balancing investment in bonds versus paying off mortgage payoff

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cloudcover
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balancing investment in bonds versus paying off mortgage payoff

Post by cloudcover » Fri Aug 02, 2019 7:25 pm

I'm assuming this has been discussed before but i couldn't find much so i would appreciate any pointers to previous threads:

Let's say I owe 200k on my mortgage at 3.75% (and have no other debts and maxing out all retirement savings).
Let's also say that I have a 3 fund portfolio (total $1M) with 20% in bonds ($200k).

Is there an argument for selling the bonds in my portfolio and paying off the mortgage, which would give me guaranteed 3.75% return (higher than bonds are likely to give me)? If so, do i change my allocation for the remaining $0.8M? or keep all of it in stocks at that point since i'm counting the 20% as "bonds" by paying off my mortgage? or do i rebalance 80-20 again with the 1.8M? Am I thinking of this the right way or am i way off?

we1
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Re: balancing investment in bonds versus paying off mortgage payoff

Post by we1 » Fri Aug 02, 2019 7:46 pm

Ultimately this is going to boil down to how much you personally value liquidity. If you’re comfortable with lower liquidity and the spread between your mortgage rate and bond yields is meaningful, that favors paying down the mortgage.

I have a very low rate on my ARM mortgage and BND yields almost the same so at least for now I’ve choosen to stay liquid and not pay down the loan very fast.

lakpr
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Re: balancing investment in bonds versus paying off mortgage payoff

Post by lakpr » Fri Aug 02, 2019 8:10 pm

A mortgage can be thought of as a negative bond. So whether you keep the bonds in your portfolio while carrying the mortgage also, or whether you liquidate bonds and payoff the mortgage, you are no better or no worse than before.

You were actually 100% net in equities, you just didn't realize it.

The considerations to pay off the mortgage include the financial benefit you will accrue (you brought it up already), liquidity (mentioned by previous poster), the burden of capital gains or other taxes you will incur when selling the bond funds, and if course, your own risk tolerance. There is no clear cut answer.

SQRT
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Re: balancing investment in bonds versus paying off mortgage payoff

Post by SQRT » Sat Aug 03, 2019 9:16 am

lakpr wrote:
Fri Aug 02, 2019 8:10 pm
A mortgage can be thought of as a negative bond. So whether you keep the bonds in your portfolio while carrying the mortgage also, or whether you liquidate bonds and payoff the mortgage, you are no better or no worse than before.

You were actually 100% net in equities, you just didn't realize it.

The considerations to pay off the mortgage include the financial benefit you will accrue (you brought it up already), liquidity (mentioned by previous poster), the burden of capital gains or other taxes you will incur when selling the bond funds, and if course, your own risk tolerance. There is no clear cut answer.
Agree with this post. Most people don’t view their mortgage as a negative bond, although I think they should. You often hear “my mortgage is only x.xx% and surely I can do better than that with my investments. In order to keep their risk and AA constant though they should be comparing the mortgage rate to bond rates. That is usually a losing proposition. Liquidity is certainly a consideration albeit with a cost. Not sure why so many people think they are good bankers (playing the yield curve game) while ignoring mismatch risk?

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whodidntante
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Re: balancing investment in bonds versus paying off mortgage payoff

Post by whodidntante » Sat Aug 03, 2019 9:27 am

lakpr wrote:
Fri Aug 02, 2019 8:10 pm
A mortgage can be thought of as a negative bond. So whether you keep the bonds in your portfolio while carrying the mortgage also, or whether you liquidate bonds and payoff the mortgage, you are no better or no worse than before.
I agree with you, although I find the term "negative bond" somewhat grating. A more widely used term is "short position" as in "I am short fixed income." I instantly know what that means. "Negative bond" I had to learn through context clues from posters on this site. After all, we don't refer to a short stock position as "negative stock." Maybe it's just me.

JBTX
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Re: balancing investment in bonds versus paying off mortgage payoff

Post by JBTX » Sat Aug 03, 2019 5:03 pm

The actual answer is a bit more complicated. If you just compare 3.75% mortgage vs bonds at 2.0-2.5% yield, sure, it looks like a no brainer. Especially given for most the mortgage is not deductible, whereas the bond interest is likely taxable.

But there are other considerations.

- the value of having liquidity. What is that worth? What if you need the money? You may not be able to reborrow it at a competitive rate, or at all.

- the portfolio diversification of bonds vs stocks. In certain situations bonds go up when stocks go down.

- rates could go up, but your mortgage rates won't. A fixed mortgage can serve as somewhat of an inflation hedge.

- the ability to refinance. If rates go down, you can always refinance. I bet right now if you went 15 year mortgage you could get 3.25% or even lower.

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FiveK
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Re: balancing investment in bonds versus paying off mortgage payoff

Post by FiveK » Sat Aug 03, 2019 6:49 pm

cloudcover wrote:
Fri Aug 02, 2019 7:25 pm
I'm assuming this has been discussed before but i couldn't find much so i would appreciate any pointers to previous threads:
Paying down loans versus investing
invest debt site:bogleheads.org - Google Search
invest mortgage site:https://forum.mrmoneymustache.com - Google Search

Happy reading!

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grabiner
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Re: balancing investment in bonds versus paying off mortgage payoff

Post by grabiner » Sun Aug 04, 2019 9:58 am

cloudcover wrote:
Fri Aug 02, 2019 7:25 pm
I'm assuming this has been discussed before but i couldn't find much so i would appreciate any pointers to previous threads:

Let's say I owe 200k on my mortgage at 3.75% (and have no other debts and maxing out all retirement savings).
Let's also say that I have a 3 fund portfolio (total $1M) with 20% in bonds ($200k).

Is there an argument for selling the bonds in my portfolio and paying off the mortgage, which would give me guaranteed 3.75% return (higher than bonds are likely to give me)?
See Paying down loans versus investing on the wiki.

What is the tax situation? Under the current tax laws, if you are married, you can't deduct that mortgage interest unless you donate a lot to charity; if you are single, you can deduct most or all of it. You need to adjust that 3.75% return by the tax deduction.

Likewise, consider the after-tax return on the bonds. If they are available to pay off your mortgage, they are presumably in your taxable account, and they may be subject to federal or state tax.

Finally, for a fair comparison, you should compare bonds of the same duration as your mortgage. If your bonds are in Vanguard Long-Term Tax-Exempt Admiral shares at a 2.12% yield, they have a duration of 6.3 years, which is the duration of a mortgage with 14 years left. Thus, to get a fair comparison, you might consider refinancing your 30-year mortgage to a 15-year at current rates of about 3.25%.

Now, look at the net gain. If you are in a 24% tax bracket and are deducting the interest, the return from paying off a 3.25% mortgage is 2.47%. Selling bonds yielding 2.12% to get a 2.47% return is a small net gain. If you cannot deduct the interest, the difference between 3.25% at 2.12% is much larger. If you deduct the interest in a 32% bracket, it's only break-even.

So what do you lose for that gain? You may lose liquidity, depending on how much of your portfolio is in a 401(k), or in stocks you would have a large tax bill for selling. And you do lose optionality. If you don't pay off your mortgage now and rates drop, you can refinance (but you won't get the full benefit of the rate increase on your muni portfolio because some of the munis will be called).

My recommendation would be to pay off the mortgage if it is not deductible, but keep it if it is deductible and there is any liquidity benefit.

I am currently working out the numbers for myself on another thread. My rate is 2.625%, fully deductible, which is 1.79% after federal and state tax. I have only nine years on my mortgage, so my alternative is Vanguard Intermediate-Term Tax-Exempt with its 1.69% yield, which is 1.56% after state tax. The capital-gains tax I would have to pay to sell the stock makes it a marginal decision for me.
Wiki David Grabiner

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