing benefits of bonds in a portfolio cannot be under-stated. :annoyed
I understand your concern. I built a spreadsheet to track my "true AA" including debts (mortgage and student loans). Some other concerns occurred to me.... Should I add the value of my home as a "REIT" investment in my AA? How do I avoid impacting my AA if I make an extra mortgage payment using money that is not retirement savings (maybe from a bonus or pay increase)? How do I keep my regular monthly mortgage payments and decreasing loan principal from affecting my asset allocation?

I believe there are two ways to avoid the confusion.
Method 1) Treat your mortgage payemnt as an expense, just like you would a rent payment. (I haven't seen anyone accounting for rental agreements as a negative bond). This essentially ignores your question, which is not satisfying, but it's simple and workable.
Method 2) Write up a loan agreement between your retirement portfolio and yourself, and pay your retirement portfolio back per the terms of that loan agreement. In this scenario, you don't include your mortgage as a negative bond in your AA. But, your retirement portfolio can "loan" you money at a fixed rate for a fixed term to pay down your mortgage (or anything else). But you must pay your retirement portfolio back each month.

For example:
Before the loan:
Monthly retirement savings: $2000
Portfolio $400,000 Total Stock Market, $100,000 Total Bond Market (80/20 AA)
Mortgage payment: $2387.08/month (principal and interest) for a $500,000 inital loan amount 30 year fixed at 4% ($472,493 principal and 27 years remaining)
Total retirement and mortgage payment: $4387.08/month

After the loan:
Monthly retirement savings: $2000
Portfolio $400,000 Total Stock Market, $50,000 Total Bond Market, $50,000 loan to self (80/20 AA) * TBM and 'loan to self' values will adjust each month
Mortgage: $2387.08/month (principal and interest) for a $500,000 inital loan amount 30 year fixed at 4% ($422,493 principal and ~24 years remaining)
Loan from retirement portfolio: $252.60/month (principal and interest) for a $50,000 loan amount 27 year fixed at 4%
Total retirement + mortgage + self loan payment: $4639.68/month (+252.60)

If your mortgage company will "recast" your mortgage you can lower the payment to allow the loan to be paid over the original term.
Monthly retirement savings: $2000
Portfolio $400,000 Total Stock Market, $50,000 Total Bond Market, $50,000 loan to self (80/20 AA) * TBM and 'loan to self' values will adjust each month
Recast mortgage payment: $2134.48 for a $500,000 inital loan amount 30 year fixed at 4% ($422,493 principal and 27 years remaining)
Loan from retirement portfolio: $252.60/month (principal and interest) for a $50,000 loan amount 27 year fixed at 4%
Total retirement + mortgage + self loan payment: $4387.08 (same as before the loan)
Or, you can ... decline to let me, a stranger on the Internet, egg you on to an exercise in time-wasting, and you could say "I'm probably OK and I don't care about it that much." -Nisiprius

mrpotatoheadsays
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Re: How to treat a mortgage in context of long term investment

Post by mrpotatoheadsays » Thu May 03, 2018 12:55 am

Your home isn't an investment; it's a place to live. Pay off the mortgage as soon as possible without any extremes.

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Chan_va
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Re: How to treat a mortgage in context of long term investment

Post by Chan_va » Thu May 03, 2018 1:09 am

Op, you are mostly right with 2 caveats

1. The "duration" of a 30 year fixed rate mortgage is closer to 9 years, so you would compare it to a bond of that duration
2. A fixed rate mortgage has option value wrt inflation/deflation. You can think of it as a non callable negative bond, but you have the option to recast it anytime. This is unique and hard to place an exact value on without trying to predict inflation. I would value it at least 100 bps.

grettman
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Re: How to treat a mortgage in context of long term investment

Post by grettman » Thu May 03, 2018 5:52 am

Chan_va wrote:
Thu May 03, 2018 1:09 am
Op, you are mostly right with 2 caveats

1. The "duration" of a 30 year fixed rate mortgage is closer to 9 years, so you would compare it to a bond of that duration.
Why?

kiddoc
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Re: How to treat a mortgage in context of long term investment

Post by kiddoc » Thu May 03, 2018 5:33 pm

Chan_va wrote:
Thu May 03, 2018 1:09 am
1. The "duration" of a 30 year fixed rate mortgage is closer to 9 years, so you would compare it to a bond of that duration
I couldn't understand that either. :confused

EHEngineer's plan to "loan money from your bond allocation" does sound interesting. However, it will increase the overall portfolio risk while I am carrying debt. Might be reasonable to do that with some of the allocation.
"The four most dangerous words in investing are: 'this time it's different.'" - Sir John Templeton

Trezcan
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Re: How to treat a mortgage in context of long term investment

Post by Trezcan » Thu May 03, 2018 5:48 pm

grettman wrote:
Thu May 03, 2018 5:52 am
Chan_va wrote:
Thu May 03, 2018 1:09 am
Op, you are mostly right with 2 caveats

1. The "duration" of a 30 year fixed rate mortgage is closer to 9 years, so you would compare it to a bond of that duration.
Why?
It may be a reference to the fact most people don't stay in their homes for 30 years, but rather move every nine or so years. At which point, a new 30 year mortgage is established.

Dottie57
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Re: How to treat a mortgage in context of long term investment

Post by Dottie57 » Thu May 03, 2018 6:00 pm

I thibk of my home as a place to live. I also need to maintain it. It doesn’t bring me money unless I choose tolive elsewhere.

More xpense than asset. I count it in net worth since it is paid off.

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Watty
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Re: How to treat a mortgage in context of long term investment

Post by Watty » Thu May 03, 2018 6:07 pm

runner540 wrote:
Wed May 02, 2018 10:18 pm
If you are investing in taxable while holding a mortgage at 3.875%, you are indeed betting that your aftertax rerurns will be higher than 3.875% (you're paying the mortgage with after tax dollars).
Investing and getting a higher return is harder than it might sound because you also have a sequence of returns risk. Here is an example I have posted before.
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.

bradpevans
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Re: How to treat a mortgage in context of long term investment

Post by bradpevans » Thu May 03, 2018 7:19 pm

Watty wrote:
Thu May 03, 2018 6:07 pm
runner540 wrote:
Wed May 02, 2018 10:18 pm
If you are investing in taxable while holding a mortgage at 3.875%, you are indeed betting that your aftertax rerurns will be higher than 3.875% (you're paying the mortgage with after tax dollars).
Investing and getting a higher return is harder than it might sound because you also have a sequence of returns risk. Here is an example I have posted before.
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.

That’s not quite how I would look at. The idea is that over the long haul the money does better in the market

In other words auto invest x dollars per month rather than paying x dollars on the mortgage

In the long run that sequence of investments, after tax, does better than the mortgage rate

wootwoot
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Re: How to treat a mortgage in context of long term investment

Post by wootwoot » Thu May 03, 2018 7:21 pm

runner540 wrote:
Wed May 02, 2018 10:18 pm
If you are investing in taxable while holding a mortgage at 3.875%, you are indeed betting that your aftertax rerurns will be higher than 3.875% (you're paying the mortgage with after tax dollars).
I disagree. Investing gives higher returns and TLH opportunities, both of which will likely provide more than a 3.875% payback.

runner540
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Re: How to treat a mortgage in context of long term investment

Post by runner540 » Thu May 03, 2018 7:30 pm

wootwoot wrote:
Thu May 03, 2018 7:21 pm
runner540 wrote:
Wed May 02, 2018 10:18 pm
If you are investing in taxable while holding a mortgage at 3.875%, you are indeed betting that your aftertax rerurns will be higher than 3.875% (you're paying the mortgage with after tax dollars).
I disagree. Investing gives higher returns and TLH opportunities, both of which will likely provide more than a 3.875% payback.
Please reread what you quoted from me: I was not taking a position on whether or not "investing" will give greater returns than 3.875% after taxes. I was just answering OP's question about how to frame it.

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