"Investing versus debt pay-off?"

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Taylor Larimore
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"Investing versus debt pay-off?"

Post by Taylor Larimore » Mon Oct 22, 2018 2:10 pm

Bogleheads:

Jim Dahle, editor of The White Coat Investor, has written an excellent article attempting to answer a perennial Boglehead question: "Investing versus debt pay-off?" The link is below:

Investing versus debt pay-off

Best wishes.
Taylor
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Re: "Investing versus debt pay-off?"

Post by willthrill81 » Mon Oct 22, 2018 2:23 pm

It's a very good post, like most that Jim writes.

In general, I think that aside from mortgages, it's probably significantly better to pay off debt, assuming that one is taking advantage of 'free money' like a 401k match. The risk-adjusted return from paying off a 6% car loan, for instance, is probably going to beat anything else you have access to hands down. We had some very low interest (around 3%) student loans a while back, but we still paid those off early and don't regret it for a second.

With regard to mortgages at the rates that we've seen for many years now, I think it really comes down to the individual investor's personality, risk tolerance level, and specifics. We have chosen to pay off our 3.375% mortgage very early, but I wouldn't fault anyone for choosing to drag that out in order to invest in something like stocks.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: "Investing versus debt pay-off?"

Post by Portfolio7 » Mon Oct 22, 2018 3:31 pm

The point regarding arbitrage seems central to me. It's comparison to the risk free rate of return that's key, and the one that most of us ignore.

We've had cash flow issues for some time due to a few reasons, encompassing both business & educational opportunities and things like unexpected health care costs - we planned for it in advance, but cash imbalances were higher for longer than originally anticipated. It's been difficult to move back into positive territory. Our net worth has tripled over the ten years that we've been balanced on the cash-flow tipping point, putting us into 7 digit territory; and from that perspective our arbitrage approach has been wildly successful... but that wealth is virtually all behind tax walls or illiquid for various reasons, so we're still struggling to push our cash flow definitively into the black. Ten years is a long time to be playing that kind of tug of war, and carrying this amount of risk. Dave Ramsey focuses heavily on eliminating most debt before you start saving. In some ways, rate/return arbitrage is doing it backwards; it's now a big focal point for us to eliminate debt quickly.

I offer this as an anecdotal perspective... a temporary dip into the red, even if well-planned with room for error, doesn't always stay temporary.
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Re: "Investing versus debt pay-off?"

Post by Random Walker » Mon Oct 22, 2018 4:22 pm

I’ve found paying off the mortgage as soon as possible to be a great move. A big side effect for me is that I have found that it helps build the fortitude to stick to a more aggressive asset allocation.

Dave

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Re: "Investing versus debt pay-off?"

Post by Nowizard » Mon Oct 22, 2018 4:41 pm

Some of us have invested rather than paid debt in an effort to eventually reach the point the author assumes is the start for many docs!

Tim

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Re: "Investing versus debt pay-off?"

Post by chicagoan23 » Mon Oct 22, 2018 5:20 pm

This is the one area of this website where I just don't understand the logic of the consensus opinion. To me, low-fixed-rate, unsecured debt is a tremendous opportunity to be taken advantage of--not a noose around your neck.

Assume one has a student loan with a fixed interest rate for the next few years of 2.5%. Today, to get an equivalent unsecured personal loan from somewhere like SoFi, the APR is 6.99%. That assumes great credit and auto-pay. If you went out and got a personal loan for 2.5% today, the IRS would probably want to impute interest because the deal you are getting is so unbelievably good. Yet some are willing to throw that incredible deal away by paying off the loan early? Why? Peace of mind? OK, there is value to that, but it is not a good financial decision.

This also ignores other benefits of keeping a loan balance, like liquidity. After you pay off debt early and lose all liquidity of those funds, if you find yourself wanting to use that cash for whatever reason (emergencies beyond the emergency fund, down payments on distressed real estate after a crash, a true once-in-a-lifetime opportunity to buy a business) your big pile of money is gone forever. I'd rather lose a few basis points and roll those funds over every month in 4-week Treasury Bills in order to have that liquidity available to me if I ever wanted to use it for any reason, to say nothing about the expected return on that money invested in a long-term portfolio.

Keeping debt is also a way to deal with inflation. If we have significant deflation then you are better off paying debt with today's dollars. But if we have significant inflation then your future debt repayments will be paid with less valuable dollars, and you will inflate away the impact of your debt. If you expect significant inflation from here, then a strategy to defer even higher-rate unsecured loan repayments is probably a sound one.

Even keeping secured debt has advantages. I have a 15-year fixed-rate mortgage at 2.35% with 12+ years left. Not only am I happy with my decision not to pay it off early, I truly regret not pushing for more money in a cash-out refi. I don't expect to see such a good deal available to me again for the next 10+ years. That is true even if I don't itemize deductions; if I do, that's yet another benefit to keeping that debt. I can write a check today and pay off that balance, but instead I am going to stretch that mortgage out until the very last day.

If you are a compulsive spender and the money goes out the door on toys before it ever hits your bank account, then yes, don't live beyond your means and get yourself out of debt. But if you are high income and can easily handle debt servicing (usually the type of person who is asking those questions here), to me the smart move is to keep your low-rate debt for as long as you can.

Earlier this year I paid off my law school student loans 21 years after I took the first one out. I already miss them.....

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Re: "Investing versus debt pay-off?"

Post by pierremonfrere » Mon Oct 22, 2018 5:44 pm

chicagoan23 wrote:
Mon Oct 22, 2018 5:20 pm
This is the one area of this website where I just don't understand the logic of the consensus opinion. To me, low-fixed-rate, unsecured debt is a tremendous opportunity to be taken advantage of--not a noose around your neck.

Assume one has a student loan with a fixed interest rate for the next few years of 2.5%. Today, to get an equivalent unsecured personal loan from somewhere like SoFi, the APR is 6.99%.
...

Earlier this year I paid off my law school student loans 21 years after I took the first one out. I already miss them.....
Too bad it's impossible to get a federal student loan with a rate of 2.5% these days.
My average interest rate is 6.75%

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Re: "Investing versus debt pay-off?"

Post by chicagoan23 » Mon Oct 22, 2018 5:51 pm

pierremonfrere wrote:
Mon Oct 22, 2018 5:44 pm

Too bad it's impossible to get a federal student loan with a rate of 2.5% these days.
My average interest rate is 6.75%
Today yes, but if you locked in a rate a few years ago, you'd have been there. I know I refinanced somewhere in the high 2's. I think your comment proves my point.....low-rate unsecured debt is really missed when it is gone/no longer available.

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Re: "Investing versus debt pay-off?"

Post by azanon » Mon Oct 22, 2018 6:05 pm

Why are people lamenting over not being able to get low interest rates for investing? Interactive Brokers current rate for a margin loan with 300K is 3.34%, and 3.04% if you have 1.5M. Have at it and amp up that portfolio!

Joking aside, isn't it a good thing that the consensus is to not invest with leverage (or effectively do so if you have a loan and any (taxable) investment at the same time)? I think there's a lot to be said for getting out of debt first before you invest. My view, in a nutshell, is that investing, particularly with a healthy amount of stocks, is risky enough even with no leverage. If you must, at least max out on equities, before you add leverage.

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Re: "Investing versus debt pay-off?"

Post by willthrill81 » Mon Oct 22, 2018 6:13 pm

azanon wrote:
Mon Oct 22, 2018 6:05 pm
Why are people lamenting over not being able to get low interest rates for investing? Interactive Brokers current rate for a margin loan with 300K is 3.34%, and 3.04% if you have 1.5M. Have at it and amp up that portfolio!

Joking aside, isn't it a good thing that the consensus is to not invest with leverage (or effectively do so if you have a loan and any (taxable) investment at the same time)? I think there's a lot to be said for getting out of debt first before you invest. My view, in a nutshell, is that investing, particularly with a healthy amount of stocks, is risky enough even with no leverage. If you must, at least max out on equities, before you add leverage.
I'm inclined to agree. Buying on margin gives me the heebee-jeebees (technical term). It certainly has some similarities to investing while one also has debt, but in the latter instance, you don't have to worry about margin calls.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: "Investing versus debt pay-off?"

Post by pierremonfrere » Mon Oct 22, 2018 6:14 pm

chicagoan23 wrote:
Mon Oct 22, 2018 5:51 pm
pierremonfrere wrote:
Mon Oct 22, 2018 5:44 pm

Too bad it's impossible to get a federal student loan with a rate of 2.5% these days.
My average interest rate is 6.75%
Today yes, but if you locked in a rate a few years ago, you'd have been there. I know I refinanced somewhere in the high 2's. I think your comment proves my point.....low-rate unsecured debt is really missed when it is gone/no longer available.
I took my first loan out in 2011, so it's been gone for a while (relatively speaking).

I do get a little jealous when I hear of others with rates like yours. :happy

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Re: "Investing versus debt pay-off?"

Post by willthrill81 » Mon Oct 22, 2018 6:15 pm

chicagoan23 wrote:
Mon Oct 22, 2018 5:20 pm
This is the one area of this website where I just don't understand the logic of the consensus opinion. To me, low-fixed-rate, unsecured debt is a tremendous opportunity to be taken advantage of--not a noose around your neck.

Assume one has a student loan with a fixed interest rate for the next few years of 2.5%. Today, to get an equivalent unsecured personal loan from somewhere like SoFi, the APR is 6.99%. That assumes great credit and auto-pay. If you went out and got a personal loan for 2.5% today, the IRS would probably want to impute interest because the deal you are getting is so unbelievably good. Yet some are willing to throw that incredible deal away by paying off the loan early? Why? Peace of mind? OK, there is value to that, but it is not a good financial decision.

This also ignores other benefits of keeping a loan balance, like liquidity. After you pay off debt early and lose all liquidity of those funds, if you find yourself wanting to use that cash for whatever reason (emergencies beyond the emergency fund, down payments on distressed real estate after a crash, a true once-in-a-lifetime opportunity to buy a business) your big pile of money is gone forever. I'd rather lose a few basis points and roll those funds over every month in 4-week Treasury Bills in order to have that liquidity available to me if I ever wanted to use it for any reason, to say nothing about the expected return on that money invested in a long-term portfolio.

Keeping debt is also a way to deal with inflation. If we have significant deflation then you are better off paying debt with today's dollars. But if we have significant inflation then your future debt repayments will be paid with less valuable dollars, and you will inflate away the impact of your debt. If you expect significant inflation from here, then a strategy to defer even higher-rate unsecured loan repayments is probably a sound one.

Even keeping secured debt has advantages. I have a 15-year fixed-rate mortgage at 2.35% with 12+ years left. Not only am I happy with my decision not to pay it off early, I truly regret not pushing for more money in a cash-out refi. I don't expect to see such a good deal available to me again for the next 10+ years. That is true even if I don't itemize deductions; if I do, that's yet another benefit to keeping that debt. I can write a check today and pay off that balance, but instead I am going to stretch that mortgage out until the very last day.

If you are a compulsive spender and the money goes out the door on toys before it ever hits your bank account, then yes, don't live beyond your means and get yourself out of debt. But if you are high income and can easily handle debt servicing (usually the type of person who is asking those questions here), to me the smart move is to keep your low-rate debt for as long as you can.

Earlier this year I paid off my law school student loans 21 years after I took the first one out. I already miss them.....
You're basically arguing against most fixed income investments, which are currently yielding around 3%, in lieu of stocks. And if one has no FI and debt and is also investing in stocks, they are effectively more than 100% in stocks.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: "Investing versus debt pay-off?"

Post by aspirit » Mon Oct 22, 2018 6:19 pm

As usual a great point by JD, obviously endorsed by TL. Many despise debt, many more pay interest carrying it, ask any financial services actuary. :mrgreen:
Time & tides wait for no one. A man has to know his limitations.

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Re: "Investing versus debt pay-off?"

Post by pierremonfrere » Mon Oct 22, 2018 6:25 pm

Professional school will make you debt-numb. Wake up to its wealth-destroying effects on your life! Do you have $400K in student loans? Then you’re likely one of the poorest people in the world. The guy living under the bridge is richer than you. His net worth is $0. You should be driving a beater and living somewhere that feels very middle-class.
I do enjoy reading WCI, but this comparison of residents (or other professionals) to homeless people bothers me more each time it comes up.

Do I have a ton of debt? yes
Is it an emergency? yes
Should I pay it off as fast as possible? yes
Have I ever wondered if my basic human needs (food and shelter, etc.) would not be met? No

Surely there is a better way to articulate this point.

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Re: "Investing versus debt pay-off?"

Post by IowaFarmBoy » Mon Oct 22, 2018 6:53 pm

Random Walker wrote:
Mon Oct 22, 2018 4:22 pm
I’ve found paying off the mortgage as soon as possible to be a great move. A big side effect for me is that I have found that it helps build the fortitude to stick to a more aggressive asset allocation.
I agree.
I think of paying down debt as the equivalent of investing in a bond fund. If the interest rate on the debt is higher than the rate on a bond fund, I think it makes sense to pay it down instead of buying the bond fund. Maybe stay with the stock portion of your investments but direct the bond portion to getting the mortgage paid down. This assumes that liquidity and/or the need to withdraw soon isn't an issue.

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Re: "Investing versus debt pay-off?"

Post by willthrill81 » Mon Oct 22, 2018 6:55 pm

IowaFarmBoy wrote:
Mon Oct 22, 2018 6:53 pm
Random Walker wrote:
Mon Oct 22, 2018 4:22 pm
I’ve found paying off the mortgage as soon as possible to be a great move. A big side effect for me is that I have found that it helps build the fortitude to stick to a more aggressive asset allocation.
I agree.
I think of paying down debt as the equivalent of investing in a bond fund. If the interest rate on the debt is higher than the rate on a bond fund, I think it makes sense to pay it down instead of buying the bond fund. Maybe stay with the stock portion of your investments but direct the bond portion to getting the mortgage paid down. This assumes that liquidity and/or the need to withdraw soon isn't an issue.
That's my take on it as well. My paying down/off our mortgage, I'm getting a perfectly stable, guaranteed 3.375% after-tax return on the investment (no tax deduction for us). Those are few and far between these days. And liquidity is no problem for us.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: "Investing versus debt pay-off?"

Post by sport » Mon Oct 22, 2018 7:28 pm

Those with low rate mortgages might want to consider not only current interest rates, but what rates will be in the not-too-distant future. For example, a 3.75% mortgage would seem to be a good no-risk return for extra payments now. However, what if CD rates go to 4%? This is not unlikely, and the CD is essentially as safe as paying down debt. Paying 3.75% interest while earning 4% (or more) is not a burden. The advantage of holding low rate debt can become substantial.

In my case, we bought our first house in 1971. We had a 6.75% twenty year loan, a very good rate at the time. At first, I did not have the money to pay extra on the loan. However, after 10 years, I was earning 18% in my money market fund, and inflation was making the loan payments smaller in real terms going forward. I still have a bank statement that shows a rate of 14.3% on a CD. I was just sorry I did not take out a loan longer than 20 years because I was making a profit on the loan balance without taking any extra risk. I was not earning a big salary, but I was able to make the mortgage payments and put additional money into savings. The last thing I wanted to do was pay anything extra on that loan.

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Re: "Investing versus debt pay-off?"

Post by grabiner » Mon Oct 22, 2018 8:25 pm

sport wrote:
Mon Oct 22, 2018 7:28 pm
Those with low rate mortgages might want to consider not only current interest rates, but what rates will be in the not-too-distant future. For example, a 3.75% mortgage would seem to be a good no-risk return for extra payments now. However, what if CD rates go to 4%? This is not unlikely, and the CD is essentially as safe as paying down debt. Paying 3.75% interest while earning 4% (or more) is not a burden. The advantage of holding low rate debt can become substantial.
This is why you should compare equal durations. If you have 25 years left on your mortgage, paying down the mortgage is equivalent to buying a 25-year bond; you lock in today's rates for 25 years, with no opportunity to re-borrow at the original rate if interest rates rise. Therefore, it isn't fair to compare the rate on a 25-year mortgage to the rate on a 5-year CD. If you bought a 25-year bond instead, you would get a higher yield, because of the extra risk and the expectation of future rate increases; the difference between 25-year and 5-year rates is the premium investors demand for the longer duration.

You also need to consider the tax situation. In your example above, paying down a 3.75% mortgage would still be better than buying a 4% CD if you take the standard deduction (which many homeowners do under the new tax law) and the CD is a taxable investment.
Wiki David Grabiner

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Re: "Investing versus debt pay-off?"

Post by chicagoan23 » Mon Oct 22, 2018 8:27 pm

willthrill81 wrote:
Mon Oct 22, 2018 6:15 pm
chicagoan23 wrote:
Mon Oct 22, 2018 5:20 pm
This is the one area of this website where I just don't understand the logic of the consensus opinion.
You're basically arguing against most fixed income investments, which are currently yielding around 3%, in lieu of stocks. And if one has no FI and debt and is also investing in stocks, they are effectively more than 100% in stocks.
OK this might be where I’m missing something. I view investing in bonds as a diversifier for my stock portfolio, and I also hold cash. So can you explain why keeping debt (ie, not paying it off) is equivalent to arguing against buying bonds or bond funds? When I buy bonds, won’t the value of the bond go up/down when interest rates fall/rise? And I can always sell to get my principal back (at the market price) so the liquidity is there.

Also, margin loans to invest are of course secured loans, and typically with variable rates tied to current market rates. I view low-fixed-rate, unsecured debt differently than margin loans. A bank or broker can call in a margin loan, but no one can repossess my brain.

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Re: "Investing versus debt pay-off?"

Post by JoeRetire » Mon Oct 22, 2018 8:33 pm

Good article but "# 7 If Unsure, Split the Difference" is rather weak.

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Re: "Investing versus debt pay-off?"

Post by sport » Mon Oct 22, 2018 8:57 pm

grabiner wrote:
Mon Oct 22, 2018 8:25 pm
You also need to consider the tax situation. In your example above, paying down a 3.75% mortgage would still be better than buying a 4% CD if you take the standard deduction (which many homeowners do under the new tax law) and the CD is a taxable investment.
David,
Please explain. If the 3.75% is deductible, then it could be preferable to a 4% taxable CD. But, if the borrower takes the standard deduction, it would seem to be better to earn 4% rather than pay off 3.75%. You get the standard deduction either way.

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Re: "Investing versus debt pay-off?"

Post by abuss368 » Mon Oct 22, 2018 8:59 pm

Thanks Taylor!
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: "Investing versus debt pay-off?"

Post by grabiner » Mon Oct 22, 2018 9:07 pm

sport wrote:
Mon Oct 22, 2018 8:57 pm
grabiner wrote:
Mon Oct 22, 2018 8:25 pm
You also need to consider the tax situation. In your example above, paying down a 3.75% mortgage would still be better than buying a 4% CD if you take the standard deduction (which many homeowners do under the new tax law) and the CD is a taxable investment.
David,
Please explain. If the 3.75% is deductible, then it could be preferable to a 4% taxable CD. But, if the borrower takes the standard deduction, it would seem to be better to earn 4% rather than pay off 3.75%. You get the standard deduction either way.
If you take the standard deduction, you get a 3.75% after-tax return from paying down a 3.75% mortgage. If you itemize deductions in a 22% tax bracket, you get a 2.93% after-tax return from paying down a 3.75% mortgage, because your pay less interest and thus get a smaller deduction. In either case, you earn 3.12% on the CD, because the CD interest is taxable. Therefore, at these rates, it is better to pay down the mortgage if you don't get a tax deduction from the interest, and invest if you do get a tax deduction.
Wiki David Grabiner

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Re: "Investing versus debt pay-off?"

Post by willthrill81 » Mon Oct 22, 2018 9:13 pm

chicagoan23 wrote:
Mon Oct 22, 2018 8:27 pm
willthrill81 wrote:
Mon Oct 22, 2018 6:15 pm
chicagoan23 wrote:
Mon Oct 22, 2018 5:20 pm
This is the one area of this website where I just don't understand the logic of the consensus opinion.
You're basically arguing against most fixed income investments, which are currently yielding around 3%, in lieu of stocks. And if one has no FI and debt and is also investing in stocks, they are effectively more than 100% in stocks.
OK this might be where I’m missing something. I view investing in bonds as a diversifier for my stock portfolio, and I also hold cash. So can you explain why keeping debt (ie, not paying it off) is equivalent to arguing against buying bonds or bond funds? When I buy bonds, won’t the value of the bond go up/down when interest rates fall/rise? And I can always sell to get my principal back (at the market price) so the liquidity is there.

Also, margin loans to invest are of course secured loans, and typically with variable rates tied to current market rates. I view low-fixed-rate, unsecured debt differently than margin loans. A bank or broker can call in a margin loan, but no one can repossess my brain.
A debt like a mortgage is basically a reverse bond. By paying off a mortgage with an interest rate of 4%, for instance, your monetary savings are equivalent to the gains from holding a bond with a 4% yield, aside from taxes. Therefore, if you don't like paying off a 4% mortgage, just about the only logical reason for holding a 4% bond would be the latter's liquidity. So aside from the liquidity issue, if you want to be a debt holder, then you shouldn't want to be a debt issuer.

To your second point, if you have $100k of stocks and $100k of debt as your only assets, then your allocation would effectively be 200% stocks, a highly leverage position. Holding debt of any kind while investing means that you are leveraging your investments to some degree. This can be perfectly acceptable, but it does increase your risk profile compared to not holding the debt.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: "Investing versus debt pay-off?"

Post by azanon » Mon Oct 22, 2018 9:31 pm

willthrill81 wrote:
Mon Oct 22, 2018 6:13 pm
azanon wrote:
Mon Oct 22, 2018 6:05 pm
Why are people lamenting over not being able to get low interest rates for investing? Interactive Brokers current rate for a margin loan with 300K is 3.34%, and 3.04% if you have 1.5M. Have at it and amp up that portfolio!

Joking aside, isn't it a good thing that the consensus is to not invest with leverage (or effectively do so if you have a loan and any (taxable) investment at the same time)? I think there's a lot to be said for getting out of debt first before you invest. My view, in a nutshell, is that investing, particularly with a healthy amount of stocks, is risky enough even with no leverage. If you must, at least max out on equities, before you add leverage.
I'm inclined to agree. Buying on margin gives me the heebee-jeebees (technical term). It certainly has some similarities to investing while one also has debt, but in the latter instance, you don't have to worry about margin calls.
I admit, that makes it slightly less extreme, but there's still no escaping the reality of what's happening, which is that effectively someone is borrowing to invest, if they have large, taxable investment accounts, and also large loans (at any rate) at the same time. I sometimes worry about worst case for certain people in risky professions, where they could lose a job, most of their taxable investments (because the reason they lost their job is because the economy, including stock market, got hit), but then are still left with their large loans with payments that are due. So in a bad situation, the effect of a margin call might happen anyway.

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Re: "Investing versus debt pay-off?"

Post by willthrill81 » Mon Oct 22, 2018 9:48 pm

azanon wrote:
Mon Oct 22, 2018 9:31 pm
willthrill81 wrote:
Mon Oct 22, 2018 6:13 pm
azanon wrote:
Mon Oct 22, 2018 6:05 pm
Why are people lamenting over not being able to get low interest rates for investing? Interactive Brokers current rate for a margin loan with 300K is 3.34%, and 3.04% if you have 1.5M. Have at it and amp up that portfolio!

Joking aside, isn't it a good thing that the consensus is to not invest with leverage (or effectively do so if you have a loan and any (taxable) investment at the same time)? I think there's a lot to be said for getting out of debt first before you invest. My view, in a nutshell, is that investing, particularly with a healthy amount of stocks, is risky enough even with no leverage. If you must, at least max out on equities, before you add leverage.
I'm inclined to agree. Buying on margin gives me the heebee-jeebees (technical term). It certainly has some similarities to investing while one also has debt, but in the latter instance, you don't have to worry about margin calls.
I admit, that makes it slightly less extreme, but there's still no escaping the reality of what's happening, which is that effectively someone is borrowing to invest, if they have large, taxable investment accounts, and also large loans (at any rate) at the same time. I sometimes worry about worst case for certain people in risky professions, where they could lose a job, most of their taxable investments (because the reason they lost their job is because the economy, including stock market, got hit), but then are still left with their large loans with payments that are due. So in a bad situation, the effect of a margin call might happen anyway.
Indeed. That is a big part of the reason that we are aggressively paying off our mortgage. In the event of a job loss and/or dire economic troubles, being mortgage free is a position of strength, more so than having money invested in accounts that are not easily accessible and may be deeply depressed in value. Yes, bonds may hold their value in such an instance (or not if the 1970s bring their inflation back), but I'd rather have no debt and no bonds than both, especially in a rising rate environment. And yes, we have liquidity.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

Random Walker
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Re: "Investing versus debt pay-off?"

Post by Random Walker » Mon Oct 22, 2018 9:56 pm

IowaFarmBoy wrote:
Mon Oct 22, 2018 6:53 pm
Random Walker wrote:
Mon Oct 22, 2018 4:22 pm
I’ve found paying off the mortgage as soon as possible to be a great move. A big side effect for me is that I have found that it helps build the fortitude to stick to a more aggressive asset allocation.
I agree.
I think of paying down debt as the equivalent of investing in a bond fund. If the interest rate on the debt is higher than the rate on a bond fund, I think it makes sense to pay it down instead of buying the bond fund. Maybe stay with the stock portion of your investments but direct the bond portion to getting the mortgage paid down. This assumes that liquidity and/or the need to withdraw soon isn't an issue.
Totally agree. I agree mortgage is a negative bond. I realize the effective cost of the mortgage interest should account for tax deductible interest and inflation, but the piece of mind is worth something too. I think it’s worth a lot. I was initially 100% equity in my early 40s. Once I started to add bonds, I started wondering why have a bond position and a mortgage at the same time?

Dave

Nate79
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Re: "Investing versus debt pay-off?"

Post by Nate79 » Mon Oct 22, 2018 10:13 pm

I wonder if we need a decade of negative returns to remind people that investing in stocks have risk?

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willthrill81
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Re: "Investing versus debt pay-off?"

Post by willthrill81 » Mon Oct 22, 2018 10:14 pm

Nate79 wrote:
Mon Oct 22, 2018 10:13 pm
I wonder if we need a decade of negative returns to remind people that investing in stocks have risk?
Maybe a few months of it will do the trick.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

chicagoan23
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Re: "Investing versus debt pay-off?"

Post by chicagoan23 » Tue Oct 23, 2018 10:44 am

willthrill81 wrote:
Mon Oct 22, 2018 9:13 pm
chicagoan23 wrote:
Mon Oct 22, 2018 8:27 pm
willthrill81 wrote:
Mon Oct 22, 2018 6:15 pm
chicagoan23 wrote:
Mon Oct 22, 2018 5:20 pm
This is the one area of this website where I just don't understand the logic of the consensus opinion.
You're basically arguing against most fixed income investments, which are currently yielding around 3%, in lieu of stocks. And if one has no FI and debt and is also investing in stocks, they are effectively more than 100% in stocks.
OK this might be where I’m missing something. I view investing in bonds as a diversifier for my stock portfolio, and I also hold cash. So can you explain why keeping debt (ie, not paying it off) is equivalent to arguing against buying bonds or bond funds? When I buy bonds, won’t the value of the bond go up/down when interest rates fall/rise? And I can always sell to get my principal back (at the market price) so the liquidity is there.

Also, margin loans to invest are of course secured loans, and typically with variable rates tied to current market rates. I view low-fixed-rate, unsecured debt differently than margin loans. A bank or broker can call in a margin loan, but no one can repossess my brain.
A debt like a mortgage is basically a reverse bond. By paying off a mortgage with an interest rate of 4%, for instance, your monetary savings are equivalent to the gains from holding a bond with a 4% yield, aside from taxes. Therefore, if you don't like paying off a 4% mortgage, just about the only logical reason for holding a 4% bond would be the latter's liquidity. So aside from the liquidity issue, if you want to be a debt holder, then you shouldn't want to be a debt issuer.

To your second point, if you have $100k of stocks and $100k of debt as your only assets, then your allocation would effectively be 200% stocks, a highly leverage position. Holding debt of any kind while investing means that you are leveraging your investments to some degree. This can be perfectly acceptable, but it does increase your risk profile compared to not holding the debt.
My problem with this analogy is that it disregards the market. With a regular bond, if interest rates rise, then the value of that bond will fall. If you truly look at a loan like a reverse bond, then when interest rates rise, the value of having that loan also rises, in that you get to use the money and pay a rate that is less than what the market currently is requiring. Isn't there value in that?

For example, my 2.35% fixed rate mortgage is more valuable today than it was when I took it out, because that same loan would cost me 3.875% today. I can use the money that I borrowed to refinance my house at a below-market rate. Just like if I bought a 10-year Treasury from two years ago at 1.5%, the value of that bond is now much lower than it was when I bought it. That is a benefit aside from liquidity.

And holding cash or Treasuries is great protection in a bad market/economy. Deploying all that cash to pay off debt--especially unsecured, low-fixed-rate debt--eliminates the protection you get from having that strong position. You may no longer have to meet your monthly debt service payment but there is now a lot of cash that you don't have access to anymore. It is gone forever. You can't re-borrow student loans (like you can re-mortgage a house that has been paid off). If you have a need/want for that cash you're out of luck.

Paying fixed-rate debt is also one of the best inflation hedges available. If we do see massive inflation, the dollars used to pay that debt are worth much less than the dollars that were used to pay down a mortgage now.

I guess this is one area of advice where I will just have to be a contrarian.

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Re: "Investing versus debt pay-off?"

Post by willthrill81 » Tue Oct 23, 2018 12:04 pm

chicagoan23 wrote:
Tue Oct 23, 2018 10:44 am
My problem with this analogy is that it disregards the market. With a regular bond, if interest rates rise, then the value of that bond will fall. If you truly look at a loan like a reverse bond, then when interest rates rise, the value of having that loan also rises, in that you get to use the money and pay a rate that is less than what the market currently is requiring. Isn't there value in that?

For example, my 2.35% fixed rate mortgage is more valuable today than it was when I took it out, because that same loan would cost me 3.875% today. I can use the money that I borrowed to refinance my house at a below-market rate. Just like if I bought a 10-year Treasury from two years ago at 1.5%, the value of that bond is now much lower than it was when I bought it. That is a benefit aside from liquidity.
What you say is true, but that is a knife that cuts both ways to some extent. If rates fall, then the value of your loan goes down unless you can refinance the debt, but there can be significant costs associated with doing that. And when rates are falling, it is often during recessionary periods when lenders are less willing to refinance debt.
chicagoan23 wrote:
Tue Oct 23, 2018 10:44 am
And holding cash or Treasuries is great protection in a bad market/economy. Deploying all that cash to pay off debt--especially unsecured, low-fixed-rate debt--eliminates the protection you get from having that strong position. You may no longer have to meet your monthly debt service payment but there is now a lot of cash that you don't have access to anymore. It is gone forever. You can't re-borrow student loans (like you can re-mortgage a house that has been paid off). If you have a need/want for that cash you're out of luck.
You're arguing for liquidity, and most BHs, including me, agree that some degree of liquidity is needed. But this doesn't mean that an illiquid 'investment' like paying off debt is necessarily sub-optimal.
chicagoan23 wrote:
Tue Oct 23, 2018 10:44 am
Paying fixed-rate debt is also one of the best inflation hedges available. If we do see massive inflation, the dollars used to pay that debt are worth much less than the dollars that were used to pay down a mortgage now.
It is indeed a good inflation hedge, but it's far from the only one and not necessarily the best one either. TIPS are probably the best guaranteed inflation hedge available to all.
chicagoan23 wrote:
Tue Oct 23, 2018 10:44 am
I guess this is one area of advice where I will just have to be a contrarian.
That's okay. I'm a contrarian to certain BH concepts myself. :beer
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: "Investing versus debt pay-off?"

Post by ThrustVectoring » Tue Oct 23, 2018 12:54 pm

The duration of the debt is highly important for this. Fixed-rate debt is equivalent to shorting a bond and buying a call option that costs the par value to exercise to close out the position. The cost of the call option is the spread between the treasury rate and the interest rate you're paying.

Shorting long-term bonds - eg, through a 30-year fixed rate mortgage - is a really fantastic financial play, especially with the downside protection of the embedded call option. Long-term nominal bonds are just about the last thing an individual investor should buy, and the only reason long-term rates are as low as they are is that insurance companies and other institutions are obligated to purchase them in order to have sufficient backing for their nominal liabilities.

Of course, you should pay off any short-term or revolving debt basically immediately, unless the interest rate is below something like Interactive Broker's margin rates. Call it 4% to be a nice round number.
Current portfolio: 60% VTI / 40% VXUS

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