Bonds in Portfolio or Pay Down Mortgage

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socialforums2019
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Joined: Sun Aug 25, 2019 10:12 am

Bonds in Portfolio or Pay Down Mortgage

Post by socialforums2019 »

I'm trying to decide what to do with my AA and if I should put cash towards mortgage or invest. If I put cash towards mortgage, I've read some suggestions that the house represents your bond allocation, therefore your setup is all equities + house. If I put cash towards the market, trying to determine best AA to have the best chance of getting 5%+ return a year for the next 20 years. Will have just shy of $1M cash to decide where to put it.

Mortgage is around $1M @ 2.375%

Current Portfolio - $775K
401K - $330K S&P 500 ETF, $28K Bonds ETF
HSA - $7K S&P 500 ETF
Roth IRA - $27K VTSAX
Taxable - $232K VTI
Current Cash - $151K
Incoming cash - $840K
lakpr
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by lakpr »

Interest paid on the mortgage principal above $750k is not tax deductible. If you are not hurting for liquidity (and sounds like you are not, with that $840k incoming cash), I would reduce the principal balance at least by $250k, then ask the lender to recast the mortgage.

I am in the camp of "rah rah, pay off your mortgage" camp, so if I were you I would take the $840k incoming cash + $232k VTI and secure the home free and clear. I own a more modest home ($600k value) and I did pay off the mortgage in November 2018. But then I am biased, so seek other opinions and make your own decision.
Topic Author
socialforums2019
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by socialforums2019 »

lakpr wrote: Tue Jul 27, 2021 8:22 am Interest paid on the mortgage principal above $750k is not tax deductible. If you are not hurting for liquidity (and sounds like you are not, with that $840k incoming cash), I would reduce the principal balance at least by $250k, then ask the lender to recast the mortgage.

I am in the camp of "rah rah, pay off your mortgage" camp, so if I were you I would take the $840k incoming cash + $232k VTI and secure the home free and clear. I own a more modest home ($600k value) and I did pay off the mortgage in November 2018. But then I am biased, so seek other opinions and make your own decision.
If we pay off the mortgage, that improves cashflow by around $3800/mo but all the models I've worked, even if I put all that money into taxable, it is significantly less 20 years from now v.s. having the amount invested now and paying remaining mortgage off in 20 years.
lakpr
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by lakpr »

socialforums2019 wrote: Tue Jul 27, 2021 10:53 am If we pay off the mortgage, that improves cashflow by around $3800/mo but all the models I've worked, even if I put all that money into taxable, it is significantly less 20 years from now v.s. having the amount invested now and paying remaining mortgage off in 20 years.
Right, that's why I said I am biased. When I was growing up, we always lived in rental houses, so owning a home free and clear has always been my top priority. Yes I could have earned more if I carried the mortgage than paying it off, but I have absolutely zero regrets. My SWAN factor (sleep-well-at-night) is achieved only after I owned my home.

You seem to be intent on maximizing the returns on your investment; so of course with higher returns expected from stocks rather than bonds (or mortgages), all models WILL predict higher wealth in 20 years. So you got to make your own decision.

What you are seeing is also the effect of lumpsum vs. dollar cost averaging effect. You are either investing entire $840k into market at once, or pay off the mortgage and investing $45k per year ($3800 * 12) into the market. We already know lumpsum wins, 66% of the time.
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Svensk Anga
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by Svensk Anga »

Looks to me like you may be comfortable with an 80/20 portfolio given your existing allocation. If so, you need to find a fixed income home for 20% of the incoming cash, so $168,000. That gets you a good bit of the way to the 750k deductibility limit lakpr suggested as a target. 168k gets you a few more years of maximum deductibility. You cannot get 2.375% safe after tax fixed income return anywhere else, except I bonds for who knows how long, and you can’t get much into those. $168k against the mortgage looks attractive to me.

Are you comfortable lump-summing the other 80% into equities now? If not, you will be dollar cost averaging and partial mortgage payoff with a recast may fit well with that.

Your models likely assume some nice positive average equity return. It will not necessarily play out like that. Keeping the mortgage is effectively investing with leverage. That can work out if your employment is secure and the markets are cooperative. But it is a higher risk/higher potential return path.
mervinj7
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by mervinj7 »

socialforums2019 wrote: Tue Jul 27, 2021 7:37 am I'm trying to decide what to do with my AA and if I should put cash towards mortgage or invest. If I put cash towards mortgage, I've read some suggestions that the house represents your bond allocation, therefore your setup is all equities + house. If I put cash towards the market, trying to determine best AA to have the best chance of getting 5%+ return a year for the next 20 years. Will have just shy of $1M cash to decide where to put it.

Mortgage is around $1M @ 2.375%

Current Portfolio - $775K
401K - $330K S&P 500 ETF, $28K Bonds ETF
HSA - $7K S&P 500 ETF
Roth IRA - $27K VTSAX
Taxable - $232K VTI
Current Cash - $151K
Incoming cash - $840K
What year did you acquire the house? Does the 750k deductible limit apply to you or the grandfathered $1M?
Personally, I would not payoff the mortgage early but would consider reducing the loan amount to maximize incentives (e.g. interest deduction). Instead I would use the $1M in cash and your other taxable assets to reduce the mortgage rate even further with relationship mortgage discounts banking. You can always revisit this question in five years but in the meantime reduce your carrying costs.

viewtopic.php?f=2&t=280692

For example, would you feel differently if your mortgage was a 5/1 ARM for 2.125%-0.5%= 1.625%
https://www.schwab.com/public/schwab/ba ... gage_rates

Some folks have just reported 1.5% interest rates but that's at higher asset levels. At that point, it's not a financial decision whether or not to pay down a mortgage but a purely psychological one (and there's nothing wrong with that by the way as long you are aware of it and accept it).
WageSlave
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by WageSlave »

Just my personal anecdote, FWIW: I had a mortgage on my previous home. It was very conservative: I only mortgaged about 50% of the home purchase price; I had enough in my investment portfolio to cover the rest (by a factor of 2x); and I made sure I could cover the mortgage even if I took a cut in pay (wife doesn't work). So, in this situation, for things to be really bad for me, (1) I'd have to lose my job and not be able to find another that paid reasonably well, (2) my portfolio would have to loose a tremendous amount of value, and (3) housing prices would have to collapse so that I'd be underwater on the mortgage. It seems unlikely that all those things could happen at once... yet I was still bothered by it. Not to the point of losing sleep or anything like that. But I had to keep reminding myself, "This is a very conservative mortgage, and in the long run, I will likely have more wealth than if I paid off the mortgage."

When I bought the house we now live in, I only took out a short-term loan until the previous house sold, and used the proceeds to completely pay off the loan on the new house. Now I occasionally have the opposite thoughts: "maybe I should have kept a mortgage, and sought bigger returns?" But more often, I remember the mild anxiety I had from the previous mortgage, and am quite content to not have any debt.

That's more a comment about my personality, but that's really a huge part of the decision. In the end, you are likely to end up with greater wealth by implicitly leveraging your portfolio via the mortgage. As with most things, it's a risk vs reward decision. Paying off the mortgage is lower risk, and probably lower returns.
harikaried
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by harikaried »

socialforums2019 wrote: Tue Jul 27, 2021 7:37 amIf I put cash towards mortgage, I've read some suggestions that the house represents your bond allocation
Perhaps you're thinking of owning a home as not needing to pay (imputed) rent, so that gives people the ability to shift their asset allocation to be more towards equities and less bonds. However, this is somewhat independent of the home equity / mortgage as you've already purchased the house.

The debt that you have is similar to a bond you sold to the bank, and likewise you can buy bonds from the US government as part of a Bonds ETF, so if you look just at these "bonds," you can calculate how much you're netting in yield - interest. If you find yourself as net negative, that's fine as you're effectively leveraged to be able to buy more equities than without the debt, and plenty of people do this especially during accumulation with the hopes that equities outperform relative to bonds/debt. So putting cash towards the mortgage in effect reduces the leverage and risk if that's desired.
hudson
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by hudson »

socialforums2019 wrote: Tue Jul 27, 2021 7:37 am I'm trying to decide what to do with my AA and if I should put cash towards mortgage or invest. If I put cash towards mortgage, I've read some suggestions that the house represents your bond allocation, therefore your setup is all equities + house. If I put cash towards the market, trying to determine best AA to have the best chance of getting 5%+ return a year for the next 20 years. Will have just shy of $1M cash to decide where to put it.

Mortgage is around $1M @ 2.375%

Current Portfolio - $775K
401K - $330K S&P 500 ETF, $28K Bonds ETF
HSA - $7K S&P 500 ETF
Roth IRA - $27K VTSAX
Taxable - $232K VTI
Current Cash - $151K
Incoming cash - $840K
House counts as bond allocation? That doesn't work for me. A house counts as a house....nothing else except maybe in net worth. Net worth is only good for bragging rights or psychological feel good.
Use incoming $840K to payoff house? I like being debt free; I like a paid off house. I would never ever reduce my holdings to payoff a house. In your situation, if your portfolio was $5M, I might pay it off. Otherwise, I would pay it out of current income with maybe double or triple payments. Keeping the $840K gives you options that are gone, if you payoff the house.
Bud
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by Bud »

My personal experience...

I split the difference - paid down a significant portion of my mortgage and waited a year to see how it felt. In my case, I ended up paying it all off.

Unless you are considering placing the $1m directly into stocks immediately, I would suggest at least paying off 25% of the mortgage or some significant portion (more than 10%). I like the idea of no mortgage - so inexpensive to live and the decision matrix concerning finances without debt is simplified.

One option to consider is make sure you pre-pay payments (we were a couple years ahead before I ended up paying of a 15 year loan in 4 years) - this is what I did and essentially this serves as mortgage payment insurance in case of some unseen catastrophe.

All the best
Topic Author
socialforums2019
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by socialforums2019 »

The approach I have been going back and forth is to invest it all in the market in hopes that it gets a nice little "cushion". It also provides the flexibility regarding liquidity as needed but with my luck, the day I put the money in, the market will have its 5-10% pull back. If that were the case, I wouldn't do anything (e.g. sell) and just ride it out. Just unlucky and know that sooner or later, it will recover in that 20 year span...one would hope. The only reason why I am considering if I should put some money to pay down the mortgage is if that were to happen (market pull back) at least I had put some of that money into the mortgage and I can built it back up overtime. Again, if my model is right:

If I put $250K into the mortgage to get it down to $750K and then I contribute a minimum of 401K max + $1,500 into taxable each month for the next 20 years, it will equal the same amount as if I just put all the money in the market and contributed only the 401K max.
harikaried
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by harikaried »

socialforums2019 wrote: Wed Jul 28, 2021 6:51 amthe day I put the money in, the market will have its 5-10% pull back. If that were the case, I wouldn't do anything (e.g. sell) and just ride it out
If it did drop soon after investing in taxable, you could do some Tax loss harvesting to get some immediate tax benefits.
socialforums2019 wrote: Wed Jul 28, 2021 6:51 amIf I put $250K into the mortgage to get it down to $750K and then I contribute a minimum of 401K max + $1,500 into taxable each month for the next 20 years, it will equal the same amount as if I just put all the money in the market and contributed only the 401K max.
If you believe the market will go up more than the non/partially-deductible mortgage interest rate, you wouldn't need to pay down to $750k and just invest the cash with more leverage. But if you don't want to be fully committed to using other people's money, reducing your average mortgage balance to be at most $750k by the end of the year does seem reasonable.
Outer Marker
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by Outer Marker »

socialforums2019 wrote: Tue Jul 27, 2021 10:53 am If we pay off the mortgage, that improves cashflow by around $3800/mo but all the models I've worked, even if I put all that money into taxable, it is significantly less 20 years from now v.s. having the amount invested now and paying remaining mortgage off in 20 years.
Buying equities vs. paying down the mortgage have vastly different risk profiles. The models are only a guess, and you quite possibly will have more money by being fully invested vs. paying off the mortgage -- but maybe not. Consider this: "After accounting for dividends, inflation, taxes and fees, $10,000 invested at the end of 1961 would have shrunk to $6,600 by 1981." http://archive.nytimes.com/www.nytimes. ... aphic.html

Paying down the mortgage is a 100% safe guaranteed return. Stocks are a gamble. I'd do some of both. There are many roads to Rome and complementary and simultaneous strategies increase your chances of success. For starters, I'd do as suggested to at least pay down the mortgage to $750,000 so it is all tax deductable. Personally, I wouldn't recast it, but would continue to pay down the debt and be done with it sooner.
OatmealAddict
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by OatmealAddict »

We recently took out a 30 year at 2.75% on a $700k home and put 20% down.

Our goal is to retire at age 60 and we are currently 39 years old, so we are paying an extra $650/month to effectively turn our 30 year into a 21 year and will have the house paid off the month before I strut into the office and tell them peace out.

As an added bonus, I always struggled with the decision to put excess funds toward the mortgage or in taxable, but now, I do both with the extra principal taking precedence. And while that may prove to not be the best decision from a pure financial perspective, I can rest easy knowing that it won't be the worst decision either since I'm not putting all of my eggs in one basket. Good enough is good enough for me.

As for a bond equivalent, I don't look at it that way at all. We keep an 80/20 portfolio and it has nothing to do with our home or mortgage.
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grabiner
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by grabiner »

socialforums2019 wrote: Tue Jul 27, 2021 10:53 am
lakpr wrote: Tue Jul 27, 2021 8:22 am Interest paid on the mortgage principal above $750k is not tax deductible. If you are not hurting for liquidity (and sounds like you are not, with that $840k incoming cash), I would reduce the principal balance at least by $250k, then ask the lender to recast the mortgage.

I am in the camp of "rah rah, pay off your mortgage" camp, so if I were you I would take the $840k incoming cash + $232k VTI and secure the home free and clear. I own a more modest home ($600k value) and I did pay off the mortgage in November 2018. But then I am biased, so seek other opinions and make your own decision.
If we pay off the mortgage, that improves cashflow by around $3800/mo but all the models I've worked, even if I put all that money into taxable, it is significantly less 20 years from now v.s. having the amount invested now and paying remaining mortgage off in 20 years.
And that is why it often makes sense to sell bonds to pay down the mortgage; you get a guaranteed benefit with little change in risk. (However, if your rate is 2.375%, you might not want to pay down deductible interest, as the benefit will be relatively low.)

It is a separate decision whether to sell stocks to pay down the mortgage; this reduces both return and risk. You might prefer to pay down a 2.375% mortgage rather than holding bonds yielding 1.06% (current yield on Vanguard Long-Term Tax-Exempt), but once you run out of those bonds, your risk tolerance might be consistent with buying stock rather than a risk-free long-term 2.375% return.
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gblack
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by gblack »

Without knowing the entire picture (ie total net worth or income), I would do some version of splitting the difference - between 250K to 500K toward mortgage and recast. Personally, my goal would be to lower the monthly mortgage to a "painless" amount relative to your income/net worth and then keep the rest invested at your present asset allocation, around 80/20.
NabSh
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by NabSh »

First of all I am biast as well. With today low interest rate you want accelerate the mortgage payment. Keep the money in VT/Bond or high value MM (80/20) . Keep paying the 30 year mortgage as per schedule.

I agree house is not a replacement for Bond. It is just an illiquid asset. When you sell it you will lose 7-8% of its value in commission, Taxes and Fees.

Everything that goes up will eventually come down. House and Stocks are both have been up. No one knows the limit. However stocks are liquid asset.

If you ever need funds tap into your taxable investment funds.
lakpr
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by lakpr »

NabSh wrote: Sat Jul 31, 2021 10:29 am I agree house is not a replacement for Bond. It is just an illiquid asset. When you sell it you will lose 7-8% of its value in commission, Taxes and Fees.
This is incurred whether or not you pay the mortgage down, when you sell. It is neither an argument for nor an argument against paying down the mortgage. One of those irrelevant facts /factors.
Outer Marker
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by Outer Marker »

gblack wrote: Sat Jul 31, 2021 10:16 am Personally, my goal would be to lower the monthly mortgage to a "painless" amount relative to your income/net worth and then keep the rest invested at your present asset allocation, around 80/20.
I respectfully disagree. “No pain, No gain”. OP has indicated no difficulty meeting his/her current monthly payment. Reducing the mortgage payment just enables extra spending. Creating a bit of “artificial scarcity” helps to build wealth. If you don’t see it, you won’t spend it. See, “Millionaire Next Door”. When I was building, half my paycheck was swept into investments without ever touching my checking account. I kept it on even keel without ever having to raid savings or reduce contributions. Sometimes it required a little belt tightening. It’s good for you.
Just_For_Jenna
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Re: Bonds in Portfolio or Pay Down Mortgage

Post by Just_For_Jenna »

I calculate my home equity completely separate from net worth. That being said, I am paying down my 30yr 2.99% with enough additional principle to pay it in 15. I could refi to a 15 year now with a lower rate, but I like the flexibility.

I love the idea of no mortgage, but I can’t justify cashing out my bonds to clear the mortgage. I could do it right now and cover the rest in cash that I’m sitting on, but I won’t.

I’m 38, have a $1.5m portfolio, 76% stock / 24% bonds, not including $85k in cash (for emergency expenses, some home project budget and travel cash).

Do what you feel is right. Doesn’t have to be all one or the other. Split it up 25/75 or 50/50.
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