I notice that the portfoliovisualizer backtest for VFINX/VUSTX goes back to June 1986. It reminded me of something. Back about that same time, I was at work one day when two of my co-workers got into a huge debate about this very topic, using mortgage to invest in the stock market. The first guy had a mortgage but was investing in stocks. The second guy said he would not invest in the stock market until he paid off his mortgage.
First guy said if stocks return more than he pays in mortgage interest, he will come out ahead. Second guy didn't believe it and said impossible. The debate raged on. Each came up with example and counter-example. This was long before you could look up everything on the internet. Basically you only had a whiteboard and a calculator. Only a few people even had Lotus 1,2,3 spreadsheet at that time. Very little historical market data was available to the average investor. Maybe you had Random Walk Down Wall Street
which had a few tables.
It is funny that the debate is still going on. I still don't know the answer. But I decided to look up what the numbers would have looked like back then. If we had data back then, would it have seemed like a good idea to leverage a 40/60 VFINX/VUSTX? Let's find out!
I looked up most of the numbers on FRED and did some back-of-the-envelope calculations.
Code: Select all
1M LIBOR 7.12500%
1M LIBOR+1% 8.125%
30 YR FIXED MORTGAGE 10.38%
20-YR TREAS 7.69%
CPI CHANGE Y-O-Y 3.54%
INFLATION EXP 3.54%
VFINX E.R. 10.74%
VUSTX E.R. 7.69%
40/60 VFINX/VUSTX 8.91%
SPREAD (bsp) 78.48
First of all, the 30-Year Fixed mortgage was 10.38% and the 20-Year Treasury was yielding 7.69%.
The previous year had +3.54% CPI inflation, which I am calling the inflation expectations. They didn't start reporting inflation expectations until the 2000's.
CAPE was 13.89, so I am estimating that the S&P500 would return 10.74% before inflation.
The 40/60 portfolio had Expected Return = 8.91% before inflation.
This is less than the 30-Year mortgage rate of 10.38%. So I would have said, forget about mortgaging the house to invest in 40/60 in June 1986.
What about borrowing at 1-Month LIBOR + 1% = 8.125% ?
That gives you a spread of 78 basis points. I would have passed on that, also.
What was the actually result with 40/60 VFINX/VUSTX?
Jan 1987 - Jan 2019
Code: Select all
Portfolio Initial Final Balance CAGR Stdev Best Worst Max. Drawdown Sharpe Ratio
40/60 $10,000 $156,802 8.96% 7.99% 33.03% -3.75% -14.52% 0.74
Very close to what a forecast using CAPE, last-year's inflation rate and 20-year Treasury yield would have predicted.