Really up to personal preference whether to treat your mortgage as a "negative exposure" to bonds
– but in reality it is
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/viewtop ... 2&t=100993