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

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

Post by USAFperio »

I've read and heard that a mortgage should be considered a negative bond, although I'm trying to figure out how this concept affects my asset allocation.

For example, if I have a $1M investment portfolio with $600K in stocks and $400K in bonds, and I also have a $300K mortgage, does the mortgage (as a negative bond) effectively decrease my bonds to $100K (i.e., $400K - $300K = $100K)? Moreover, does the mortgage effectively change my asset allocation of 60/40 into something more akin to 86/14 (i.e., $600K stocks, $100K bonds)?

Based on your answer, I think I have a follow-up question but I'll hold for now. Many thanks for your help clarifying this.
Last edited by USAFperio on Tue Apr 20, 2021 10:15 pm, edited 2 times in total.
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JoeRetire
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Re: "Mortage is a negative bond" - help me understand

Post by JoeRetire »

USAFperio wrote: Wed Apr 14, 2021 1:28 pm I've read and heard that a mortgage should be considered a negative bond, although I'm trying to figure out how this concept affects my asset allocation.

For example, if I have a $1M investment portfolio with $600K in stocks and $400K in bonds, and I also have a $300K mortgage, does the mortgage (as a negative bond) effectively decrease my bonds to $100K (i.e., $400K - $300K = $100K)? Moreover, does the mortgage effectively change my asset allocation of 60/40 into something more akin to 86/14 (i.e., $600K stocks, $100K bonds)?
Yup, that's the theory.
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mushripu
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Re: "Mortage is a negative bond" - please help me understand

Post by mushripu »

Think of it this way

You are always solvent and would never be in a position that you have to get out of the house due to non-payment of mortgage etc. At least you have discipline and confident enough to remain that way.

Now you assume the full value of the house as an asset you have.not just the paid principal part of it. At this point the mortgage payment is like the negative yield on a bond and the house value is your bond holding. When the mortgage is paid off, the house value replaces any bold holding you need in portfolio. The return may turn positive through appreciation at some point in the mortgage life.

Portfolio 1m + 300k = 1.3 mil
For 60/40 you need 780k stock/220k +300k bond


Some people are not comfortable to throw mortgage debt into the portfolio allocation mix

Some people are strictly against considering primary residence as investment.

Some are ok with taking just the paid up principal/home equity portion of the home value into portfolio.
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Re: "Mortage is a negative bond" - please help me understand

Post by ObliviousInvestor »

Your household has a balance sheet: assets on one side, liabilities on the other. The difference between the two is your equity (net worth).

A mortgage exists in the liabilities column. And it is a fixed liability. So, it is akin to a bond where you are the borrower.

The key takeaways of this idea are that:
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.

2) Many people do not recognize that they are borrowing money at one rate while simultaneously lending it back out at a lower rate. Again, they think of the mortgage as simply an offset to the house on the balance sheet -- failing to see that they could sell some of their bonds to pay down the mortgage, generally with positive results.
USAFperio wrote: Wed Apr 14, 2021 1:28 pm For example, if I have a $1M investment portfolio with $600K in stocks and $400K in bonds, and I also have a $300K mortgage, does the mortgage (as a negative bond) effectively decrease my bonds to $100K (i.e., $400K - $300K = $100K)? Moreover, does the mortgage effectively change my asset allocation of 60/40 into something more akin to 86/14 (i.e., $600K stocks, $100K bonds)?
If you are only counting liquid assets (edit: and liabilities), then yes. But there is also a house on the balance sheet.
Last edited by ObliviousInvestor on Wed Apr 14, 2021 3:29 pm, edited 1 time in total.
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Re: "Mortage is a negative bond" - please help me understand

Post by Thesaints »

ObliviousInvestor wrote: Wed Apr 14, 2021 2:24 pm If you are only counting liquid assets, then yes. But there is also a house on the balance sheet.
I'd say it is the opposite.
In the OP example, he has a 60/40 portfolio worth a million. When he purchases a 300k home (for simplicity I'm assuming a no money down mortgage), he continues to own a 1M 60/40 portfolio which will continue to provide the same return, just as if he had not bought any house, and be subject to all the market gyrations typical of a 60/40 portfolio.
On the side he also has a 300k asset (the house) and a 300k debt (the mortgage) and his net worth continues to be 1M. Also, for simplicity, I'm assuming that purchase did not take place on especially good, nor bad, terms.

Going forward, the mortgage, as the interest payment part is concerned, is simply an additional outlay. Not any different from all the other current expenses (viz. butter, shoes, gas, cable bill, a nice vacation on the Riviera). The balance repayment part of the mortgage payments is instead not an outlay, but simply a transfer of assets from "cash" into "house".
On top of this there is the change in market value of the house, which adds or subtracts to one's net worth.

A bond, on the other hand, is an asset. At the time a bond is acquired, that too is simply a transfer of assets from "cash" into "bonds". Following that, any change in valuation is just like the change in valuation of the house, while any interest payment would be a negative expense (i.e. an increase in net worth), although sophisticated investors use an accrual method: instead of recognizing the interest payment only on the day it is received, they constantly increase their assets balance as the payment day gets closer. For instance, a $365 yearly interest payment, instead of being accounted as a $365 jump in assets on the day the payment is received, is accounted as a $1 increase on every passing day.

Based on the above, the "negative bond" is kind of a useless definition. It does not reflect changes in portfolio volatility and, just by itself, it is not even correct accounting-wise; one has to consider the house valuation to get a correct figure.
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Re: "Mortage is a negative bond" - please help me understand

Post by alex_686 »

Another vote for a mortgage as a negative bond.

Technically this is true. A bond and loan are just 2 different sides of the same coin.

From a pragmatic view point it is true. Bonds and mortgages act inversely the same way, driven by the same factors of interest rates and inflation.

From a practical view it is true. If you have 300k mortgage and a 400k in bonds why don't you sell the bonds and pay off the mortgage? Now, there are good reasons why you should or shouldn't. But it gives you a cohesive unified framework to ask the question. Yeah, I will grant you it is a more abstract complex way of thinking about things. Any other method is going to result in ad hoc and heuristic logic which will have holes.
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Re: "Mortage is a negative bond" - please help me understand

Post by Thesaints »

alex_686 wrote: Wed Apr 14, 2021 3:31 pm From a pragmatic view point it is true. Bonds and mortgages act inversely the same way, driven by the same factors of interest rates and inflation.
Well, no. Generally your bonds change price depending on market conditions, while your mortgage does not.
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Re: "Mortage is a negative bond" - please help me understand

Post by alex_686 »

Thesaints wrote: Wed Apr 14, 2021 6:01 pm
alex_686 wrote: Wed Apr 14, 2021 3:31 pm From a pragmatic view point it is true. Bonds and mortgages act inversely the same way, driven by the same factors of interest rates and inflation.
Well, no. Generally your bonds change price depending on market conditions, while your mortgage does not.
How do you figure? The fancy bond calculator that I have argues otherwise. :twisted: In fairness, this is kind of my day job.

So your bank does not mark-to-market you mortgage like your brokerage mark-to-markets your bonds. That does not change the reality of the situation.

Your mortgage isn't liquid and has a call option (you can repay at any time). This makes things mathematically complex. I will be honest, my bond calculator struggles with the calculations involved. Still does not change the reality of the situation.

But there are some intuitive examples out there.

Lets say that interest rates increased, either because real rates or inflation increased. Bond prices would fall but the value of your mortgage would increase. If mortgage rates jumped from 3% to 5% would you be more or less likely to refinance your home? Probably not - you would want to hang onto it. What about selling your home with a advantageous low rate mortgage on it? Historical evidence suggests you would be disinclined.
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Re: "Mortage is a negative bond" - please help me understand

Post by JoMoney »

I don't follow much of the "portfolio effect" asset allocation, but when it comes to the bottom line I'm not going to borrow at 3% (mortgage or otherwise) and then buy bonds paying 2%.
... although I can see some justification for a larger short-term "emergency fund" if you're a homeowner.
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Re: "Mortage is a negative bond" - please help me understand

Post by LongRoad »

ObliviousInvestor wrote: Wed Apr 14, 2021 2:24 pm 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.
Thank you for stating this so clearly. This point is widely misunderstood, even on Bogleheads.
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Re: "Mortage is a negative bond" - please help me understand

Post by Thesaints »

alex_686 wrote: Wed Apr 14, 2021 6:53 pm How do you figure? The fancy bond calculator that I have argues otherwise. :twisted: In fairness, this is kind of my day job.

So your bank does not mark-to-market you mortgage like your brokerage mark-to-markets your bonds. That does not change the reality of the situation.

Your mortgage isn't liquid and has a call option (you can repay at any time). This makes things mathematically complex. I will be honest, my bond calculator struggles with the calculations involved. Still does not change the reality of the situation.

But there are some intuitive examples out there.

Lets say that interest rates increased, either because real rates or inflation increased. Bond prices would fall but the value of your mortgage would increase. If mortgage rates jumped from 3% to 5% would you be more or less likely to refinance your home? Probably not - you would want to hang onto it. What about selling your home with a advantageous low rate mortgage on it? Historical evidence suggests you would be disinclined.
My bank may mark-to-market my mortgage, but I don't. If mortgage rates jump I don't really care. If they fall I may have an incentive in lowering my interest expense, but the balance amount would stay the same.
I'm saying that from the individual investor's point of view a mortgage is not a "negative bond", whatever than means.
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Re: "Mortage is a negative bond" - please help me understand

Post by BHawks87 »

I always get confused by "a mortgage is a negative bond" as well. It seems like the advice if following that phrase should be to buy more bonds if you have a mortgage right? So if you desire to be at 80/20 on a 1 million portfolio and you take out a $200k mortgage then you are effectively at 100% stocks and would need to sell $160k worth of stocks and shift to bonds to get back to 80/20?
JoMoney wrote: Wed Apr 14, 2021 7:01 pm I don't follow much of the "portfolio effect" asset allocation, but when it comes to the bottom line I'm not going to borrow at 3% (mortgage or otherwise) and then buy bonds paying 2%.
... although I can see some justification for a larger short-term "emergency fund" if you're a homeowner.
This makes the most sense to me but seems to be the exact opposite of the OP's phrase right?
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Re: "Mortage is a negative bond" - please help me understand

Post by alex_686 »

BHawks87 wrote: Wed Apr 14, 2021 8:47 pm I always get confused by "a mortgage is a negative bond" as well. It seems like the advice if following that phrase should be to buy more bonds if you have a mortgage right? So if you desire to be at 80/20 on a 1 million portfolio and you take out a $200k mortgage then you are effectively at 100% stocks and would need to sell $160k worth of stocks and shift to bonds to get back to 80/20?
JoMoney wrote: Wed Apr 14, 2021 7:01 pm I don't follow much of the "portfolio effect" asset allocation, but when it comes to the bottom line I'm not going to borrow at 3% (mortgage or otherwise) and then buy bonds paying 2%.
... although I can see some justification for a larger short-term "emergency fund" if you're a homeowner.
This makes the most sense to me but seems to be the exact opposite of the OP's phrase right?
Maybe.

Money is fungible. For example...
JoMoney wrote: Wed Apr 14, 2021 7:01 pm I don't follow much of the "portfolio effect" asset allocation, but when it comes to the bottom line I'm not going to borrow at 3% (mortgage or otherwise) and then buy bonds paying 2%.
... although I can see some justification for a larger short-term "emergency fund" if you're a homeowner.

If you would not borrow at 3% to by 2% bonds, would you sell a long duration fixed rate bond of 3% to buy equites?

It you don't want a mortgage, would you sell the bonds to pay it down? Equities? A 80/20 split?

A critical point is that you can run the numbers forwards or backwards to be internally consistent. If you not willing to sell equites to pay down your mortgage that must mean you are willing to take out a loan to buy more equities. If not cognitive errors creep in, and these are common errors.

Also you get to ask yourself if you really want to be 80/20. I mean, why do you want to be at 80/20? Why not 95/5? Most people avoid these hard questions - really questing the ad hoc decisions that were made years ago.

And I am not advocating that you go one way or the other. It just gets you to a better more rational viewpoint of yourself.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

OP,

Liquidity.

Please explain how to take money out of the "negative bond" like the normal bond.

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

Post by LongRoad »

KlangFool wrote: Wed Apr 14, 2021 9:08 pm OP,

Liquidity.

Please explain how to take money out of the "negative bond" like the normal bond.

KlangFool
Why would one expect to take money out of a negative bond?

You took out the money already, when the negative bond (mortgage) was originated.
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Re: "Mortage is a negative bond" - please help me understand

Post by random_walker_77 »

When you own a bond, you have lent out your money.
When you have a mortgage, you have borrowed money.

If you've lent out money at 3%, and inflation rises to 5%, that hurts you.
When someone has lent you money at 3%, and inflation rises to 5%, that helps you.

If you've lent out money at 3%, and rates rise to 4%, you lose out on lending that money to someone else at 4% (interest rate risk). If you need your money back, you do so by selling the bond to someone else, but they're going to want that 4% so you have to take a haircut on the principal so that the seller "sees" a 4% return***.
If you've borrowed money at 3%, and rates rise to 4%, the lender loses out. Better yet, if rates drop to 2%, you can refi the mortgage (equivalent to "calling" a bond). So heads you win and tails they lose.

***Analogous example -- not mathematically accurate but shows the general principle: Let say you've lent out $97 expecting to get $100 in 1 year. Immediately, rates rise and borrowers can borrow $96, and would owe $100 in 1 year. If you want to sell your bond immediately for cash, no one's going to give you $97 for that IOU. You'd need to sell it for the market rate of $96, and thus lose $1. Or you can hold it for the year (to the end of the term) and end up with the original $100 you were promised.
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Re: "Mortage is a negative bond" - please help me understand

Post by Fat Tails »

Thesaints wrote: Wed Apr 14, 2021 6:01 pm
alex_686 wrote: Wed Apr 14, 2021 3:31 pm From a pragmatic view point it is true. Bonds and mortgages act inversely the same way, driven by the same factors of interest rates and inflation.
Well, no. Generally your bonds change price depending on market conditions, while your mortgage does not.
A mortgage certainly changes in value with changes in interest rates and repayment history and value of the collateral ... in the eyes of the “negative bond” buyer, the bank. That why banks sell mortgages, all the time. A mortgage is a negative bond.

The mortgagee doesn't see the change in value UNTIL they try to refinance, i.e. issue another bond.

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

Post by Doc7 »

If a mortgage is a negative bond,

Should a 28 year old desiring a 90/10 portfolio with a 180K mortgage, and a $150K 401k balance, saving $15K a year, be putting all of his 401K savings into bonds (current and future investments?) Otherwise he can’t get to 10% Bonds, and would be constantly rebalancing out of his 100+% Equities position back to them.



Next question
If “it doesn’t make sense to buy bonds while you hold a mortgage”, so one puts all Roth, 401K, HSA money into US TSM Fund, cutting investment to bonds to throw that money to the mortgage. How does one rebalance? In the end, they are really going to sell equities to pay the mortgage down. (When they rebalance into bonds, that they didn’t buy on recurring investments due to paying the mortgage)
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Re: "Mortage is a negative bond" - please help me understand

Post by LongRoad »

Doc7 wrote: Thu Apr 15, 2021 12:52 am
Next question
If “it doesn’t make sense to buy bonds while you hold a mortgage”, so one puts all Roth, 401K, HSA money into US TSM Fund, cutting investment to bonds to throw that money to the mortgage. How does one rebalance? In the end, they are really going to sell equities to pay the mortgage down. (When they rebalance into bonds, that they didn’t buy on recurring investments due to paying the mortgage)
"Is a mortgage a negative bond?", and "Can I hold some bonds if I have a mortgage?" are really two separate questions. Yes and Yes are possible answers.

Though simultaneously holding a mortgage and bonds usually has a negative expected value, there can be valid reasons to do so. Liquidity and the ability to rebalance my invested portfolio are the most obvious; just recognize that they do not come for free if financed with a mortgage. My house insurance surely has a negative expected value (for me), but I accept (even embrace) it because I understand its impact on my overall finances.
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Re: "Mortage is a negative bond" - please help me understand

Post by m@ver1ck »

Good thread and makes me change my mental model.

Seems like one should consider a mortgage a negative bond if one is also considering home equity as part of asset allocation.

And if not considering home equity as part of asset allocation no reason to consider it a negative bond.

I would not consider it a negative bond - rather an expense that I need to ensure I can meet and plan for as part of my EF.
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Re: "Mortage is a negative bond" - please help me understand

Post by Tony Stark »

I view home ownership separately from an investment account. I have never heard a good explanation of how to factor in the home equity part of home ownership into asset allocation. All the focus seems to be on the mortgage as a negative bond. But lets say you own a 1 million dollar home and have a $250000 mortgage. How do you factor in the $750000 home equity into your asset allocation? On a separate note, how should a renter factor in their monthly rental payment into their asset allocation? Is a rental payment also a negative bond paid in perpetuity? We all have to live somewhere.
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Re: "Mortage is a negative bond" - please help me understand

Post by Dandy »

I tend to keep things as they really are. Debt is debt whether it is a mortgage, school loan or car loan. You should take your entire financial picture into account when determining your investment allocation. e.g. a person with a lot of debt might want to keep a bit more assets in fixed income. Same if they feel their employment might be at more risk.

Same with income e.g. if you are collecting a pension, annuity or Social Security it is income not a bond. It allows you to have a more aggressive investment allocation if you choose but in reality it reduces your potential required draw from your investments to support your life style.

Periodically, you should review your financial situation and decide if any changes are warranted to your investment allocation. You should take a lot of factors into consideration e.g. age, health, debt, income, inflation, portfolio size, employment status, etc.
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Re: "Mortage is a negative bond" - please help me understand

Post by Slacker »

While this is an interesting discussion from an economics and mathematical perspective I go back to the idea of: "I have to have somewhere to live, my mortgage is the cost to put a roof over my head and not part of my investment portfolio".
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

Tony Stark wrote: Thu Apr 15, 2021 6:43 am How do you factor in the $750000 home equity into your asset allocation?
The house (all of it, not just “home equity”) is an asset, but not necessarily exactly like a stock or a bond. Most people treat real estate as a distinct asset class.

Tony Stark wrote: Thu Apr 15, 2021 6:43 am On a separate note, how should a renter factor in their monthly rental payment into their asset allocation? Is a rental payment also a negative bond paid in perpetuity? We all have to live somewhere.
No, expenses are just expenses: not an asset or a liability.
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Re: "Mortage is a negative bond" - please help me understand

Post by Tony Stark »

vineviz wrote: Thu Apr 15, 2021 8:26 am
Tony Stark wrote: Thu Apr 15, 2021 6:43 am How do you factor in the $750000 home equity into your asset allocation?
The house (all of it, not just “home equity”) is an asset, but not necessarily exactly like a stock or a bond. Most people treat real estate as a distinct asset class.

Tony Stark wrote: Thu Apr 15, 2021 6:43 am On a separate note, how should a renter factor in their monthly rental payment into their asset allocation? Is a rental payment also a negative bond paid in perpetuity? We all have to live somewhere.
No, expenses are just expenses: not an asset or a liability.
So, ignore the $1m asset but pay attention to the $250K liability when determining the asset allocation for your stock/bond percentages in your investment portfolio? It just does not make sense to me and never has. That is why I view home ownership separately. The mortgage is an expense just like a rental payment would be.
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Re: "Mortage is a negative bond" - please help me understand

Post by firebirdparts »

If we're voting, I also vote "yes" to the original post.

It seems to cause more confusion than clarity, but if you hold a bond that pays 2% and a negative bond that cost 3%, then at least you need to think about why you'd pay that. You can have a reason and it's okay to do it, but you just need to ask yourself what that reason might be.
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

Tony Stark wrote: Thu Apr 15, 2021 8:55 am So, ignore the $1m asset but pay attention to the $250K liability when determining the asset allocation for your stock/bond percentages in your investment portfolio?
No, I don't think anyone is suggesting that you ignore anything. I certainly am not suggesting that.
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Re: "Mortage is a negative bond" - please help me understand

Post by Tingting1013 »

vineviz wrote: Thu Apr 15, 2021 8:26 am
Tony Stark wrote: Thu Apr 15, 2021 6:43 am How do you factor in the $750000 home equity into your asset allocation?
The house (all of it, not just “home equity”) is an asset, but not necessarily exactly like a stock or a bond. Most people treat real estate as a distinct asset class.
“Home equity” can reasonably be treated as its own asset line item in states that have non-recourse mortgages and you are willing to exercise the put option if things came to a head.
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Re: "Mortage is a negative bond" - please help me understand

Post by Ben Mathew »

Tony Stark wrote: Thu Apr 15, 2021 8:55 am
vineviz wrote: Thu Apr 15, 2021 8:26 am
Tony Stark wrote: Thu Apr 15, 2021 6:43 am How do you factor in the $750000 home equity into your asset allocation?
The house (all of it, not just “home equity”) is an asset, but not necessarily exactly like a stock or a bond. Most people treat real estate as a distinct asset class.

Tony Stark wrote: Thu Apr 15, 2021 6:43 am On a separate note, how should a renter factor in their monthly rental payment into their asset allocation? Is a rental payment also a negative bond paid in perpetuity? We all have to live somewhere.
No, expenses are just expenses: not an asset or a liability.
So, ignore the $1m asset but pay attention to the $250K liability when determining the asset allocation for your stock/bond percentages in your investment portfolio? It just does not make sense to me and never has. That is why I view home ownership separately. The mortgage is an expense just like a rental payment would be.
Don't ignore the house. Owning a house is equivalent to prepaying rent forever (if we ignore property taxes and maintenance). That risk reduction can free people up to choose a riskier AA on the portfolio.

The $250K mortgage is still a negative bond, meaning someone with $1 million in stocks, $400K in bonds and $250K in mortgage will end up in roughly the same place as someone with $1 million in stocks and $150K in bonds. As long as you remember that, you don't have to explicitly count it. Just keep in mind that paying off $1 of your mortgage leaves you with an equivalent AA as investing $1 in bonds, usually with higher after-tax returns but less flexibility.
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Re: "Mortage is a negative bond" - please help me understand

Post by Cash is King »

A mortgage is NOT a negative bond. Period.

Everyone should treat a mortgage as a debt that is not tied to any specific asset.

A lot of folks believe a mortgage or any type of borrowing is a short bond position. But this thinking IMO is shortsighted. Why, because a mortgage is not attached to an individual's bond portfolio nor is a car loan or credit card debt.

A mortgage is just borrowed money.
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Re: "Mortage is a negative bond" - please help me understand

Post by dboeger1 »

I think mortgage debt is basically a negative bond for portfolio construction purposes in the case of long-term investors saving for retirement. Where they are not simply inverses of each other is in the nitty gritty of their differing implementations. For example, having a large amount of mortgage debt, such as across multiple rental properties, may allow you to itemize taxes. They're also likely handled differently by your heirs upon inheriting your estate. Perhaps the most obvious difference is that one might hold a mortgage for themself but then invest in bonds to fund some shorter term obligation, such as paying for a child's education, as opposed to paying off the mortgage just to do a cash-out refinance later.
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Re: "Mortage is a negative bond" - please help me understand

Post by Ben Mathew »

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.
Yes. If the house loses 10% of its value, you lose $40,000. If you had owned only 50% of the house, you would have lost only $20,000.
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

Cash is King wrote: Thu Apr 15, 2021 11:14 am A mortgage is just borrowed money.
And a bond is just loaned money. That's why the shorthand of thinking of bonds and mortgages as inverses of each other works as a heuristic, and is an accurate characterization.
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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 11:14 am A mortgage is NOT a negative bond. Period.

Everyone should treat a mortgage as a debt that is not tied to any specific asset.

A lot of folks believe a mortgage or any type of borrowing is a short bond position. But this thinking IMO is shortsighted. Why, because a mortgage is not attached to an individual's bond portfolio nor is a car loan or credit card debt.

A mortgage is just borrowed money.
You can use whatever terminology you want, as the term itself does not commit you to any particular course of action. The term "negative bond" is frequently used as a shorthand way of pointing out that a mortgage does share a lot similarities with bonds, so it makes sense for people to at least examine the reasons that they have bonds in their portfolio while simultaneously having a mortgage.

This doesn't necessarily mean that people should all be liquidating their bond holdings and using the proceeds to pay off their mortgages, as we also need to consider liquidity and rebalancing opportunities. In other words, the phrase "negative bond" does not imply that bonds and mortgages are identical and, therefore, interchangeable. It does mean that completely ignoring the equity, if any, that you have in the house and the corresponding mortgage balance may not be wise in the context of your overall asset allocation, as doing so will frequently cause you to end up with an asset allocation different from the AA that you'd like to have, which will negatively affect your returns.
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Re: "Mortage is a negative bond" - please help me understand

Post by Call_Me_Op »

USAFperio wrote: Wed Apr 14, 2021 1:28 pm I've read and heard that a mortgage should be considered a negative bond, although I'm trying to figure out how this concept affects my asset allocation.
With a mortgage, you owe money. With a bond, you are owed money. Not any more complicated than that.
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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 11:44 am
Cash is King wrote: Thu Apr 15, 2021 11:14 am A mortgage is NOT a negative bond. Period.

Everyone should treat a mortgage as a debt that is not tied to any specific asset.

A lot of folks believe a mortgage or any type of borrowing is a short bond position. But this thinking IMO is shortsighted. Why, because a mortgage is not attached to an individual's bond portfolio nor is a car loan or credit card debt.

A mortgage is just borrowed money.
You can use whatever terminology you want, as the term itself does not commit you to any particular course of action. The term "negative bond" is frequently used as a shorthand way of pointing out that a mortgage does share a lot similarities with bonds, so it makes sense for people to at least examine the reasons that they have bonds in their portfolio while simultaneously having a mortgage.

This doesn't necessarily mean that people should all be liquidating their bond holdings and using the proceeds to pay off their mortgages, as we also need to consider liquidity and rebalancing opportunities. In other words, the phrase "negative bond" does not imply that bonds and mortgages are identical and, therefore, interchangeable. It does mean that completely ignoring the equity, if any, that you have in the house and the corresponding mortgage balance may not be wise in the context of your overall asset allocation, as doing so will frequently cause you to end up with an asset allocation different from the AA that you'd like to have, which will negatively affect your returns.
We disagree when it comes to the term negative bond. Cheers.
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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 11:51 am
UALflyer wrote: Thu Apr 15, 2021 11:44 am
Cash is King wrote: Thu Apr 15, 2021 11:14 am A mortgage is NOT a negative bond. Period.

Everyone should treat a mortgage as a debt that is not tied to any specific asset.

A lot of folks believe a mortgage or any type of borrowing is a short bond position. But this thinking IMO is shortsighted. Why, because a mortgage is not attached to an individual's bond portfolio nor is a car loan or credit card debt.

A mortgage is just borrowed money.
You can use whatever terminology you want, as the term itself does not commit you to any particular course of action. The term "negative bond" is frequently used as a shorthand way of pointing out that a mortgage does share a lot similarities with bonds, so it makes sense for people to at least examine the reasons that they have bonds in their portfolio while simultaneously having a mortgage.

This doesn't necessarily mean that people should all be liquidating their bond holdings and using the proceeds to pay off their mortgages, as we also need to consider liquidity and rebalancing opportunities. In other words, the phrase "negative bond" does not imply that bonds and mortgages are identical and, therefore, interchangeable. It does mean that completely ignoring the equity, if any, that you have in the house and the corresponding mortgage balance may not be wise in the context of your overall asset allocation, as doing so will frequently cause you to end up with an asset allocation different from the AA that you'd like to have, which will negatively affect your returns.
We disagree when it comes to the term negative bond. Cheers.
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.

Those who object to the term almost always explain that since they have to live somewhere, they exclude any equity that they have in the house from their AA (because they wouldn't sell the house, as they need to live somewhere), but do factor in mortgage payments as an expense of having a roof over their heads. That's perfectly fine, but it's all just mental gymnastics and is similar to those always running late intentionally advancing their clocks by 10 minutes, so that they can be on time. If it helps the former sleep better at night and helps the latter be on time, it can be worth it, but it doesn't change the facts.

The reason that the above matters is because if you're not careful, the above mental gymnastics can also cause you to end up with absurd results. For instance, let's suppose that you have a portfolio that is large enough, such that liquidity isn't a concern and you are comfortable with your holdings without any need to rebalance. Suppose that you have a mortgage and your portfolio has bonds. In this case, you can increase your net returns by selling bonds and paying off your mortgage, which will also reduce your cashflow needs, thereby giving you additional flexibility and downside protection. Yet, if you don't factor your home equity and your mortgage balance into your financial picture, selling bonds and using the proceeds to pay off your mortgage would cause you to incorrectly conclude that your AA has become more aggressive and that you're taking on more risks, all while you'd be doing the exact opposite.
Last edited by UALflyer on Thu Apr 15, 2021 12:23 pm, edited 1 time in total.
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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

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. In other words, what purpose do bonds serve in your specific portfolio?

If we are being honest about risk, let's be honest about the fact that a ton of people out there, including quite a few posters on this very board, just don't know how to evaluate it and find comfort in going with traditional asset allocation advice that calls for bonds in an investment portfolio. This is also the reason that those same people don't find any comfort in being offered an opportunity to replace all or a portion of their bond holdings with other things that offer higher yields and lower risk, such as CD's (or, for certain people and certain situations, mortgage payoffs).

It's all very understandable, as if you do not know the exact reason that you have bonds in your portfolio, you cannot determine whether substitute assets/investments can allow you to achieve the same goals with lower risk and/or higher yields.

Long term investors are told to use bonds in their portfolios in large part because of the "loss aversion" phenomenon, which is a purely behavioral issue. People have a tendency to strongly prefer avoiding losses to acquiring gains (that's the whole "loss aversion" phenomenon), which often means that during severe market downturns, investors freak out and sell, thereby locking in their losses. Having bonds in your portfolio helps to dampen that volatility, which then makes it less likely that people will sell at the bottom.

The vast majority of the population is susceptible to loss aversion, and there is no shame in it, as it's a natural human reaction. So, you have to be aware of it, recognize it and then develop both behavioral and portfolio construction techniques that help you control it. For a lot of people, seeing the value of their overall portfolio plummet is incredibly anxiety provoking even in situations where those paper losses are of no practical consequence to them (because, of instance, they still have plenty of runway left before they start drawing on those funds). For those people, having bonds in their portfolios can be very valuable, as they help to cushion the blow, thereby reducing that anxiety and allowing them to control the loss aversion impulse. Substituting bonds with other types of things, such as CD's (or mortgage payoff, etc...), wouldn't help those investors, as psychologically, they'd start thinking of themselves as being 100% in equities (even though nothing could be further from the truth) and would find looking at the swings in their brokerage account balances too unnerving, as mentally they wouldn't be factoring in their CD balances (or mortgage payoffs, etc...).

For other people, it's less about paper losses triggering anxiety and more about having sufficient retirement income to satisfy their expenses, as well as reducing their overall sequence of returns risk. As several other posters have correctly pointed out above, and is something that should be pretty self evident, not having mortgage payments reduces your cashflow requirements, which makes it much easier to account for the necessities. Paying off your mortgage accomplishes this exact goal, so they use their lower yielding bond holdings to pay off the mortgage, which reduces their cashflow requirements and allows them to withstand the volatility in their investment accounts.
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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 12:11 pm
Cash is King wrote: Thu Apr 15, 2021 11:51 am
UALflyer wrote: Thu Apr 15, 2021 11:44 am
Cash is King wrote: Thu Apr 15, 2021 11:14 am A mortgage is NOT a negative bond. Period.

Everyone should treat a mortgage as a debt that is not tied to any specific asset.

A lot of folks believe a mortgage or any type of borrowing is a short bond position. But this thinking IMO is shortsighted. Why, because a mortgage is not attached to an individual's bond portfolio nor is a car loan or credit card debt.

A mortgage is just borrowed money.
You can use whatever terminology you want, as the term itself does not commit you to any particular course of action. The term "negative bond" is frequently used as a shorthand way of pointing out that a mortgage does share a lot similarities with bonds, so it makes sense for people to at least examine the reasons that they have bonds in their portfolio while simultaneously having a mortgage.

This doesn't necessarily mean that people should all be liquidating their bond holdings and using the proceeds to pay off their mortgages, as we also need to consider liquidity and rebalancing opportunities. In other words, the phrase "negative bond" does not imply that bonds and mortgages are identical and, therefore, interchangeable. It does mean that completely ignoring the equity, if any, that you have in the house and the corresponding mortgage balance may not be wise in the context of your overall asset allocation, as doing so will frequently cause you to end up with an asset allocation different from the AA that you'd like to have, which will negatively affect your returns.
We disagree when it comes to the term negative bond. Cheers.
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.

Those who object to the term almost always explain that since they have to live somewhere, they exclude any equity that they have in the house from their AA (because they wouldn't sell the house, as they need to live somewhere), but do factor in mortgage payments as an expense of having a roof over their heads. That's perfectly fine, but it's all just mental gymnastics and is similar to those always running late intentionally advancing their clocks by 10 minutes, so that they can be on time. If it helps the former sleep better at night and helps the latter be on time, it can be worth it, but it doesn't change the facts.

The reason that the above matters is because if you're not careful, the above mental gymnastics can also cause you to end up with absurd results. For instance, let's suppose that you have a portfolio that is large enough, such that liquidity isn't a concern and you are comfortable with your holdings without any need to rebalance. Suppose that you have a mortgage and your portfolio has bonds. In this case, you can increase your net returns by selling bonds and paying off your mortgage, which will also reduce your cashflow needs, thereby giving you additional flexibility and downside protection. Yet, if you don't factor your home equity and your mortgage balance into your financial picture, selling bonds and using the proceeds to pay off your mortgage would cause you to incorrectly conclude that your AA has become more aggressive and that you're taking on more risks, all while you'd be doing the exact opposite.
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.
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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 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. In other words, what purpose do bonds serve in your specific portfolio?

If we are being honest about risk, let's be honest about the fact that a ton of people out there, including quite a few posters on this very board, just don't know how to evaluate it and find comfort in going with traditional asset allocation advice that calls for bonds in an investment portfolio. This is also the reason that those same people don't find any comfort in being offered an opportunity to replace all or a portion of their bond holdings with other things that offer higher yields and lower risk, such as CD's (or, for certain people and certain situations, mortgage payoffs).

It's all very understandable, as if you do not know the exact reason that you have bonds in your portfolio, you cannot determine whether substitute assets/investments can allow you to achieve the same goals with lower risk and/or higher yields.

Long term investors are told to use bonds in their portfolios in large part because of the "loss aversion" phenomenon, which is a purely behavioral issue. People have a tendency to strongly prefer avoiding losses to acquiring gains (that's the whole "loss aversion" phenomenon), which often means that during severe market downturns, investors freak out and sell, thereby locking in their losses. Having bonds in your portfolio helps to dampen that volatility, which then makes it less likely that people will sell at the bottom.

The vast majority of the population is susceptible to loss aversion, and there is no shame in it, as it's a natural human reaction. So, you have to be aware of it, recognize it and then develop both behavioral and portfolio construction techniques that help you control it. For a lot of people, seeing the value of their overall portfolio plummet is incredibly anxiety provoking even in situations where those paper losses are of no practical consequence to them (because, of instance, they still have plenty of runway left before they start drawing on those funds). For those people, having bonds in their portfolios can be very valuable, as they help to cushion the blow, thereby reducing that anxiety and allowing them to control the loss aversion impulse. Substituting bonds with other types of things, such as CD's (or mortgage payoff, etc...), wouldn't help those investors, as psychologically, they'd start thinking of themselves as being 100% in equities (even though nothing could be further from the truth) and would find looking at the swings in their brokerage account balances too unnerving, as mentally they wouldn't be factoring in their CD balances (or mortgage payoffs, etc...).

For other people, it's less about paper losses triggering anxiety and more about having sufficient retirement income to satisfy their expenses, as well as reducing their overall sequence of returns risk. As several other posters have correctly pointed out above, and is something that should be pretty self evident, not having mortgage payments reduces your cashflow requirements, which makes it much easier to account for the necessities. Paying off your mortgage accomplishes this exact goal, so they use their lower yielding bond holdings to pay off the mortgage, which reduces their cashflow requirements and allows them to withstand the volatility in their investment accounts.
I don't agree on a one size fits all portfolio . I do think you need to understand what you own. I think portfolio weightings are important, and I agree with you that behavior is a critical component.
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Re: "Mortage is a negative bond" - please help me understand

Post by NearlyRetired »

Cash is King wrote: Thu Apr 15, 2021 11:14 am Everyone should treat a mortgage as a debt that is not tied to any specific asset.
Umm, yes it is, it is a debt tied to the property (which is an asset)
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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 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.
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Re: "Mortage is a negative bond" - please help me understand

Post by Ironman1977 »

alex_686 wrote: Wed Apr 14, 2021 3:31 pm Another vote for a mortgage as a negative bond.

Technically this is true. A bond and loan are just 2 different sides of the same coin.

From a pragmatic view point it is true. Bonds and mortgages act inversely the same way, driven by the same factors of interest rates and inflation.

From a practical view it is true. If you have 300k mortgage and a 400k in bonds why don't you sell the bonds and pay off the mortgage? Now, there are good reasons why you should or shouldn't. But it gives you a cohesive unified framework to ask the question. Yeah, I will grant you it is a more abstract complex way of thinking about things. Any other method is going to result in ad hoc and heuristic logic which will have holes.
Does this mean that every monthly installment excluding interest is a purchase of bonds? I think so
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Re: "Mortage is a negative bond" - please help me understand

Post by alex_686 »

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

Post by alex_686 »

Ironman1977 wrote: Thu Apr 15, 2021 1:46 pm Does this mean that every monthly installment excluding interest is a purchase of bonds? I think so
Not if you have a interest only mortgage. :happy

But yes. I would point out that Mr. Bogle suggested treating Social Security as a bond-like asset.

In the big picture you should include / exclude mortgages - or anything else - from your asset allocation as it makes sense. It is supposed to be a useful tool.

I have a fair amount of formal training and favor a rational mathematical approach over a heuristic intuitive approach, so I push strongly to include it. Maybe too strongly. But there you go.
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

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.

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.

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

Post by ObliviousInvestor »

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

Post by KlangFool »

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.

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

Post by Thesaints »

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.
Last edited by Thesaints on Thu Apr 15, 2021 2:24 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 2:18 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.
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