Why buying homes with mortgages is good but buying stocks on margin is bad

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smarcus3
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Why buying homes with mortgages is good but buying stocks on margin is bad

Post by smarcus3 » Wed Dec 05, 2018 11:37 am

Can someone explain to me why the advise is NEVER buy stocks on margin; however, everyone who has a mortgage and still buying stocks is basically doing the same thing? Can't seem to wrap my head around this one.

Thanks!
This is my personal opinion. I'm an engineer not a financial advisor.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by Smorgasbord » Wed Dec 05, 2018 11:45 am

I'm all for buying stocks on margin so long as it is with a non-callable 30-year fixed-rate term. Good luck finding that.
Last edited by Smorgasbord on Wed Dec 05, 2018 11:46 am, edited 1 time in total.


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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by smarcus3 » Wed Dec 05, 2018 11:46 am

Smorgasbord wrote:
Wed Dec 05, 2018 11:45 am
I'm all for buying stocks on margin so long as it is with a non-callable 30 year fixed rate term. Good luck finding that.
Very true and at the same rate.
This is my personal opinion. I'm an engineer not a financial advisor.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by whodidntante » Wed Dec 05, 2018 12:26 pm

I think a lot of rational, well informed people avoid prepaying their mortgage. If you use that free cash flow to buy equity index ETFs instead of buying luxury cars and vacations, you are effectively putting borrowed money in the stock market. It increases your risk and your expected returns, unless the expected returns are lower than your mortgage rate. Then it just increases your risk.

Margin isn't necessarily a non starter. However, most brokers including vanguard charge an interest rate that is much higher than expected returns from stocks as an asset class, so you'd have to be willing to go to the few brokers who offer low rates. People also don't like that the rate is variable, as this adds a weird dimension of interest rate risk in your stock investments. Also that the maintenance margin requirements can be changed by regulators or on a whim by your broker. It also involves confusing terminology that varies by broker, and people don't like to feel stupid, so they just reject the idea. It's also associated with "traders" and it's easy to find blow up stories.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by Jack FFR1846 » Wed Dec 05, 2018 12:28 pm

If your house value drops below your mortgage number, you don't get a call or someone coming and selling your house to settle your account.
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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by adamthesmythe » Wed Dec 05, 2018 12:36 pm

Because a stock is an investment and a house isn't, it is a building I can live in.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by alex_686 » Wed Dec 05, 2018 12:42 pm

I am modestly for using leverage via mortgages.

Partly this is because I think home ownership with a mortgage is a decent investment for most people, and that I recognize that a mortgage is a negative bond that leverages one's entire portfolio. I can go into the nuts and bolts if you like, but the lower volatility and volatility drag of a home/mortgage portfolio tends to serve the average investor better.

Mainly it is because I worked on the margin desk during the dot.com boom and bust. First, no one is ever going to ask you to pony up 10k overnight on your home mortgage. Second - and for me this is the most important point for myself - the use of margin encourages irrational euphoria and gambling behavior by the use of investors while a home mortgage enforces discipline saving behavior. I can point to highly sophisticated investors who blew themselves up with margin and leverage.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by Morgan Dollar 1921 » Wed Dec 05, 2018 12:53 pm

Jack FFR1846 wrote:
Wed Dec 05, 2018 12:28 pm
If your house value drops below your mortgage number, you don't get a call or someone coming and selling your house to settle your account.
This was going to be my reply, that margin call is like a snowball.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by megabad » Wed Dec 05, 2018 1:11 pm

Smorgasbord wrote:
Wed Dec 05, 2018 11:45 am
I'm all for buying stocks on margin so long as it is with a non-callable 30-year fixed-rate term. Good luck finding that.
+1

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by Ben Mathew » Wed Dec 05, 2018 1:16 pm

As others have mentioned, the main issue with margin is margin calls. The ease of trading on margin might also set off the gambling impulse and invite active trading behavior. Long term investing with margin loans seems uncommon (though I have considered it).

And, as mentioned in earlier posts again, by not paying off your mortgage and investing in stocks, you're already leveraged. Pushing past that (mortgaged home or renting+100% stocks+stocks on margin loan) is probably way too aggressive for all but a very tiny segment of the population. Most people aren't even at 100% stocks + no home equity.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by smarcus3 » Wed Dec 05, 2018 1:41 pm

I know I'm the minority being a renter with a 100% AA other than 12 months emergency fund in treasuries. Being young without debt, this aggressive stance doesn't cause me stress. I think I would be more stressed with a home mortgage commitment than an aggressive AA.

My thread on margin (which is just a curiosity) would only involve a buy and hold mentality. I guess for the same effect it would be to utilize leveraged funds.
This is my personal opinion. I'm an engineer not a financial advisor.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by alex_686 » Wed Dec 05, 2018 1:45 pm

smarcus3 wrote:
Wed Dec 05, 2018 1:41 pm
I guess for the same effect it would be to utilize leveraged funds.
No. Leveraged funds re-balance daily and thus are very path dependent. There are fact cases out there where the market is up for the period but leverage funds are down. Leverage funds should only be used for tactical bets with a duration of 1 month or less. Longer than that and the relationship between the index and fund fades. So, not very Bogleahds.

Futures might be a option, but they have greater complexity.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by TomatoTomahto » Wed Dec 05, 2018 1:46 pm

smarcus3 wrote:
Wed Dec 05, 2018 11:37 am
Can someone explain to me why the advise is NEVER buy stocks on margin; however, everyone who has a mortgage and still buying stocks is basically doing the same thing? Can't seem to wrap my head around this one.
Thanks!
Kudos to you for asking this question after the recent market turmoil. Usually these questions are asked when the market's direction is more clear.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by smarcus3 » Wed Dec 05, 2018 1:47 pm

Gotcha. Very interesting. Obviously no plans to leverage or margin just curious.
This is my personal opinion. I'm an engineer not a financial advisor.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by smarcus3 » Wed Dec 05, 2018 1:49 pm

TomatoTomahto wrote:
Wed Dec 05, 2018 1:46 pm
smarcus3 wrote:
Wed Dec 05, 2018 11:37 am
Can someone explain to me why the advise is NEVER buy stocks on margin; however, everyone who has a mortgage and still buying stocks is basically doing the same thing? Can't seem to wrap my head around this one.
Thanks!
Kudos to you for asking this question after the recent market turmoil. Usually these questions are asked when the market's direction is more clear.
Thanks! My father taught me long ago the secret to his financial strategy well before I stumbled across this site. Amazing they line up very nicely.
I’ve never worried too much about market vomit sessions. If I ever get nervous I look back to stocks purchased right before the last recession and how they have all appreciated very nicely. Just buy and hold baby.
This is my personal opinion. I'm an engineer not a financial advisor.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by ThrustVectoring » Wed Dec 05, 2018 2:16 pm

A 30-year fixed rate mortgage effectively shorts long-term bonds, while buying stocks on margin is borrowing at a floating rate. Long-term bonds are terrible investments, so shorting them is a fantastic choice. And as a bonus, you get an embedded call option to close out the short position via refinance, home sale, or prepayment. This effectively removes a lot of the risk of shorting long-term interest rates.
Current portfolio: 60% VTI / 40% VXUS

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by smarcus3 » Wed Dec 05, 2018 3:48 pm

ThrustVectoring wrote:
Wed Dec 05, 2018 2:16 pm
A 30-year fixed rate mortgage effectively shorts long-term bonds, while buying stocks on margin is borrowing at a floating rate. Long-term bonds are terrible investments, so shorting them is a fantastic choice. And as a bonus, you get an embedded call option to close out the short position via refinance, home sale, or prepayment. This effectively removes a lot of the risk of shorting long-term interest rates.
To play devil's advocate, if long term bonds are bad investments, why do banks offer them?
This is my personal opinion. I'm an engineer not a financial advisor.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by alex_686 » Wed Dec 05, 2018 4:23 pm

smarcus3 wrote:
Wed Dec 05, 2018 3:48 pm
To play devil's advocate, if long term bonds are bad investments, why do banks offer them?
The argugument is overstated but...

First, the US government indirectly subsides the intrest rate on home loans.

Second, these long bonds are great for insurance companies and pension funds - risk adverse investors who need to offset and match long term liabilities.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by JackoC » Wed Dec 05, 2018 4:28 pm

ThrustVectoring wrote:
Wed Dec 05, 2018 2:16 pm
A 30-year fixed rate mortgage effectively shorts long-term bonds, while buying stocks on margin is borrowing at a floating rate. Long-term bonds are terrible investments, so shorting them is a fantastic choice. And as a bonus, you get an embedded call option to close out the short position via refinance, home sale, or prepayment. This effectively removes a lot of the risk of shorting long-term interest rates.
Mortgage borrowing is shorting 'long term bonds' but borrowing on margin or using stock index futures is shorting 0-3mo 'bonds'. Along the riskless curve long term bonds have been a generally superior investment to overnight-3mo 'bonds'. IOW the realized term premium has generally been positive. Maybe you mean to claim long term bonds have been an inferior investment to stocks? But true or not, that wouldn't be directly relevant here. And the mortgage rate is a wider spread to the riskless curve than the futures implied borrowing rate and still at least as much as the best margin rates. It's true part of that greater spread pays for a call option, but it's not a free option. See rates and spreads as of now*.

But margin loans only make sense at the best rates (ie Interactive Brokers, see below, among major retail oriented brokers). Both margin loans and futures positions require attention to liquidity and futures require some basic comfort level with trading to roll the positions every 3 months. That means that, practically, mortgage borrowing might make more sense for a lot of people. But it's not slam dunk return-wise compared to the best margin rates or futures.

*rates as of now:
30 yr mortgage rate:4.90%=~18yr (avg life of 30 yr mortgage) treasury+176 (per bankrate.com)
S&P index futures implied borrowing rate: 2.94%=~Fed Funds+74 (per CME 'roll analyzer' for the Dec to Mar roll of e-mini S&P futures, 1 contract equivalent to ~$135,000 of stock)
Interactive Brokers' margin rate (for $300k position): 3.34%~FF+114 (per IB)
Fidelity margin rate: 5.25%~FF+305 (next best per IB's comparison)

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by WhiteMaxima » Wed Dec 05, 2018 4:39 pm

1) margin rate is much higher than mortgage

2) no tax deduction

3) you will be forced to sell if your stock value drop to certain level

Home mortgage will not have all these. Besides, your home is your shelter. Stock certificate has no usage, it has value only of the company will pay you dividend.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by mrspock » Wed Dec 05, 2018 4:45 pm

smarcus3 wrote:
Wed Dec 05, 2018 11:37 am
Can someone explain to me why the advise is NEVER buy stocks on margin; however, everyone who has a mortgage and still buying stocks is basically doing the same thing? Can't seem to wrap my head around this one.

Thanks!
House dives 30% in value on your 4:1 leveraged loan what does bank do? Nothing. Stocks dive 30% on your 4:1 leveraged loan? You can kiss that loan or some portion of the stock holdings goodbye.

Bonus: House dives 50%, you can hand in the keys and go your merry way (non-recourse loan). Try that with a margin loan (after stocks tank 50%)? You’ll find out your paycheck is garnished pretty quick.

Not the same thing by a long shot.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by serbeer » Wed Dec 05, 2018 4:54 pm

Also, for individual stocks, the value can drop all the way to 0. House can lose quite a bit of value, but dropping to 0 is much less likely, even if it total loss while uninsured :oops: , the land is worth something.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by EfficientInvestor » Wed Dec 05, 2018 5:51 pm

smarcus3 wrote:
Wed Dec 05, 2018 1:41 pm
I guess for the same effect it would be to utilize leveraged funds.
I would encourage you to do some more research on the use of leveraged ETFs as part of a diversified portfolio. While it is true that a leveraged ETF can lag behind "intended" return in some years due to volatility drag, they also outperform "intended" return during large down years and in large up years. For instance, this year the Nasdaq (QQQ) is up 7.0% while the 3X Nasdaq (TQQQ) is only up 2.6% when a pure 3x leverage would be up 21% (excluding borrowing cost). However, in 2017, QQQ was up 32.7% while the 3X Nasdaq (TQQQ) was up 118.7% when pure 3x leverage would have returned 98.1%. The real advantage that nobody talks about is the "protection" during down years. In 2008, QQQ was down -41.7%. TQQQ would have been down about -90% whereas a pure 3x leverage would have been down -125.1%.

But I would never recommend buying and holding a single leveraged ETF. That would be a horrible idea. Instead, consider holding something like this: 35% stock (TQQQ or your preferred mix), 55% long term treasury (TMF), and 10% gold (UGLD). You can pull daily data for all these and calculate what these leveraged ETFs would have done going back 30+ years. I pulled daily data from Yahoo for Nasdaq (^NDX) and LT Treasury (VUSTX). For gold, you can get daily data here: https://fred.stlouisfed.org/series/GOLDAMGBD228NLBM. My backtest (Jan 1987 - Oct 2018) shows that this blend, rebalanced annually, would have returned 29.8% CAGR with a max drawdown of -49.2%. Similar drawdown to the stock market with almost three times the return over the time period. I don't expect this same kind of return moving forward due to the falling bond rates over the last 30 years. However, I do expect this "leveraged indexing" to continue to outperform the stock market on a return/risk basis.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by ThrustVectoring » Wed Dec 05, 2018 7:34 pm

JackoC wrote:
Wed Dec 05, 2018 4:28 pm
Mortgage borrowing is shorting 'long term bonds' but borrowing on margin or using stock index futures is shorting 0-3mo 'bonds'. Along the riskless curve long term bonds have been a generally superior investment to overnight-3mo 'bonds'. IOW the realized term premium has generally been positive. Maybe you mean to claim long term bonds have been an inferior investment to stocks? But true or not, that wouldn't be directly relevant here. And the mortgage rate is a wider spread to the riskless curve than the futures implied borrowing rate and still at least as much as the best margin rates. It's true part of that greater spread pays for a call option, but it's not a free option. See rates and spreads as of now*.
Bonds are not riskless - they have duration, and each bond has a dollar value change when the relevant interest rate changes. Long term bonds are a superior investment to the riskless asset (overnight to 3mo duration) because long-term investors should be taking on risk. You're simply not adequately compensated for the risk a 30-year bond is taking on.

Conversely, the short position here has a positive skew due to the embedded option, and even with the spread over treasury rates is still a fantastic rate. Like, if you think that a "fair" price for duration risk is something like 10 basis points per year of duration, and a 30-year mortgage effectively has a duration of about 27 years, and the two-year treasury rate is 2.8%, then you should be willing to take out any mortgage with an interest rate below 5.3%. Mortgages are running about 4.5% right now. This is a fantastic deal.
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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by JackoC » Wed Dec 05, 2018 10:18 pm

ThrustVectoring wrote:
Wed Dec 05, 2018 7:34 pm
JackoC wrote:
Wed Dec 05, 2018 4:28 pm
Mortgage borrowing is shorting 'long term bonds' but borrowing on margin or using stock index futures is shorting 0-3mo 'bonds'. Along the riskless curve long term bonds have been a generally superior investment to overnight-3mo 'bonds'. IOW the realized term premium has generally been positive. Maybe you mean to claim long term bonds have been an inferior investment to stocks? But true or not, that wouldn't be directly relevant here. And the mortgage rate is a wider spread to the riskless curve than the futures implied borrowing rate and still at least as much as the best margin rates. It's true part of that greater spread pays for a call option, but it's not a free option. See rates and spreads as of now*.
1. Bonds are not riskless - they have duration, and each bond has a dollar value change when the relevant interest rate changes.

2. Long term bonds are a superior investment to the riskless asset (overnight to 3mo duration) because long-term investors should be taking on risk.
3. You're simply not adequately compensated for the risk a 30-year bond is taking on.

4. Conversely, the short position here has a positive skew due to the embedded option, and even with the spread over treasury rates is still a fantastic rate. Like, if you think that a "fair" price for duration risk is something like 10 basis points per year of duration, and a 30-year mortgage effectively has a duration of about 27 years, and the two-year treasury rate is 2.8%, then you should be willing to take out any mortgage with an interest rate below 5.3%. Mortgages are running about 4.5% right now. This is a fantastic deal.
1. I was referring to the *credit* riskless curve. A mortgage is above that curve because of the credit risk to the bank.

2 and 3 seem to contradict one another. But in general 2 is the correct one. As I said, historically the term premium is positive, meaning *buying* bonds of longer maturity has made more than *buying* bonds of shorter maturity and rolling them over. Therefore, *shorting* long term bonds has been more costly than *shorting* short term bonds. Funding a stock position with a mortgage is shorting long term bonds. Funding a stock position with margin or using index futures is shorting very short term bonds. According to the history of the term premium, borrowing short is generally cheaper over time, just as investing short generally earns less over time.

4. There is an option, but you pay for it as part of the higher rate and spread over treasuries of the mortgage. See the table with my original post. 30 yr mortgages are ~176 bps over the comparable treasury. The current implied futures borrowing rate is only around 74bps over the Fed Funds rate or ~50 bps over the 3 mo T-bill rate (max holding period of the futures, ~3months). The best margin rates are 114 over Fed Funds. As for the rest though, you're losing me. 10 bps per year of duration...says who based on what?

Simply, it's not an obviously better deal to borrow at the ~4.90% current mortgage rate (let alone a 5.3% rate pulled out of the air) to fund a stock position when you can fund it implicitly at 2.94% in futures or 3.34% on margin. It's not obviously better for everyone in every circumstance to borrow at the lower rate because a) it's a floating rate than can rise b) there are liquidity considerations to using futures or margin which have to be considered separately from the rate. But your position seems to be to proclaim how cheap mortgage rates are without actually comparing them to other ways to borrow to fund a stock position. I don't understand that.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by AlphaLess » Wed Dec 05, 2018 10:23 pm

smarcus3 wrote:
Wed Dec 05, 2018 11:37 am
Can someone explain to me why the advise is NEVER buy stocks on margin; however, everyone who has a mortgage and still buying stocks is basically doing the same thing? Can't seem to wrap my head around this one.

Thanks!
These are not equivalent concepts.

Most people spend money on a mortgage that would otherwise be spent on rent. Rent or own, you have some carrying costs.

Mortgage payments (mortgage rate) are fixed.
Also, mortgages do not have margin calls. I.e., you won't be asked to pay the full principal of the mortgage (as long as you are current on your payment).

And lastly, the vast majority of people could not afford to buy a house, if it were not for a mortgage.
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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by JackoC » Wed Dec 05, 2018 10:43 pm

WhiteMaxima wrote:
Wed Dec 05, 2018 4:39 pm
1) margin rate is much higher than mortgage

2) no tax deduction

3) you will be forced to sell if your stock value drop to certain level

Home mortgage will not have all these. Besides, your home is your shelter. Stock certificate has no usage, it has value only of the company will pay you dividend.
1. Not true. The current 30 yr mortgage rate around 4.90%, best margin rate 3.34% from Interactive Brokers on $300k size (slightly lower for larger size), the stock index futures implied borrowing rate 2.94%

2. Not true. You can deduct margin interest to the extent of net investment income. There are limitations so real answer is 'depends' but it's not 'no'. And there are limits on the mortgage deduction also. Futures work best in IRA's where tax deductions wouldn't be an issue.

3. True. However depending how much you borrow that certain level could be quite low.

Last point is comparing the apples and oranges of buying houses or stocks. That's not the question as I see it, but whether people should fund home purchases with less cash and more mortgage to use the extra cash to buy stocks, or else use the cash to have a smaller mortgage then use existing stocks as collateral to borrow to buy more stocks. Same house and same amount of stocks in either case, just a bigger mortgage and no margin loans in one case, smaller mortgage and some margin loans in the other case. Or, being long stock index futures rather than borrowing money (mortgage or margin) to buy the same stock position. The right answer could come out any of the three ways but it's not because best margin/futures rates are higher than mortgage rates which they aren't, and it's not because margin loan interest is never deductible, in many cases it is. The answer depends a lot on the liquidity issue though.
Last edited by JackoC on Wed Dec 05, 2018 10:54 pm, edited 2 times in total.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by AlohaJoe » Wed Dec 05, 2018 10:44 pm

alex_686 wrote:
Wed Dec 05, 2018 4:23 pm
smarcus3 wrote:
Wed Dec 05, 2018 3:48 pm
To play devil's advocate, if long term bonds are bad investments, why do banks offer them?
The argugument is overstated but...

First, the US government indirectly subsides the intrest rate on home loans.

Second, these long bonds are great for insurance companies and pension funds - risk adverse investors who need to offset and match long term liabilities.
They are terrible for insurance companies and pension funds, which is why virtually none of them invest directly in mortgages. Few actuaries would hedge a long term liability with a callable bond. And not just "callable in theory" but "the evidence shows that virtually every single one will be called before the term and you will be left with substantial interest rate risk".

Banks offer 30-year mortgages because the FHA guarantees they won't lose money on them. There were no 30 year mortgages before that went into effect in 1934. And then a few years later, in 1938, FNMA (Fannie Mae) was created and not only were the loans insured by the Federal government but they were then purchased from the banks, so the banks took even less risk.

The US is virtually unique in having 30-year fixed-rate mortgages, thanks to that substantial government support. Most other countries don't offer the same level of government subsidy to home buyers. A few other countries have started making them available in the last 5-10 years or so but they are still pretty uncommon. (I think France might be the only other Western country that offers them but I'm not sure; I had a link to a Federal Reserve study about it once but can't seem to find it right now.)

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by Nate79 » Wed Dec 05, 2018 10:48 pm

mrspock wrote:
Wed Dec 05, 2018 4:45 pm
smarcus3 wrote:
Wed Dec 05, 2018 11:37 am
Can someone explain to me why the advise is NEVER buy stocks on margin; however, everyone who has a mortgage and still buying stocks is basically doing the same thing? Can't seem to wrap my head around this one.

Thanks!
House dives 30% in value on your 4:1 leveraged loan what does bank do? Nothing. Stocks dive 30% on your 4:1 leveraged loan? You can kiss that loan or some portion of the stock holdings goodbye.

Bonus: House dives 50%, you can hand in the keys and go your merry way (non-recourse loan). Try that with a margin loan (after stocks tank 50%)? You’ll find out your paycheck is garnished pretty quick.

Not the same thing by a long shot.
Only a few states are non recourse and even those that are have had rules change overtime and can be quite restrictive.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by AlohaJoe » Wed Dec 05, 2018 11:01 pm

smarcus3 wrote:
Wed Dec 05, 2018 11:37 am
Can someone explain to me why the advise is NEVER buy stocks on margin; however, everyone who has a mortgage and still buying stocks is basically doing the same thing? Can't seem to wrap my head around this one.
I use margin. I have about $270,000 of margin at the moment with Interactive Brokers. I expect that makes me a fairly extreme outlier among Bogleheads. That said, here are some reasons most people should avoid margin:

Most people already have leverage via a mortgage. I think it is difficult to make the case that people should take on more leverage when they already have a mortgage. If margin is best people without a mortgage what does that mean? It largely means people who are in their 50s or 60s and people in their 20s. People in their 50s & 60s will rarely get a material benefit from margin. If their plans are on track, they don't need margin. If their plans are off track, margin is probably not the most effective way to get them on track.

For people in their 20s does margin make sense? Yes, maybe. But you also have to think about how you'd unwind the position if you buy a house (since we don't want to have two sources of leverage). Are you going to generate a large tax burden when you pay off your margin as you prepare to buy a house?

So I think that for most people in most situations "don't use margin" is a pretty good default. That said, I think people often make ridiculous arguments against margin. There is also a massive US bias to all of the replies (which is understandable, given Bogleheads). Hundreds of millions of people buy houses with variable rate mortgages. Having a fixed rate is not a meaningful explanation for why a mortgage is okay and margin is not. Otherwise you're telling every single Australian they aren't allowed to buy a house since there is no such thing as a fixed rate mortgage in Australia.

What's more very few people suggest leveraging up on margin 4-1 like you would with a house. But then you're making an apples-to-oranges comparison of 300% leverage with a house versus, say, 15% leverage with margin. Many people look at that and conclude that the marginal improvement isn't worth the additional risk. That's a perfectly fine conclusion to reach.

I think that using margin is also a much more complicated decision making process than using leverage with a house. With margin, do you leverage yourself up highly and then gradually pay that down over the years? So in year 1 you are at 40% but by year 5 you are at 25%? Or do you use a more modest level of margin but seek to keep it constant over time. So you keep it at 12%, which means using more leverage as your portfolio goes up in value and deleveraging if things go down for a while?

Another part of the decision complexity: how much margin to use? With mortgages there's quite a bit of research and experience about what levels are okay and what levels aren't. And the government programs mean that people are generally forced to stay within those limits. It is harder (but not impossible) to shoot yourself in the foot. There's really nothing like that with margin (though the new portfolio margin calculations are kinda sorta a step in that direction; they have such a short track record that I don't have much faith in them, though). Do you take 12%? 25%? 50%? 180%?

Mostly I think that margin is one of those things that falls into the category of: if you need to ask anonymous strangers on the internet about it -- and can't figure it out on your own -- then you probably shouldn't be doing it. Lots of things in life fall into that category, though, not just margin :D
Last edited by AlohaJoe on Wed Dec 05, 2018 11:04 pm, edited 1 time in total.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by Random Musings » Wed Dec 05, 2018 11:03 pm

I don't think that mortgages are "good", but they serve a more useful purpose than buying stocks on margin. Most people can't afford to buy a home outright. Reality is, many people can't buy a car outright or pay for tuition. Saying that, i believe that lenders stretch too far with risky loans that led us to the too big to fail moment about a decade ago.

Stocks on margin is pure speculation and eats into average returns.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by grabiner » Wed Dec 05, 2018 11:08 pm

If you have enough cash to buy a home without a mortgage, it is usually better to do that than to buy with a mortgage. Look at this from the bank's point of view; if you take out a mortgage, the bank has to sell other investments to get the money to lend you, so it will only do this if it would rather sell the investments and earn the mortgage rate. Therefore, you would rather sell (or not buy) the same investments in order to earn the mortgage rate yourself by not taking out the mortgage.

However, most people who buy homes can't do this, because they don't have enough cash. Even if your net worth is high enough that you could pay cash, it isn't a good idea to withdraw from your 401(k) to pay cash for a house, or to sell stock for a large capital gain. But buying a house is still a good deal, even with a mortgage, because of the other benefits of homeownership. (The same applies to college educations, which is why student loans are also considered "good" debt by many financial advisors; a college degree that allows you to work in a good career is worth much more to you than its cost.)

There are also exceptions created by the tax laws. If you are in a 40% combined federal and state tax bracket, you pay only 2.4% after tax on a 4% mortgage, and you might choose to take out the mortgage and buy bonds from your state yielding more than 2.4%. (This won't work with buying on margin, because you cannot deduct margin interest used to buy or carry municipal bonds. If you own any municipal bonds, the IRS rules that a prorated share of your margin interest was used to buy or carry those bonds. But if you took out a loan to buy a house, the IRS allows you to deduct the interest on that loan even if you also hold some municipal bonds.)
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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by JoMoney » Wed Dec 05, 2018 11:13 pm

I don't see margin as morally wrong or anything, but it is a lot more risk for less return (based on the cost to borrow). It can very easily turn a positive investing experience into a negative one.
I don't believe a mortgage is a "good" thing, but one that does make it better than margin borrowing is the extremely low rates, and the fact that you can get one fixed for 30 years, which is only available thanks to subsidies from the government for individual buyers. Your home is also a necessary consumption, and a tax advantaged one at that, if you rent using your investment income instead of owning a home, you have to come up with more taxable investment income to cover the same tax-free imputed rent you get living in your own home (the advantage with that though, goes up when the mortgage is gone).
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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by JackoC » Thu Dec 06, 2018 10:09 am

AlohaJoe wrote:
Wed Dec 05, 2018 11:01 pm
smarcus3 wrote:
Wed Dec 05, 2018 11:37 am
Can someone explain to me why the advise is NEVER buy stocks on margin; however, everyone who has a mortgage and still buying stocks is basically doing the same thing? Can't seem to wrap my head around this one.
...
So I think that for most people in most situations "don't use margin" is a pretty good default. That said, I think people often make ridiculous arguments against margin. ...

Mostly I think that margin is one of those things that falls into the category of: if you need to ask anonymous strangers on the internet about it -- and can't figure it out on your own -- then you probably shouldn't be doing it. Lots of things in life fall into that category, though, not just margin :D
Excellent post, but I agree with those two statements most of all. There have been at least three posts specifically saying that margin rates are higher than 30 yr mortgage rates, and that's not true of best margin rates. I gave the numbers and sources in a previous post. *Bad* margin rates are higher than the 30yr mortgage rate, but the best margin rate now is around 3.34% (varies by size) v average 30 yr mortgage rate of 4.90%, see the sources in post above. 4.90% is not lower than 3.34%, nor lower than the current 2.94% financing rate implied by stock index futures prices. Lowest current borrowing rate doesn't always win regardless of everything else, but it's factually untrue that margin rates are necessarily higher.

And I also especially agree with your final statement. It is like many other non-beginner topics in finance. If I show in my posts that *I* don't know what I'm talking about wrt an investment or investing tool, then that's actually a pretty good argument that *I* should steer clear of that investment or tool. But to effectively argue that everyone should steer clear of it, I have to show that I fully understand it and give correct info.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by alex_686 » Thu Dec 06, 2018 2:03 pm

AlohaJoe wrote:
Wed Dec 05, 2018 10:44 pm
They are terrible for insurance companies and pension funds, which is why virtually none of them invest directly in mortgages. Few actuaries would hedge a long term liability with a callable bond. And not just "callable in theory" but "the evidence shows that virtually every single one will be called before the term and you will be left with substantial interest rate risk".

Banks offer 30-year mortgages because the FHA guarantees they won't lose money on them. There were no 30 year mortgages before that went into effect in 1934. And then a few years later, in 1938, FNMA (Fannie Mae) was created and not only were the loans insured by the Federal government but they were then purchased from the banks, so the banks took even less risk.

The US is virtually unique in having 30-year fixed-rate mortgages, thanks to that substantial government support. Most other countries don't offer the same level of government subsidy to home buyers. A few other countries have started making them available in the last 5-10 years or so but they are still pretty uncommon. (I think France might be the only other Western country that offers them but I'm not sure; I had a link to a Federal Reserve study about it once but can't seem to find it right now.)
A couple of points.

"Whole Mortgages" are rarely found in insurance portfolios because of regulatory issues. It is a slipper slope and one could easily be consider a bank and be under banking regulators instead of insurance regulators, and no insurance company wants that. However insurance companies would load up on them if they could. You are right on the issues with home mortgages. However I will point out that 10 year treasuries have the opposite problem. If you could combine whole mortgages with treasury bonds one could have long term exposure and lower risk because the assets would provided a natural hedge to each other.

But they don't, and it is not because of FHA, who is a small fry. The big players in the market are Fanie Mae and Freddie Mac. They buy up mortgages and repackage them as CMOs. CMOs get sliced up into 20 or "tranches", each one doing something different. There tends to be 2 tranches on the left which adsorb higher than expected prepayments, and 2 tranches on the right that adsorb lower than expected cash flow. The result is that the main trache is pretty well insulated and has mostly the same interest rate risk as normal bonds. It is these that get stuffed into insurance portfolios.

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Re: Why buying homes with mortgages is good but buying stocks on margin is bad

Post by ThrustVectoring » Thu Dec 06, 2018 2:19 pm

Buying a home with a mortgage is often a good idea because the imputed or actual rents offset the mortgage payments. The asset you're buying on margin acts a lot like the loan you're taking out to finance it, so the actual risk of the position is significantly lower. Any sort of offsetting position is less risky than analysis of one side alone would suggest, and the financial markets recognize this in other contexts (eg, if you're long six 2-year treasury futures contracts, you get margin refunded to you if you then go short a 30-year treasury bond contract).

So the only open question is that once you net out the risks between the property cashflows and the mortgage payments, are you taking an appropriate amount of risk? A paid off house plus 100% stocks might not be enough, depending on your personal situation.
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