"Mortgage is a negative bond" - please help me understand

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UALflyer
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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

KlangFool wrote: Thu Apr 15, 2021 2:06 pm
UALflyer wrote: Thu Apr 15, 2021 1:45 pm
So, if you put aside liquidity and rebalancing considerations, the question is whether it makes sense for people to be collecting $10 in interest on their bonds while paying out $13 in interest on their mortgage? The answer will depend on the situation, but you do need to examine this question.
UALflyer,

Why does it makes sense for you to think of it this way?

A) The money borrowed from the mortgage is invested ONLY in the bond portion of the portfolio

versus

B) The money borrowed from the mortgage is invested in the WHOLE 60/40 portfolio.

(A) could be right. But, (B) is not wrong either.
I completely agree that depending on the situation either one could be correct. What is important is for each person to examine this question and to determine the rationale that applies to him/her. I posted an example above, for instance, where a person's failure to examine this question would lead to absurd results and would cost you money down the road, all while subjecting the person to greater downside risk.
That is my problem with the term, "negative bond". It assumes that only (A) is correct. I disagreed with that.
As I've mentioned above, what you are saying here is also the primary reason that people tend to object to this term. In reality, there's no such assumption or implication, and all the posters in this thread who've used the term have explained this exact thing.

Again, regardless of the terminology, the point here is to encourage people to examine their rationale for holding bonds and to determine if there are better ways for them to achieve the same goals. In a lot of cases, the answer will be "no," but it's an important question to ask, as it'll be "yes" for lots of other people.
Why does it makes sense for me to pay off a 3.49% mortgage when my 60/40 portfolio returns a lot more than that? That would be my question back to you.
All that you're saying here is that you are using leverage for your investments. There's nothing wrong with that, but what is the purpose of the bonds in your asset allocation? It's to dampen volatility, correct?

If you can sell the bond portion of that portfolio and pay off (not just pay down, but pay off) the mortgage, wouldn't you increase your net returns, while decreasing your downside risk and reducing your cashflow requirements? If, on the other hand, you don't have enough bonds to pay off the mortgage, then that's a totally different situation, as paying down the mortgage reduces your liquidity while keeping the cashflow requirements the same.
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vineviz
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

KlangFool wrote: Thu Apr 15, 2021 2:06 pm B) The money borrowed from the mortgage is invested in the WHOLE 60/40 portfolio.

(A) could be right. But, (B) is not wrong either.

That is my problem with the term, "negative bond". It assumes that only (A) is correct. I disagreed with that. I borrowed money via my mortgage. It could used for any purpose. It does not have to offset the bond only. It can even be used to pay for college education versus a student loan. Money is fungible.

You want to go with (A). Go ahead. But, that does not mean (B) is wrong.

Why does it makes sense for me to pay off a 3.49% mortgage when my 60/40 portfolio returns a lot more than that? That would be my question back to you.
(B) is, in fact, "wrong".

It's true that money is fungible, but you've chosen to borrow money at 3.49% and invest that money at 1.23%. Apart from being an effective way to get poor slowly, the only advantage of this strategy is that it provides you with a bit of extra liquidity. Is that really worth paying 2%/year to get?


Imagine an investor with an investment portfolio of $1,000,000 invested 60/40. This investor has a mortgage of $200,000.

This investor has three entries in their asset allocation:

$600,000 in stocks, earning 6%.
$400,000 in bonds, earning 1.3%
$200,000 in debt, costing 3.5%.

This produces a blended return of 4.28%/ year. If they are rational, they will sell $200k in bonds and pay off the mortgage.

$600,000 in stocks, earning 6%.
$200,000 in bonds, earning 1.3%

This produces a blended return of 4.83%/year with the same amount of risk.
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Doc7
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Re: "Mortage is a negative bond" - please help me understand

Post by Doc7 »

vineviz wrote: Thu Apr 15, 2021 2:31 pm
KlangFool wrote: Thu Apr 15, 2021 2:06 pm B) The money borrowed from the mortgage is invested in the WHOLE 60/40 portfolio.

(A) could be right. But, (B) is not wrong either.

That is my problem with the term, "negative bond". It assumes that only (A) is correct. I disagreed with that. I borrowed money via my mortgage. It could used for any purpose. It does not have to offset the bond only. It can even be used to pay for college education versus a student loan. Money is fungible.

You want to go with (A). Go ahead. But, that does not mean (B) is wrong.

Why does it makes sense for me to pay off a 3.49% mortgage when my 60/40 portfolio returns a lot more than that? That would be my question back to you.
(B) is, in fact, "wrong".

It's true that money is fungible, but you've chosen to borrow money at 3.49% and invest that money at 1.23%. Apart from being an effective way to get poor slowly, the only advantage of this strategy is that it provides you with a bit of extra liquidity. Is that really worth paying 2%/year to get?


Imagine an investor with an investment portfolio of $1,000,000 invested 60/40. This investor has a mortgage of $200,000.

This investor has three entries in their asset allocation:

$600,000 in stocks, earning 6%.
$400,000 in bonds, earning 1.3%
$200,000 in debt, costing 3.5%.

This produces a blended return of 4.28%/ year. If they are rational, they will sell $200k in bonds and pay off the mortgage.

$600,000 in stocks, earning 6%.
$200,000 in bonds, earning 1.3%

This produces a blended return of 4.83%/year with the same amount of risk.

But now this investor is going to look and see that has to sell a bunch of equities to rebalance to his original desire 60/40, so really he sold a bunch of stocks to pay off that mortgage also and the blended ratio.... at 480K / 320K blended return is 4.12%.
Last edited by Doc7 on Thu Apr 15, 2021 2:37 pm, edited 2 times in total.
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ObliviousInvestor
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Re: "Mortage is a negative bond" - please help me understand

Post by ObliviousInvestor »

Thesaints wrote: Thu Apr 15, 2021 2:23 pm
alex_686 wrote: Thu Apr 15, 2021 1:52 pm
Cash is King wrote: Thu Apr 15, 2021 1:19 pm I don't think using the term dictates anything regarding AA. There is a disagreement. You view your mortgage as something other than debt. I don't own any bonds.
I would strongly disagree. A asset and a liability are the opposite side of the same coin. A bond and a loan are the opposite side of the same coin.

A mortgage is a debt, and a debt is just the other side of the bond.

The reason that most people call a mortgage as a negative bond is not because of wordplay.

Rather it is a reminder that having a mortgage impacts your finances. As such it should be included in your portfolio and not craved out into its own special space.
Analyze the volatility of two portfolios:

600k stocks + 400k bonds

600k stocks + 400k bonds + 400k mortgage + 400k home.

If one subscribes to the notion that a mortgage is a "negative bond", which I assume is trying to say that it is like being short on bonds, the volatility of the second portfolio would be much higher. In fact, the two volatilities are about identical. Obviously, I may add.
The second portfolio has some additional volatility due to $400k of real estate exposure. In either case there's $1,000,000 of equity (edit: "equity" in the "net worth" sense, not in the "stocks" sense). In one case there is $600k in risky assets, and in the other case there is $1,000,000 in risky assets.
Last edited by ObliviousInvestor on Thu Apr 15, 2021 2:39 pm, edited 2 times in total.
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Re: "Mortage is a negative bond" - please help me understand

Post by Cash is King »

UALflyer wrote: Thu Apr 15, 2021 1:45 pm
Cash is King wrote: Thu Apr 15, 2021 1:19 pm I don't think using the term dictates anything regarding AA. There is a disagreement. You view your mortgage as something other than debt. I don't own any bonds.
What are the specifics of the disagreement?

A bond is another term for debt. So is the term "mortgage," which describes debt secured by real estate. We use different terms to quickly explain the type of debt that we are talking about, that's all. When you buy a bond, you step into the lender's shoes and receive interest. When you take out a mortgage, you are the borrower, so you pay interest (hence, the term "negative bond," which means that you are paying interest instead of receiving it).

So, if you put aside liquidity and rebalancing considerations, the question is whether it makes sense for people to be collecting $10 in interest on their bonds while paying out $13 in interest on their mortgage? The answer will depend on the situation, but you do need to examine this question.
You and I view a mortgage loan differently.
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Re: "Mortage is a negative bond" - please help me understand

Post by not4me »

ObliviousInvestor wrote: Thu Apr 15, 2021 2:10 pm
:thumbsup :thumbsup
It amazes me how many people have decided that, for example, a 70/30 stock/bond allocation is appropriate for them without yet having decided what will count as a stock or a bond. (This comes up all the time with the "is Social Security a bond?" discussions as well.) It always makes me wonder, if you haven't yet decided what counts as what, how on earth did you decide that 70/30 was the right allocation? Perhaps that decision needs to be reassessed.
Well said! These threads often make me wonder if people don't know what a bond is or what a mortgage is. You said it better. I do think some have read that 60/40 is the thing to do & are now willing to defend that to the death...even if they can't explain what it really means or what the implications are. The good news is that for many it will work out ok regardless of whether they understand it
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Re: "Mortage is a negative bond" - please help me understand

Post by Cash is King »

alex_686 wrote: Thu Apr 15, 2021 1:52 pm
Cash is King wrote: Thu Apr 15, 2021 1:19 pm I don't think using the term dictates anything regarding AA. There is a disagreement. You view your mortgage as something other than debt. I don't own any bonds.
I would strongly disagree. A asset and a liability are the opposite side of the same coin. A bond and a loan are the opposite side of the same coin.

A mortgage is a debt, and a debt is just the other side of the bond.

The reason that most people call a mortgage as a negative bond is not because of wordplay.

Rather it is a reminder that having a mortgage impacts your finances. As such it should be included in your portfolio and not craved out into its own special space.
In my opinion, it is word play. I don't think anyone would disagree that a mortgage like any other debt impacts your finances.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

ObliviousInvestor wrote: Thu Apr 15, 2021 2:24 pm
KlangFool wrote: Thu Apr 15, 2021 2:18 pm
ObliviousInvestor wrote: Thu Apr 15, 2021 2:10 pm
UALflyer wrote: Thu Apr 15, 2021 12:11 pm I don't know about you specifically, but the vast majority of those who object to the term do so based on an implication that in their minds, using this term would somehow dictate what they should do with their AA. As I mentioned above, there is no such implication, so there's no basis for the disagreement.
UALflyer wrote: Thu Apr 15, 2021 12:19 pm I think that the issue here is that far too many people make asset allocation decisions without examining those default assumptions and determining whether they apply to their particular situation.
:thumbsup :thumbsup
It amazes me how many people have decided that, for example, a 70/30 stock/bond allocation is appropriate for them without yet having decided what will count as a stock or a bond. (This comes up all the time with the "is Social Security a bond?" discussions as well.) It always makes me wonder, if you haven't yet decided what counts as what, how on earth did you decide that 70/30 was the right allocation? Perhaps that decision needs to be reassessed.
ObliviousInvestor,

Please explain what do you mean by that? Why is that necessary or relevant?

My portfolio is 60/40 at 25X. I want 10 years of annual expense in fixed income. Hence, 40% in fixed income. It has nothing to do whether the mortgage and/or social security is "bond". Please explain.

KlangFool
I'm not sure I understand your question. If you want 10 years of annual expenses in fixed income, it seems to me that it matters what counts as fixed income when determining whether or not you have satisfied that criteria.

But either way, "10 years of annual expenses in fixed income" is a decision that appears to be based on some logic, as compared to what we often see here, which is people who have decided that the goal is to have a given percentage allocation, without yet having decided what will count toward the denominator or the numerator in the fraction.
ObliviousInvestor,

<<I'm not sure I understand your question. If you want 10 years of annual expenses in fixed income, it seems to me that it matters what counts as fixed income when determining whether or not you have satisfied that criteria.>>

In that context, neither social security or the mortgage is a "bond" and/or fixed income. Hence, it is irrelevant in my AA consideration. If you disagreed, please explain why.

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Re: "Mortage is a negative bond" - please help me understand

Post by Cash is King »

not4me wrote: Thu Apr 15, 2021 2:43 pm
ObliviousInvestor wrote: Thu Apr 15, 2021 2:10 pm
:thumbsup :thumbsup
It amazes me how many people have decided that, for example, a 70/30 stock/bond allocation is appropriate for them without yet having decided what will count as a stock or a bond. (This comes up all the time with the "is Social Security a bond?" discussions as well.) It always makes me wonder, if you haven't yet decided what counts as what, how on earth did you decide that 70/30 was the right allocation? Perhaps that decision needs to be reassessed.
Well said! These threads often make me wonder if people don't know what a bond is or what a mortgage is. You said it better. I do think some have read that 60/40 is the thing to do & are now willing to defend that to the death...even if they can't explain what it really means or what the implications are. The good news is that for many it will work out ok regardless of whether they understand it
I think it's clear by the comments thus far that people don't know what a bond is or what a mortgage is. Like you say ,it works out for most people. Good luck to everyone.
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Re: "Mortage is a negative bond" - please help me understand

Post by climber2020 »

vineviz wrote: Thu Apr 15, 2021 2:31 pm This produces a blended return of 4.28%/ year. If they are rational, they will sell $200k in bonds and pay off the mortgage.
What are the mechanics of how one actually does this if all bonds are located inside a tax deferred account? I'm assuming this would entail selling taxable stocks, incurring capital gains taxes, and converting an equivalent amount of bonds to stocks inside the 401k.
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Re: "Mortage is a negative bond" - please help me understand

Post by ObliviousInvestor »

KlangFool wrote: Thu Apr 15, 2021 2:47 pm My portfolio is 60/40 at 25X. I want 10 years of annual expense in fixed income. Hence, 40% in fixed income. It has nothing to do whether the mortgage and/or social security is "bond". Please explain.

[...]

In that context, neither social security or the mortgage is a "bond" and/or fixed income. Hence, it is irrelevant in my AA consideration. If you disagreed, please explain why.
I think "10 years of living expenses in fixed income, while counting neither Social Security nor mortgages toward the fixed income figure" is a perfectly reasonable approach. No quarrels with that at all.

What I think is nutty is, "I want a 70% stock, 30% bond allocation and will do whatever is necessary to get there. By the way, what counts as a bond?"
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Re: "Mortage is a negative bond" - please help me understand

Post by Kenkat »

vineviz wrote: Thu Apr 15, 2021 2:31 pm Imagine an investor with an investment portfolio of $1,000,000 invested 60/40. This investor has a mortgage of $200,000.

This investor has three entries in their asset allocation:

$600,000 in stocks, earning 6%.
$400,000 in bonds, earning 1.3%
$200,000 in debt, costing 3.5%.

This produces a blended return of 4.28%/ year. If they are rational, they will sell $200k in bonds and pay off the mortgage.

$600,000 in stocks, earning 6%.
$200,000 in bonds, earning 1.3%

This produces a blended return of 4.83%/year with the same amount of risk.
Here’s where these examples always break down in my opinion. Why is the debt part of the asset allocation but the house is not? Because it generates no income? But it does, in the form of inputed rent.

Using your example, let’s say that this person says “this is crazy, I am incurring this cost of 3.5% and getting nothing in return. I’m going to sell this house, get rid of the mortgage and rent. The 3.5% cost magically disappears. Look how much better off I am”.

But they are not. Now they have this monthly rent obligation. Why, it’s almost the same thing as the interest payment on the old mortgage! Did I really get rid of the effect of my debt? Did I really improve my situation? Did my portfolio return magically go up? No. Those returns never improve my net worth because there’s this other thing called a rent payment siphoning off the extra return every month.

Call a mortgage a negative bond - fine. But the house provides an offsetting bond-like entity paying imputed rent that offsets the mortgage.

My answer to that is to pull the mortgage and the house out of the asset allocation / investment accounts and into net worth instead. Yes, I should still look at cost of capital which may create a situation where I use money from the investment account to change the asset / liability mix, but that’s looking at the whole picture, not cramming the mortgage into the asset allocation without the house to offset it which never made sense to me.
Last edited by Kenkat on Thu Apr 15, 2021 2:57 pm, edited 2 times in total.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

vineviz wrote: Thu Apr 15, 2021 2:31 pm
KlangFool wrote: Thu Apr 15, 2021 2:06 pm B) The money borrowed from the mortgage is invested in the WHOLE 60/40 portfolio.

(A) could be right. But, (B) is not wrong either.

That is my problem with the term, "negative bond". It assumes that only (A) is correct. I disagreed with that. I borrowed money via my mortgage. It could used for any purpose. It does not have to offset the bond only. It can even be used to pay for college education versus a student loan. Money is fungible.

You want to go with (A). Go ahead. But, that does not mean (B) is wrong.

Why does it makes sense for me to pay off a 3.49% mortgage when my 60/40 portfolio returns a lot more than that? That would be my question back to you.
(B) is, in fact, "wrong".

It's true that money is fungible, but you've chosen to borrow money at 3.49% and invest that money at 1.23%. Apart from being an effective way to get poor slowly, the only advantage of this strategy is that it provides you with a bit of extra liquidity. Is that really worth paying 2%/year to get?


Imagine an investor with an investment portfolio of $1,000,000 invested 60/40. This investor has a mortgage of $200,000.

This investor has three entries in their asset allocation:

$600,000 in stocks, earning 6%.
$400,000 in bonds, earning 1.3%
$200,000 in debt, costing 3.5%.

This produces a blended return of 4.28%/ year. If they are rational, they will sell $200k in bonds and pay off the mortgage.

$600,000 in stocks, earning 6%.
$200,000 in bonds, earning 1.3%

This produces a blended return of 4.83%/year with the same amount of risk.
vineviz,

<<Is that really worth paying 2%/year to get?>>

Personal finance is personal. Whether something is worth it or not is up to the individual.

<<This investor has three entries in their asset allocation:

$600,000 in stocks, earning 6%.
$400,000 in bonds, earning 1.3%
>>

The return of 1 million 60/40 portfolio is not the same as the return of a 600K 100% stock portfolio and 400K bond portfolio. It could be higher or lower. But, it is not the same.

You are looking

A) X in stock, Y in bond, Z in mortgage

I am looking at

B) (X+Y) in 60/40 portfolio plus Z in mortgage

I do not see how (A) could be right and (B) could be wrong. There are two different ways of looking at things. They are both valid.

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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

Doc7 wrote: Thu Apr 15, 2021 2:34 pm
vineviz wrote: Thu Apr 15, 2021 2:31 pm
KlangFool wrote: Thu Apr 15, 2021 2:06 pm B) The money borrowed from the mortgage is invested in the WHOLE 60/40 portfolio.

(A) could be right. But, (B) is not wrong either.

That is my problem with the term, "negative bond". It assumes that only (A) is correct. I disagreed with that. I borrowed money via my mortgage. It could used for any purpose. It does not have to offset the bond only. It can even be used to pay for college education versus a student loan. Money is fungible.

You want to go with (A). Go ahead. But, that does not mean (B) is wrong.

Why does it makes sense for me to pay off a 3.49% mortgage when my 60/40 portfolio returns a lot more than that? That would be my question back to you.
(B) is, in fact, "wrong".

It's true that money is fungible, but you've chosen to borrow money at 3.49% and invest that money at 1.23%. Apart from being an effective way to get poor slowly, the only advantage of this strategy is that it provides you with a bit of extra liquidity. Is that really worth paying 2%/year to get?


Imagine an investor with an investment portfolio of $1,000,000 invested 60/40. This investor has a mortgage of $200,000.

This investor has three entries in their asset allocation:

$600,000 in stocks, earning 6%.
$400,000 in bonds, earning 1.3%
$200,000 in debt, costing 3.5%.

This produces a blended return of 4.28%/ year. If they are rational, they will sell $200k in bonds and pay off the mortgage.

$600,000 in stocks, earning 6%.
$200,000 in bonds, earning 1.3%

This produces a blended return of 4.83%/year with the same amount of risk.

But now this investor is going to look and see that has to sell a bunch of equities to rebalance to his original desire 60/40, so really he sold a bunch of stocks to pay off that mortgage also and the blended ratio.... at 480K / 320K blended return is 4.12%.
The only people who'd do that are the ones who don't understand the role that bonds play in their portfolio, so they use very mechanical and robotic ways of achieving what they think is their target AA. These are the same people who say that in their desire to have 40% bonds, they must actually be called "bonds." So, if they come across FDIC insured promotional CD's with higher yields, they wouldn't reallocate their bond holdings into the CD's because in their minds their portfolio would suddenly become a 100% equity one.

There's no shame in any of this, as lots of people just have an honest, genuinely held misunderstanding of these fundamental issues. That's the reason that these types of threads are important, as they hopefully cause people to give these things a bit more thought.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

ObliviousInvestor wrote: Thu Apr 15, 2021 2:52 pm
KlangFool wrote: Thu Apr 15, 2021 2:47 pm My portfolio is 60/40 at 25X. I want 10 years of annual expense in fixed income. Hence, 40% in fixed income. It has nothing to do whether the mortgage and/or social security is "bond". Please explain.

[...]

In that context, neither social security or the mortgage is a "bond" and/or fixed income. Hence, it is irrelevant in my AA consideration. If you disagreed, please explain why.
I think "10 years of living expenses in fixed income, while counting neither Social Security nor mortgages toward the fixed income figure" is a perfectly reasonable approach. No quarrels with that at all.

What I think is nutty is, "I want a 70% stock, 30% bond allocation and will do whatever is necessary to get there. By the way, what counts as a bond?"
ObliviousInvestor,

I have no idea who is doing that. My AA is based on my ability to take RISK. It is based on my annual expense. I would not adjust my AA based on any current or future market condition.

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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

Cash is King wrote: Thu Apr 15, 2021 2:48 pm
not4me wrote: Thu Apr 15, 2021 2:43 pm
ObliviousInvestor wrote: Thu Apr 15, 2021 2:10 pm
:thumbsup :thumbsup
It amazes me how many people have decided that, for example, a 70/30 stock/bond allocation is appropriate for them without yet having decided what will count as a stock or a bond. (This comes up all the time with the "is Social Security a bond?" discussions as well.) It always makes me wonder, if you haven't yet decided what counts as what, how on earth did you decide that 70/30 was the right allocation? Perhaps that decision needs to be reassessed.
Well said! These threads often make me wonder if people don't know what a bond is or what a mortgage is. You said it better. I do think some have read that 60/40 is the thing to do & are now willing to defend that to the death...even if they can't explain what it really means or what the implications are. The good news is that for many it will work out ok regardless of whether they understand it
I think it's clear by the comments thus far that people don't know what a bond is or what a mortgage is. Like you say ,it works out for most people. Good luck to everyone.
For whatever reason, you keep posting these cryptic, passive aggressive messages in this thread. Why don't you actually explain the specifics of your disagreement, as all these "I disagree" and "people don't know what a bond is or what a mortgage is" without explaining the nature of the disagreement does absolutely nothing to advance this discussion.
Last edited by UALflyer on Thu Apr 15, 2021 3:03 pm, edited 1 time in total.
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Re: "Mortage is a negative bond" - please help me understand

Post by ObliviousInvestor »

KlangFool wrote: Thu Apr 15, 2021 2:59 pm
ObliviousInvestor wrote: Thu Apr 15, 2021 2:52 pm
KlangFool wrote: Thu Apr 15, 2021 2:47 pm My portfolio is 60/40 at 25X. I want 10 years of annual expense in fixed income. Hence, 40% in fixed income. It has nothing to do whether the mortgage and/or social security is "bond". Please explain.

[...]

In that context, neither social security or the mortgage is a "bond" and/or fixed income. Hence, it is irrelevant in my AA consideration. If you disagreed, please explain why.
I think "10 years of living expenses in fixed income, while counting neither Social Security nor mortgages toward the fixed income figure" is a perfectly reasonable approach. No quarrels with that at all.

What I think is nutty is, "I want a 70% stock, 30% bond allocation and will do whatever is necessary to get there. By the way, what counts as a bond?"
ObliviousInvestor,

I have no idea who is doing that. My AA is based on my ability to take RISK. It is based on my annual expense. I would not adjust my AA based on any current or future market condition.

KlangFool
Your approach sounds reasonable to me (and in fact is similar to the approach I would be using if I were nearer to retirement).

As far as "who is doing that," all I can say is that I see it often here on the forum as well as in emails from many people. They pick the percentage first. Then they try to figure out how to get there, and in the process they realize they haven't decided what will count in which categories.

Relatedly, some years ago at the Bogleheads conference, one of the questions for the experts panel was the question of "should Social Security count as a bond?" The answer I gave was that it shouldn't matter. Whether you count it as a bond or not doesn't affect your actual economic reality.

So for example if you decided that 40% in bonds was appropriate without counting Social Security as a bond, then if you do decide to count Social Security as a bond, 40% would clearly no longer be the appropriate figure.
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alex_686
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Re: "Mortage is a negative bond" - please help me understand

Post by alex_686 »

ObliviousInvestor wrote: Thu Apr 15, 2021 2:34 pm Analyze the volatility of two portfolios:

600k stocks + 400k bonds

600k stocks + 400k bonds + 400k mortgage + 400k home.

If one subscribes to the notion that a mortgage is a "negative bond", which I assume is trying to say that it is like being short on bonds, the volatility of the second portfolio would be much higher. In fact, the two volatilities are about identical. Obviously, I may add.
The second portfolio has some additional volatility due to $400k of real estate exposure.

I don't think that we disagree on the level of volatility, regardless of whether a mortgage is counted as a negative bond or not.
[/quote]

Expect that the risks of the bonds are offset by the mirror exposure in the mortgage in the 2nd portfolio. And it is a leverage position.400 Except that maybe real estate is a safe and diversifying asset. And that portfolio #2 is wealthier and thus able to take more risks. So who knows?

No, this example is a real hash. Here is a better example, where both portfolios are worth 1m:

Portfolio #1: 600k stocks + 400k real estate
Portfolio #2: 600k stocks + 200k in bonds + 400k real estate - 200k mortgage

Portfolio #1 has a lower volatility than Portfolio #2. It also has a lower return, assuming that the mortgage has a higher rate than current bonds. It also has a lower liquidity and flexibility.

You can now ask how much liquidity and flexibility you need, and how much you are willing to pay.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

UALflyer wrote: Thu Apr 15, 2021 2:57 pm The only people who'd do that are the ones who don't understand the role that bonds play in their portfolio, so they use very mechanical and robotic ways of achieving what they think is their target AA. These are the same people who say that in their desire to have 40% bonds, they must actually be called "bonds." So, if they come across FDIC insured promotional CD's with higher yields, they wouldn't reallocate their bond holdings into the CD's because in their minds their portfolio would suddenly become a 100% equity one.
UALflyer,

There could another explanation here too. The person really want to invest in real BOND fund as opposed to CD aka CASH. The principal value / Net Asset Value of the bond fund could go up or down. It is not the same as CASH.

I have 3 years of expense in CASH separated from my 60/40 portfolio. I do not need more CASH in my 60/40 portfolio. CASH, BOND, and the STOCK are separate asset classes. I know that I know nothing. I do not stop investing in any of the three asset classes just because I think I can predict the future.

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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

ObliviousInvestor wrote: Thu Apr 15, 2021 3:02 pm
So for example if you decided that 40% in bonds was appropriate without counting Social Security as a bond, then if you do decide to count Social Security as a bond, 40% would clearly no longer be the appropriate figure.
ObliviousInvestor,

If and when I withdraw social security, my annual expense need will go down. Then, I go back to the same calculation. I want X years of expense in the bond and that translate into Y% of my portfolio.

In summary, I do not see a need or reason to over-complicate the AA consideration by claiming mortgage and/or social security as a "bond".

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Cash is King
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Re: "Mortage is a negative bond" - please help me understand

Post by Cash is King »

UALflyer wrote: Thu Apr 15, 2021 3:01 pm
Cash is King wrote: Thu Apr 15, 2021 2:48 pm
not4me wrote: Thu Apr 15, 2021 2:43 pm
ObliviousInvestor wrote: Thu Apr 15, 2021 2:10 pm
:thumbsup :thumbsup
It amazes me how many people have decided that, for example, a 70/30 stock/bond allocation is appropriate for them without yet having decided what will count as a stock or a bond. (This comes up all the time with the "is Social Security a bond?" discussions as well.) It always makes me wonder, if you haven't yet decided what counts as what, how on earth did you decide that 70/30 was the right allocation? Perhaps that decision needs to be reassessed.
Well said! These threads often make me wonder if people don't know what a bond is or what a mortgage is. You said it better. I do think some have read that 60/40 is the thing to do & are now willing to defend that to the death...even if they can't explain what it really means or what the implications are. The good news is that for many it will work out ok regardless of whether they understand it
I think it's clear by the comments thus far that people don't know what a bond is or what a mortgage is. Like you say ,it works out for most people. Good luck to everyone.
For whatever reason, you keep posting these cryptic, passive aggressive messages in this thread. Why don't you actually explain the specifics of your disagreement, as all these "I disagree" and "people don't know what a bond is or what a mortgage is" without explaining the nature of the disagreement does absolutely nothing to advance this discussion.
Ual,
Everyone who has a mortgage is on the hook for repayment of that mortgage regardless of what happens to the value of the home. So, it's more appropriate in my opinion to treat the mortgage as debt not attached to a specific asset. From this perspective debt is an offset to your overall portfolio.
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Re: "Mortage is a negative bond" - please help me understand

Post by CFM300 »

Cash is King wrote: Thu Apr 15, 2021 3:32 pm Everyone who has a mortgage is on the hook for repayment of that mortgage regardless of what happens to the value of the home.
About one third of the U.S. population lives in a non-recourse state, like California or Texas.
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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

Cash is King wrote: Thu Apr 15, 2021 3:32 pm
UALflyer wrote: Thu Apr 15, 2021 3:01 pm
Cash is King wrote: Thu Apr 15, 2021 2:48 pm
not4me wrote: Thu Apr 15, 2021 2:43 pm
ObliviousInvestor wrote: Thu Apr 15, 2021 2:10 pm
:thumbsup :thumbsup
It amazes me how many people have decided that, for example, a 70/30 stock/bond allocation is appropriate for them without yet having decided what will count as a stock or a bond. (This comes up all the time with the "is Social Security a bond?" discussions as well.) It always makes me wonder, if you haven't yet decided what counts as what, how on earth did you decide that 70/30 was the right allocation? Perhaps that decision needs to be reassessed.
Well said! These threads often make me wonder if people don't know what a bond is or what a mortgage is. You said it better. I do think some have read that 60/40 is the thing to do & are now willing to defend that to the death...even if they can't explain what it really means or what the implications are. The good news is that for many it will work out ok regardless of whether they understand it
I think it's clear by the comments thus far that people don't know what a bond is or what a mortgage is. Like you say ,it works out for most people. Good luck to everyone.
For whatever reason, you keep posting these cryptic, passive aggressive messages in this thread. Why don't you actually explain the specifics of your disagreement, as all these "I disagree" and "people don't know what a bond is or what a mortgage is" without explaining the nature of the disagreement does absolutely nothing to advance this discussion.
Ual,
Everyone who has a mortgage is on the hook for repayment of that mortgage regardless of what happens to the value of the home. So, it's more appropriate in my opinion to treat the mortgage as debt not attached to a specific asset. From this perspective debt is an offset to your overall portfolio.
Thanks for your explanation. Can you please clarify how this explanation ties into your objection to a statement that a mortgage shares a lot of similarities with bonds, so that it makes sense to at least consider (doesn't mean that it'll make sense in all situations) selling bonds and using their proceeds to pay off the mortgage, as doing so would increase people's net returns, while simultaneously providing downside protection (as in, paying off your mortgage results in a guaranteed return; it also reduces your cashflow requirements, which reduces the concerns that people have with volatility).

In other words, whether a mortgage is tied to your specific house or is just general debt, its debt characteristics remain the same, right?
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Re: "Mortage is a negative bond" - please help me understand

Post by UpsetRaptor »

It'd probably be more accurate to state it as "A mortgage acts as a negative bond" in one's total portfolio than the subject line. It certainly does act as a negative bond from a practical perspective, regardless if one thinks about it that way or not, or uses semantics to argue that a mortgage is not exactly a negative bond because of definitions.

The negative bond logic even holds true for inflation/deflation. Inflation is bad for bonds but beneficial if you have a mortgage, and vice versa for deflation.
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Re: "Mortage is a negative bond" - please help me understand

Post by Thesaints »

alex_686 wrote: Thu Apr 15, 2021 3:07 pm Expect that the risks of the bonds are offset by the mirror exposure in the mortgage in the 2nd portfolio.
They do not mirror. Your 400k in bonds change in value every day. Your 400k mortgage does not. You till have to repay 400k, whatever market conditions may be.
And that portfolio #2 is wealthier and thus able to take more risks. So who knows?
The 2 portfolios are exactly worth the same 1 M. Otherwise one would become wealthier the second they purchase a home.
No, this example is a real hash. Here is a better example, where both portfolios are worth 1m:

Portfolio #1: 600k stocks + 400k real estate
Portfolio #2: 600k stocks + 200k in bonds + 400k real estate - 200k mortgage

Portfolio #1 has a lower volatility than Portfolio #2. It also has a lower return, assuming that the mortgage has a higher rate than current bonds. It also has a lower liquidity and flexibility.
So you too are saying that 200k in bonds and 200k in mortgage do not cancel out.
But look at portfolio #3: 600k stocks + 200k cash + 400k RE -200k mortgage. This one is identical to portfolio #1. In fact you can in principle freely convert from one to the other at zero cost (ignoring fees). So mortgage is not a "negative bond", but "negative cash".
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Re: "Mortage is a negative bond" - please help me understand

Post by milktoast »

At the point where you have more liquidity in bonds and cash than you need to handle the scenarios you feel you need to handle, then mortgage becomes a true negative bond.

Buying bonds that pay less interest than the interest rate you are paying against the mortgage only makes sense to the extent that it gives you liquidity.

How much liquidity is enough? Well that's a emotional problem not a math problem.
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Re: "Mortage is a negative bond" - please help me understand

Post by Ocean77 »

ObliviousInvestor wrote: Wed Apr 14, 2021 2:24 pm
1) A mortgage is not "negative house" but rather "negative fixed-income." Many people think if they own a $400,000 house with a $200,000 mortgage, they only own $200,000 of real estate. But there is a $400,000 house on the balance sheet. The liability that happened to come with the house does not reduce the real estate exposure.
In most cases that's true, but not in all. If we both own a house that is worth $400k, and it falls by 90% due to some unfortunate situation, then we may find that our "real estate exposure" is different. If I have a $200k mortgage, I may send the key to the bank and walk away, incurring a $200k loss. If you own the home free and clear, you'd be in the hole by $360k.
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Re: "Mortage is a negative bond" - please help me understand

Post by Cash is King »

UALflyer wrote: Thu Apr 15, 2021 4:01 pm
Cash is King wrote: Thu Apr 15, 2021 3:32 pm
UALflyer wrote: Thu Apr 15, 2021 3:01 pm
Cash is King wrote: Thu Apr 15, 2021 2:48 pm
not4me wrote: Thu Apr 15, 2021 2:43 pm

Well said! These threads often make me wonder if people don't know what a bond is or what a mortgage is. You said it better. I do think some have read that 60/40 is the thing to do & are now willing to defend that to the death...even if they can't explain what it really means or what the implications are. The good news is that for many it will work out ok regardless of whether they understand it
I think it's clear by the comments thus far that people don't know what a bond is or what a mortgage is. Like you say ,it works out for most people. Good luck to everyone.
For whatever reason, you keep posting these cryptic, passive aggressive messages in this thread. Why don't you actually explain the specifics of your disagreement, as all these "I disagree" and "people don't know what a bond is or what a mortgage is" without explaining the nature of the disagreement does absolutely nothing to advance this discussion.
Ual,
Everyone who has a mortgage is on the hook for repayment of that mortgage regardless of what happens to the value of the home. So, it's more appropriate in my opinion to treat the mortgage as debt not attached to a specific asset. From this perspective debt is an offset to your overall portfolio.
Thanks for your explanation. Can you please clarify how this explanation ties into your objection to a statement that a mortgage shares a lot of similarities with bonds, so that it makes sense to at least consider (doesn't mean that it'll make sense in all situations) selling bonds and using their proceeds to pay off the mortgage, as doing so would increase people's net returns, while simultaneously providing downside protection (as in, paying off your mortgage results in a guaranteed return; it also reduces your cashflow requirements, which reduces the concerns that people have with volatility).

In other words, whether a mortgage is tied to your specific house or is just general debt, its debt characteristics remain the same, right?
Yes, the debt characteristics remain the same.
With regard to selling bonds to payoff the mortgage, I think you need to consider two things: Does the asset you're selling earn a higher return than the mortgage and are you comfortable with the added risk of leverage. Paying off your mortgage can increase your liquidity risk, so before going and selling those bonds it's important your cash needs are covered by other sources.
Of course, there is other considerations such as taxes, the mortgage acting as an inflation hedge, and peace of mind. For some, the peace of mind they get from not having any debt is all that matters to them. No wrong answer.
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

Doc7 wrote: Thu Apr 15, 2021 2:34 pm But now this investor is going to look and see that has to sell a bunch of equities to rebalance to his original desire 60/40, so really he sold a bunch of stocks to pay off that mortgage also and the blended ratio.... at 480K / 320K blended return is 4.12%.
Hopefully this investor is smart enough to know that they don't have to " sell a bunch of equities", because they were never ACTUALLY at 60/40 to begin with . . . .
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

Kenkat wrote: Thu Apr 15, 2021 2:53 pm
vineviz wrote: Thu Apr 15, 2021 2:31 pm Imagine an investor with an investment portfolio of $1,000,000 invested 60/40. This investor has a mortgage of $200,000.

This investor has three entries in their asset allocation:

$600,000 in stocks, earning 6%.
$400,000 in bonds, earning 1.3%
$200,000 in debt, costing 3.5%.

This produces a blended return of 4.28%/ year. If they are rational, they will sell $200k in bonds and pay off the mortgage.

$600,000 in stocks, earning 6%.
$200,000 in bonds, earning 1.3%

This produces a blended return of 4.83%/year with the same amount of risk.
Here’s where these examples always break down in my opinion. Why is the debt part of the asset allocation but the house is not? Because it generates no income? But it does, in the form of inputed rent.
If you think that's important then sure, go ahead and add that imputed rent in.

Since it goes into both examples in the same way, it doesn't change the outcome: the example without the mortgage has a higher return than the example with the mortgage.
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

KlangFool wrote: Thu Apr 15, 2021 2:56 pm You are looking

A) X in stock, Y in bond, Z in mortgage

I am looking at

B) (X+Y) in 60/40 portfolio plus Z in mortgage

I do not see how (A) could be right and (B) could be wrong. There are two different ways of looking at things. They are both valid.

KlangFool
(B) is wrong, because it treats the stock/bond allocation as immutable: it's not. Both ways of looking at this are not equally valid.
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Re: "Mortage is a negative bond" - please help me understand

Post by StevieG72 »

I find it a bit confusing myself, but with bond rates in the toilet chose to pay off mortgage. So if mortgage is a negative bond, home equity must be a positive bond!

Actually one of my goals was to have mortgage paid and reach a certain portfolio number by 50 yrs of age. A few years ago it seemed like a lofty goal, was able to make it happen about 18 months early.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

vineviz wrote: Thu Apr 15, 2021 7:13 pm
KlangFool wrote: Thu Apr 15, 2021 2:56 pm You are looking

A) X in stock, Y in bond, Z in mortgage

I am looking at

B) (X+Y) in 60/40 portfolio plus Z in mortgage

I do not see how (A) could be right and (B) could be wrong. There are two different ways of looking at things. They are both valid.

KlangFool
(B) is wrong, because it treats the stock/bond allocation as immutable: it's not. Both ways of looking at this are not equally valid.
vineviz,

You would have to explain to me what do you mean immutable in this context. If you mean that the 60/40 ratio cannot change, that is true for me. So, your statement as to the allocation can be changed is wrong for me.

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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

KlangFool wrote: Thu Apr 15, 2021 7:32 pm
vineviz wrote: Thu Apr 15, 2021 7:13 pm
KlangFool wrote: Thu Apr 15, 2021 2:56 pm You are looking

A) X in stock, Y in bond, Z in mortgage

I am looking at

B) (X+Y) in 60/40 portfolio plus Z in mortgage

I do not see how (A) could be right and (B) could be wrong. There are two different ways of looking at things. They are both valid.

KlangFool
(B) is wrong, because it treats the stock/bond allocation as immutable: it's not. Both ways of looking at this are not equally valid.
vineviz,

You would have to explain to me what do you mean immutable in this context. If you mean that the 60/40 ratio cannot change, that is true for me. So, your statement as to the allocation can be changed is wrong for me.

KlangFool
For one thing, the stock/bond ratio is only immutable if the investor is irrational. If we're dealing with irrationality, then all bets are off: someone who prefers a lower return portfolio over a higher return portfolio with the same risk is using a different calculus than the rest of us.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

UALflyer wrote: Thu Apr 15, 2021 2:26 pm

If you can sell the bond portion of that portfolio and pay off (not just pay down, but pay off) the mortgage, wouldn't you increase your net returns, while decreasing your downside risk and reducing your cashflow requirements? If, on the other hand, you don't have enough bonds to pay off the mortgage, then that's a totally different situation, as paying down the mortgage reduces your liquidity while keeping the cashflow requirements the same.
UALflyer,

<< If you can sell the bond portion of that portfolio and pay off (not just pay down, but pay off) the mortgage, wouldn't you increase your net returns, while decreasing your downside risk and reducing your cashflow requirements?>>

The answer is no.

Let's look at the number:

A) 1.5 million 60/40 portfolio with 300K mortgage.

B) 1.2 million 60/40 portfolio with ZERO mortgage.

My 60/40 portfolio is returning on the average of 7%. The mortgage is at 3.49%. Taking 300K away from the 60/40 and pay off the 300K mortgage is reducing the overall return. I lose 300K X (7% - 3.49%) = 300K x 3.51%.

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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

KlangFool wrote: Thu Apr 15, 2021 8:08 pmThe answer is no.
Please re-read the portion of the post that you've quoted. The answer is yes.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

vineviz wrote: Thu Apr 15, 2021 7:52 pm
KlangFool wrote: Thu Apr 15, 2021 7:32 pm
vineviz wrote: Thu Apr 15, 2021 7:13 pm
KlangFool wrote: Thu Apr 15, 2021 2:56 pm You are looking

A) X in stock, Y in bond, Z in mortgage

I am looking at

B) (X+Y) in 60/40 portfolio plus Z in mortgage

I do not see how (A) could be right and (B) could be wrong. There are two different ways of looking at things. They are both valid.

KlangFool
(B) is wrong, because it treats the stock/bond allocation as immutable: it's not. Both ways of looking at this are not equally valid.
vineviz,

You would have to explain to me what do you mean immutable in this context. If you mean that the 60/40 ratio cannot change, that is true for me. So, your statement as to the allocation can be changed is wrong for me.

KlangFool
For one thing, the stock/bond ratio is only immutable if the investor is irrational. If we're dealing with irrationality, then all bets are off: someone who prefers a lower return portfolio over a higher return portfolio with the same risk is using a different calculus than the rest of us.
vineviz,

<<For one thing, the stock/bond ratio is only immutable if the investor is irrational.>>

Personal finance is personal.

<< who prefers a lower return portfolio over a higher return portfolio with the same risk is using a different calculus than the rest of us.>>

A) You are assuming that I am using the same definition of RISK.

B) You are assuming that higher expected return is my portfolio goal. It is not.

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Re: "Mortage is a negative bond" - please help me understand

Post by Kenkat »

vineviz wrote: Thu Apr 15, 2021 7:08 pm
Kenkat wrote: Thu Apr 15, 2021 2:53 pm
vineviz wrote: Thu Apr 15, 2021 2:31 pm Imagine an investor with an investment portfolio of $1,000,000 invested 60/40. This investor has a mortgage of $200,000.

This investor has three entries in their asset allocation:

$600,000 in stocks, earning 6%.
$400,000 in bonds, earning 1.3%
$200,000 in debt, costing 3.5%.

This produces a blended return of 4.28%/ year. If they are rational, they will sell $200k in bonds and pay off the mortgage.

$600,000 in stocks, earning 6%.
$200,000 in bonds, earning 1.3%

This produces a blended return of 4.83%/year with the same amount of risk.
Here’s where these examples always break down in my opinion. Why is the debt part of the asset allocation but the house is not? Because it generates no income? But it does, in the form of inputed rent.
If you think that's important then sure, go ahead and add that imputed rent in.

Since it goes into both examples in the same way, it doesn't change the outcome: the example without the mortgage has a higher return than the example with the mortgage.
If the point is just that, absent any liquidity concerns, you should pay off 3.5% debt with bonds earning 1.3%, then I have no argument at all with that. I guess I don’t see what calling the debt part of your asset allocation has to do with that decision.
Last edited by Kenkat on Thu Apr 15, 2021 8:41 pm, edited 1 time in total.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

UALflyer wrote: Thu Apr 15, 2021 8:12 pm
KlangFool wrote: Thu Apr 15, 2021 8:08 pmThe answer is no.
Please re-read the portion of the post that you've quoted. The answer is yes.
Show me the numbers.

For the 300K mortgage, the Principal and Interest portion of the mortgage is 15K per year. That is the portion that will be eliminated by paying off the mortgage.

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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

KlangFool wrote: Thu Apr 15, 2021 8:20 pm
UALflyer wrote: Thu Apr 15, 2021 8:12 pm
KlangFool wrote: Thu Apr 15, 2021 8:08 pmThe answer is no.
Please re-read the portion of the post that you've quoted. The answer is yes.
Show me the numbers.

For the 300K mortgage, the Principal and Interest portion of the mortgage is 15K per year. That is the portion that will be eliminated by paying off the mortgage.

KlangFool
I invited you to re-read the statement that you've quoted, which is "If you can sell the bond portion of that portfolio and pay off (not just pay down, but pay off) the mortgage, wouldn't you increase your net returns, while decreasing your downside risk and reducing your cashflow requirements?" If you've got bonds earning 1.5% that you sell (without paying much in taxes) and use the proceeds to pay off a 3.5% mortgage, you've just improved your returns by a guaranteed 2% rate on that portion of the portfolio and eliminated the downside risk of your bond holdings. Since you've also just paid off the mortgage, you've eliminated the associated payment in its entirety, which also reduces your cashflow requirements and makes you less susceptible to market swings.

The trade off is that you reduce your liquidity and rebalancing options, which may or may not be a consideration.
Last edited by UALflyer on Thu Apr 15, 2021 8:39 pm, edited 2 times in total.
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Re: "Mortage is a negative bond" - please help me understand

Post by bobcat2 »

Joe has a $50,000 mortgage on his house. In addition Joe has an outstanding student loan of $100,000. Does Joe have $150,000 in negative bonds?

BobK
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alex_686
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Re: "Mortage is a negative bond" - please help me understand

Post by alex_686 »

bobcat2 wrote: Thu Apr 15, 2021 8:30 pm Joe has a $50,000 mortgage on his house. In addition Joe has an outstanding student loan of $100,000. Does Joe have $150,000 in negative bonds?
Yes. Plus car loans and credit card debt. All debt can, and should be included in one’s balance sheet and asset allocation.

Mortgages tend to be big. They are somewhat flexible and have a large impact. By flexible I mean question on buying a house for cash, paying down a mortgage, or doing a cash out.

This is why the get the most questions.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Kenkat
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Re: "Mortage is a negative bond" - please help me understand

Post by Kenkat »

alex_686 wrote: Thu Apr 15, 2021 8:41 pm
bobcat2 wrote: Thu Apr 15, 2021 8:30 pm Joe has a $50,000 mortgage on his house. In addition Joe has an outstanding student loan of $100,000. Does Joe have $150,000 in negative bonds?
Yes. Plus car loans and credit card debt. All debt can, and should be included in one’s balance sheet and asset allocation.

Mortgages tend to be big. They are somewhat flexible and have a large impact. By flexible I mean question on buying a house for cash, paying down a mortgage, or doing a cash out.

This is why the get the most questions.
Should all assets also be included in one’s balance sheet and asset allocation?
KlangFool
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

UALflyer wrote: Thu Apr 15, 2021 8:30 pm
KlangFool wrote: Thu Apr 15, 2021 8:20 pm
UALflyer wrote: Thu Apr 15, 2021 8:12 pm
KlangFool wrote: Thu Apr 15, 2021 8:08 pmThe answer is no.
Please re-read the portion of the post that you've quoted. The answer is yes.
Show me the numbers.

For the 300K mortgage, the Principal and Interest portion of the mortgage is 15K per year. That is the portion that will be eliminated by paying off the mortgage.

KlangFool
I invited you to re-read the statement that you've quoted, which is "If you can sell the bond portion of that portfolio and pay off (not just pay down, but pay off) the mortgage, wouldn't you increase your net returns, while decreasing your downside risk and reducing your cashflow requirements?" If you've got bonds earning 1.5% that you sell (without paying much in taxes) and use the proceeds to pay off a 3.5% mortgage, you've just improved your returns by a guaranteed 2% rate on that portion of the portfolio and eliminated the downside risk of your bond holdings. Since you've also just paid off the mortgage, you've eliminated the associated payment in its entirety, which also reduces your cashflow requirements and makes you less susceptible to market swings.

The trade off is that you reduce your liquidity and rebalancing options, which may or may not be a consideration.
UALflyer,

And, I had told you that I borrow that 300K to invest on my 60/40 portfolio. So, if I choose to pay off the 300K mortgage, I would sell 300K of my 60/40 portfolio to pay off the mortgage. Why do you believe that selling 300K of the bond is the only choice? I don't.

That is the whole point of disagreement.

I borrowed 300K at 3.49%. I have a 1.5 million 60/40 portfolio. Since I am the borrower, I get to decide how to invest that 300K. How could you tell me that the 300K is only for the bond?

KlangFool
Last edited by KlangFool on Thu Apr 15, 2021 9:06 pm, edited 1 time in total.
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alex_686
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Re: "Mortage is a negative bond" - please help me understand

Post by alex_686 »

Kenkat wrote: Thu Apr 15, 2021 8:52 pm
alex_686 wrote: Thu Apr 15, 2021 8:41 pm
bobcat2 wrote: Thu Apr 15, 2021 8:30 pm Joe has a $50,000 mortgage on his house. In addition Joe has an outstanding student loan of $100,000. Does Joe have $150,000 in negative bonds?
Yes. Plus car loans and credit card debt. All debt can, and should be included in one’s balance sheet and asset allocation.

Mortgages tend to be big. They are somewhat flexible and have a large impact. By flexible I mean question on buying a house for cash, paying down a mortgage, or doing a cash out.

This is why the get the most questions.
Should all assets also be included in one’s balance sheet and asset allocation?
If you read upthread you will see my qualified affirmative answer.

It is the only formal rational method to handle these things. It also requires a higher cognitive load to handle all of the moving parts.

If you don’t you have to resort to ad hoc and heuristic methods. Their easier but lead to errors.

It is up to you to draw the line of usefulness.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: "Mortage is a negative bond" - please help me understand

Post by Big Dog »

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UALflyer
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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

KlangFool wrote: Thu Apr 15, 2021 8:55 pm And, I had told you that I borrow that 300K to invest on my 60/40 portfolio. So, if I choose to pay off the 300K mortgage, I would sell 300K of my 60/40 portfolio to pay off the mortgage. Why do you believe that selling 300K of the bond is the only choice? I don't.
Who told you that it's the only choice? If the goal is to maintain the same AA, while simultaneously increasing net returns and decreasing downside risks, it's one of the options that can make financial sense.
That is the whole point of disagreement.

I borrowed 300K at 3.49%. I have a 1.5 million 60/40 portfolio. Since I am borrower, I get to decide how to invest that 300K. How could you tell me that the 300K is only for the bond?
I'm not sure what you're asking or what disagreement you're referring to.

You can obviously do nothing at all, but you just need to be aware of the fact that you are paying 3.5% interest on $300K, while only earning 1.5% or whatever on the same amount. You can obviously pay down the mortgage without paying it off, but need to be comfortable with the fact that you're reducing your liquidity but keeping the cashflow requirements the same (you might be able to re-cast your mortgage, although not all lenders offer it and those that do may charge a fee). You can also sell a portion of your equities and bonds portfolio and pay off your mortgage, but need to understand that doing so makes the portfolio more conservative, as it reduces your equities holdings.

You always have choices. Not all of them make a ton of financial sense.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

UALflyer wrote: Thu Apr 15, 2021 9:12 pm
KlangFool wrote: Thu Apr 15, 2021 8:55 pm And, I had told you that I borrow that 300K to invest on my 60/40 portfolio. So, if I choose to pay off the 300K mortgage, I would sell 300K of my 60/40 portfolio to pay off the mortgage. Why do you believe that selling 300K of the bond is the only choice? I don't.
Who told you that it's the only choice? If the goal is to maintain the same AA, while simultaneously increasing net returns and decreasing downside risks, it's one of the options that can make financial sense.
That is the whole point of disagreement.

I borrowed 300K at 3.49%. I have a 1.5 million 60/40 portfolio. Since I am borrower, I get to decide how to invest that 300K. How could you tell me that the 300K is only for the bond?
I'm not sure what you're asking or what disagreement you're referring to.

You can obviously do nothing at all, but you just need to be aware of the fact that you are paying 3.5% interest on $300K, while only earning 1.5% or whatever on the same amount.
UALflyer ,

<<the fact that you are paying 3.5% interest on $300K, while only earning 1.5% or whatever on the same amount. >>

This is because you are stuck on thinking that I am investing that 300K to the bond. I am not. I am borrowing that 300K to invest on my 60/40 portfolio. My 60/40 portfolio is earning around 7% per year. So, I am earning +3.5% with that 300K.

KlangFool
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USAFperio
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Re: "Mortgage is a negative bond" - please help me understand

Post by USAFperio »

Hi all, I'm the OP and am very appreciative of the diversity of thought and copious replies. I've learned quite a bit.

Quick follow-up scenario -- I'd appreciate your wisdom on this one:

I have $1M in retirement savings in a 60/40 stock/bond ratio, including $600K in VTSAX and $400K in bond index funds. I also owe $400K on my home mortgage. From what I've read in this thread, any dollar I spend toward paying off my mortgage is probably more beneficial than a dollar spent buying new bonds due to low bond interest rates. I therefore choose not to buy new bonds, but rather to sell my bonds to pay down my mortgage.

1. If I sell $200K in bonds to pay down $200K of my mortgage, I now have a $200K mortgage, $200K in bonds, $600K in stocks. Would I still consider my current AA to be 60/40? Or 75/25?

2. If I sell $400K in bonds to pay down the entire $400K mortgage, I now own a house with zero debt, $0K in bonds, and $600K in stocks. Would I still consider my current AA to be 60/40? Or 100/0?

If paying down the mortgage equates with buying new bonds, you'd think I should still consider my AA to be 60/40 in every scenario.

(For purposes of this example, I'm not including my home equity as part of my stock/bond AA . . . and I don't tend to think most people do so either, unless I'm mistaken.)
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Re: "Mortage is a negative bond" - please help me understand

Post by MoonOrb »

How do you guys have it in you to have this same argument every single month?
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