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

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

Post by alex_686 »

MoonOrb wrote: Thu Apr 15, 2021 9:43 pm How do you guys have it in you to have this same argument every single month?
It is a moral duty:

https://xkcd.com/386/
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masteraleph
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Re: "Mortage is a negative bond" - please help me understand

Post by masteraleph »

One person brought this up on the previous page (climber2020), but no one else has really hit on it-

A mortgage might be a negative bond, but if it is, it is a negative bond in a taxable reality.

That is very different from money in a tax advantaged reality. First of all, if you're under 59.5, you'll owe taxes and penalty if it's a pretax account. And if you want to maintain your asset allocation at, say, 60/40, you'll be losing out on money that could be invested in stocks. Obviously you would owe taxes eventually, but especially for those whose tax bracket is likely to go down in retirement, you're withdrawing at the worst possible time.

If it's a Roth account instead, you might be able to pull out principal (on an IRA). But then you're losing tax free appreciation- and that appreciation might last well longer than you own the house, depending on age/lifespan.


Now, all of this is different if we're talking about a world with mortgages at 8%, but tax brackets where they are now. A mortgage at 8% would pay ~160% of the principal in interest by the end of a 30 year loan, while a mortgage at 3% pays ~50% of the principal in interest. At 3% and current bond rates, and a 10% early withdrawal penalty and say a 10% tax bracket difference, pulling out bonds alone from a 401k makes little sense- you might save a very little bit total, but it's a *very* little bit total, and it's so little that even far lower than 2% inflation would wipe out the difference in real value. Depending on income level, you could also end up hitting various phaseouts with the up front withdrawal, and if you do it all at once you'd also be likely to hit the additional Medicare tax for a substantial amount.

One other difference- the (re)payment schedule of a mortgage vs. a bond. If you're holding individual bonds, you receive a level interest payment each year- they're functionally reverse balloon mortgages (reverse the reverse discussion!) (conceptually bond funds sort of do the same thing, just the balloon payment only comes when you sell the fund). But standard 30 year mortgages are amortized in a way where you're paying a level amount each year, and the earlier years are mostly interest payments, while the later payments include more principal. The result ends up being that selling bonds, particularly from retirement accounts, is a much worse investment after a few years- so if we're talking about paying off a 30 year mortgage with 25 years to go from bonds in your retirement account, the numbers favor leaving your retirement account alone even more.
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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

KlangFool wrote: Thu Apr 15, 2021 9:23 pm <<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.
You are free to do whatever you want to do with your own money. We are discussing ways to improve returns while simultaneously achieving downside protection, which is what would be accomplished by liquidating some of the bonds and using the proceeds and to pay off the mortgage (it would, however, reduce liquidity and rebalancing options, but would also reduce your cashflow requirements).

You always have the prerogative to choose to accept greater volatility and lower returns (although, in all fairness, the above strategy may not be a viable option for you, as all your bond holdings may be in a tax advantaged account, etc...), just like you are always free to pay more for something to get less. :sharebeer
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JoeRetire
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Re: "Mortage is a negative bond" - please help me understand

Post by JoeRetire »

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?

BobK
More!

You forgot to add in the $45 water payment that is due today, the $200 balance on the credit card, and the $5 I borrowed from Fred.

I keep all my negative bonds in a negative pile on my negative nightstand.
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JoeRetire
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Re: "Mortage is a negative bond" - please help me understand

Post by JoeRetire »

MoonOrb wrote: Thu Apr 15, 2021 9:43 pm How do you guys have it in you to have this same argument every single month?
Stamina.
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vineviz
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

Kenkat wrote: Thu Apr 15, 2021 8:18 pm 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.
The reason that people use phrases like "negative bond" to describe a mortgage is that it succinctly captures the points needed to MAKE that decision: if a mortgage rate is higher than the yield of an equivalent bond, then paying down the mortgage by selling the bonds increases wealth without increasing risk.

You could argue that the phrase doesn't matter, but clearly people still struggle with the concept: taking out a 3.5% mortgage to buy 1.3% bonds is obviously wealth-destructive, yet threads like this are consistently occupied by people who are advocating for doing just that.
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climber2020
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Re: "Mortage is a negative bond" - please help me understand

Post by climber2020 »

vineviz wrote: Fri Apr 16, 2021 8:11 am You could argue that the phrase doesn't matter, but clearly people still struggle with the concept: taking out a 3.5% mortgage to buy 1.3% bonds is obviously wealth-destructive, yet threads like this are consistently occupied by people who are advocating for doing just that.
How do taxes affect the decision if all of a person's bonds are located inside a tax deferred account?
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vineviz
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Re: "Mortgage is a negative bond" - please help me understand

Post by vineviz »

USAFperio wrote: Thu Apr 15, 2021 9:29 pm
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.
And, indeed, you SHOULD consider your AA to be the same in both scenarios: just don't ignore the real estate allocation.

You didn't specify the value of the real estate in your example, but let's say it's $800k. In both cases you own:

$600k in stocks
$0 in bonds
$800k in real estate.

That's because the three scenarios balance out to the same place:


$600k in stocks
$400k in bonds
-$400k in "negative bonds" (aka mortgage)
$800k in real estate.
600+400-400+800 = 1,400


$600k in stocks
$200k in bonds
-$200k in "negative bonds" (aka mortgage)
$800k in real estate.
600+200-200+800 = 1,400


$600k in stocks
$0 in bonds
-$0 in "negative bonds" (aka mortgage)
$800k in real estate.
600+0-0+800 = 1,400
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Re: "Mortage is a negative bond" - please help me understand

Post by KlangFool »

UALflyer wrote: Fri Apr 16, 2021 6:29 am
KlangFool wrote: Thu Apr 15, 2021 9:23 pm <<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.
You are free to do whatever you want to do with your own money. We are discussing ways to improve returns while simultaneously achieving downside protection, which is what would be accomplished by liquidating some of the bonds and using the proceeds and to pay off the mortgage (it would, however, reduce liquidity and rebalancing options, but would also reduce your cashflow requirements).

You always have the prerogative to choose to accept greater volatility and lower returns (although, in all fairness, the above strategy may not be a viable option for you, as all your bond holdings may be in a tax advantaged account, etc...), just like you are always free to pay more for something to get less. :sharebeer
UALflyer,

<<reduce liquidity and rebalancing options, >>

1) And, in my case, that increases the RISK. The cash flow requirement reduction by paying off the 300K mortgage does not offset the liquidity RISK.

The cash flow = 15K per year. 300K = 20 years of mortgage payment.

I am 50+ years old. Social security will provide about 30K per year. I need the liquidity to reach my social security FRA.

2) There is no way for you to claim that

A) 1.5 million in 60/40 portfolio with 300K 3.5% mortgage

B) 1.2 million in 60/40 portfolio

(B) has a higher expected return than (A).

3) In summary, not paying off the 300K mortgage gives me higher expected return and lower RISK.

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

Post by UALflyer »

KlangFool wrote: Fri Apr 16, 2021 9:04 am <<reduce liquidity and rebalancing options, >>

1) And, in my case, that increases the RISK. The cash flow requirement reduction by paying off the 300K mortgage does not offset the liquidity RISK.
Which risk? There are various types of risk that are inherent in every decision, so that you always have to balance them.
2) There is no way for you to claim that

A) 1.5 million in 60/40 portfolio with 300K 3.5% mortgage

B) 1.2 million in 60/40 portfolio

(B) has a higher expected return than (A).

3) In summary, not paying off the 300K mortgage gives me higher expected return and lower RISK.
This is a weird exchange, as for whatever reason you've set up a straw man and are tearing it down. There isn't a single person in this thread who has suggested or implied that you can reliably increase your net returns by selling both equities and bonds and using the proceeds to pay off a mortgage, and such a claim would be absurd: doing so makes your portfolio more conservative and reduces your expected returns. Yet, you seem to be having an imaginary debate against this self-evident point that was never raised or questioned in this thread.

Selling your equities and bonds and sticking the proceeds under your mattress would also reduce your expected returns. Do you want to talk about this as well?

Once again, this thread is dedicated to a discussion of the similarities that mortgages have with bonds. Hence, the reason that for some people it'll make sense to sell their bonds and to use the proceeds to pay off their mortgage. If you have anything to contribute on this particular point, please post it.
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Re: "Mortage is a negative bond" - please help me understand

Post by rudeboy »

vineviz wrote: Fri Apr 16, 2021 8:11 am
You could argue that the phrase doesn't matter, but clearly people still struggle with the concept: taking out a 3.5% mortgage to buy 1.3% bonds is obviously wealth-destructive, yet threads like this are consistently occupied by people who are advocating for doing just that.
But then isn't holding bonds and/or real estate wealth-destructive as compare to holding 100% stocks? The element of diversification is missing from this comparison.
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Re: "Mortage is a negative bond" - please help me understand

Post by rudeboy »

vineviz wrote: Fri Apr 16, 2021 8:11 am
You could argue that the phrase doesn't matter, but clearly people still struggle with the concept: taking out a 3.5% mortgage to buy 1.3% bonds is obviously wealth-destructive, yet threads like this are consistently occupied by people who are advocating for doing just that.
But then isn't holding bonds and/or real estate wealth-destructive as compare to holding 100% stocks? The element of diversification is missing from this comparison.
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

rudeboy wrote: Fri Apr 16, 2021 11:59 am But then isn't holding bonds and/or real estate wealth-destructive as compare to holding 100% stocks? The element of diversification is missing from this comparison.
It's not owning real estate that is wealth-destructive. The wealth destruction comes from borrowing (via a mortgage) at a higher interest rate than you can earn on the equivalently risky investment asset (e.g. Treasury bonds).
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Re: "Mortage is a negative bond" - please help me understand

Post by rudeboy »

vineviz wrote: Fri Apr 16, 2021 12:13 pm
rudeboy wrote: Fri Apr 16, 2021 11:59 am But then isn't holding bonds and/or real estate wealth-destructive as compare to holding 100% stocks? The element of diversification is missing from this comparison.
It's not owning real estate that is wealth-destructive. The wealth destruction comes from borrowing (via a mortgage) at a higher interest rate than you can earn on the equivalently risky investment asset (e.g. Treasury bonds).
I'm with you there, I should have said "home" instead of "real estate."

It justs seems to me that if someone is uncomfortable putting hundreds of thousands of dollars into a home (particularly if that would be a large chunk of one's portfolio), and is also uncomfortable with holding 100% stocks, then diversifying into a bond fund in addition seems a perfectly sensible third way, with the rationale than diversification is meant to reduce downside risk and not increase the upside.

There are enough unique factors that can impact the value of one particular house that I don't think one can make a 1:1 comparison between a mortgage and a diversified bond fund rate.
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vineviz
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

rudeboy wrote: Fri Apr 16, 2021 12:35 pm It justs seems to me that if someone is uncomfortable putting hundreds of thousands of dollars into a home (particularly if that would be a large chunk of one's portfolio), and is also uncomfortable with holding 100% stocks, then diversifying into a bond fund in addition seems a perfectly sensible third way, with the rationale than diversification is meant to reduce downside risk and not increase the upside.
I know it seems this way, and I guess the logic of it is alluring since so many people seem to see it this way, but it's not rational.

If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.

The only way to reduce the risk of "hundreds of thousands of dollars into a home" is to buy a smaller home.

Owning a $500k house with a $400k mortgage is way riskier than owning a $500k house with no mortgage, not less risky. And taking out the mortgage and then using the cash from that mortgage as leverage to buy MORE risky assets (like stocks or bonds) increases the risk even more. Now add in the reality that the bonds you purchase almost surely have an expected return which is LESS than the cost of the mortgage.
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UALflyer
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Re: "Mortage is a negative bond" - please help me understand

Post by UALflyer »

rudeboy wrote: Fri Apr 16, 2021 12:35 pmIt justs seems to me that if someone is uncomfortable putting hundreds of thousands of dollars into a home (particularly if that would be a large chunk of one's portfolio), and is also uncomfortable with holding 100% stocks, then diversifying into a bond fund in addition seems a perfectly sensible third way, with the rationale than diversification is meant to reduce downside risk and not increase the upside.
I think you already know this, but just in case, diversification for the sake of diversification carries no benefit. This is the reason that we don't diversify our investments by splitting up the funds that would be invested in a single S&P500 index fund and, instead, purchase multiple S&P 500 index funds offered by Vanguard, Fidelity, Schwab, etc... You'd get more "diversification," but your investment returns and just about every risk metric would remain exactly the same, and you'd simply introduce needless complexity.

In simple terms, the idea of investing diversification is to spread your investments around hopefully uncorrelated asset classes, so that you aren't making a concentrated bet on a single investment and your fortunes aren't tied to the success or failure of that particular investment. Back in the day of higher interest rates, you could expect to receive 7%-8% yields from your bonds, which effectively increased your returns and allowed you to more or less have your cake and eat it too, by having a higher concentration of your assets in bonds, which were generally less volatile than stocks, while still enjoying very nice returns. This is no longer the case, which is also the reason that all the economists have been warning investors to expect greater volatility.

Regardless, I don't think that people are saying not to invest in bonds. The point is that if you can find an asset class that provides higher returns and lower volatility, you could replace your bond holdings with it and enjoy greater overall returns with lower volatility. For some people, paying off the mortgage would accomplish exactly that, which is one of the reasons that this is being discussed here.
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Re: "Mortage is a negative bond" - please help me understand

Post by rudeboy »

vineviz wrote: Fri Apr 16, 2021 12:48 pm
rudeboy wrote: Fri Apr 16, 2021 12:35 pm It justs seems to me that if someone is uncomfortable putting hundreds of thousands of dollars into a home (particularly if that would be a large chunk of one's portfolio), and is also uncomfortable with holding 100% stocks, then diversifying into a bond fund in addition seems a perfectly sensible third way, with the rationale than diversification is meant to reduce downside risk and not increase the upside.
I know it seems this way, and I guess the logic of it is alluring since so many people seem to see it this way, but it's not rational.

If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.

The only way to reduce the risk of "hundreds of thousands of dollars into a home" is to buy a smaller home.

Owning a $500k house with a $400k mortgage is way riskier than owning a $500k house with no mortgage, not less risky. And taking out the mortgage and then using the cash from that mortgage as leverage to buy MORE risky assets (like stocks or bonds) increases the risk even more. Now add in the reality that the bonds you purchase almost surely have an expected return which is LESS than the cost of the mortgage.
I will have to think on this perspective and see if I come around to it -- I want to.
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Re: "Mortage is a negative bond" - please help me understand

Post by rudeboy »

UALflyer wrote: Fri Apr 16, 2021 12:59 pm
rudeboy wrote: Fri Apr 16, 2021 12:35 pmIt justs seems to me that if someone is uncomfortable putting hundreds of thousands of dollars into a home (particularly if that would be a large chunk of one's portfolio), and is also uncomfortable with holding 100% stocks, then diversifying into a bond fund in addition seems a perfectly sensible third way, with the rationale than diversification is meant to reduce downside risk and not increase the upside.
I think you already know this, but just in case, diversification for the sake of diversification carries no benefit. This is the reason that we don't diversify our investments by splitting up the funds that would be invested in a single S&P500 index fund and, instead, purchase multiple S&P 500 index funds offered by Vanguard, Fidelity, Schwab, etc... You'd get more "diversification," but your investment returns and just about every risk metric would remain exactly the same, and you'd simply introduce needless complexity.

In simple terms, the idea of investing diversification is to spread your investments around hopefully uncorrelated asset classes, so that you aren't making a concentrated bet on a single investment and your fortunes aren't tied to the success or failure of that particular investment. Back in the day of higher interest rates, you could expect to receive 7%-8% yields from your bonds, which effectively increased your returns and allowed you to more or less have your cake and eat it too, by having a higher concentration of your assets in bonds, which were generally less volatile than stocks, while still enjoying very nice returns. This is no longer the case, which is also the reason that all the economists have been warning investors to expect greater volatility.

Regardless, I don't think that people are saying not to invest in bonds. The point is that if you can find an asset class that provides higher returns and lower volatility, you could replace your bond holdings with it and enjoy greater overall returns with lower volatility. For some people, paying off the mortgage would accomplish exactly that, which is one of the reasons that this is being discussed here.
Agreed with all but the bolded part. A house is an asset, not an asset class, and therefore is not a 1:1 comparison to a bond fund, much like an individual stock holding is not a 1:1 comparison to a mutual fund. But as I said above, I'll have to mull over this perspective.
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Kenkat
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Re: "Mortage is a negative bond" - please help me understand

Post by Kenkat »

vineviz wrote: Fri Apr 16, 2021 12:48 pm
rudeboy wrote: Fri Apr 16, 2021 12:35 pm It justs seems to me that if someone is uncomfortable putting hundreds of thousands of dollars into a home (particularly if that would be a large chunk of one's portfolio), and is also uncomfortable with holding 100% stocks, then diversifying into a bond fund in addition seems a perfectly sensible third way, with the rationale than diversification is meant to reduce downside risk and not increase the upside.
If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.
Don’t you have $600k in stocks, $400k in bonds, $400k in mortgage, and $500k house? And while I get that the bonds and mortgage (negative bond) offset and it does not make sense to hold lower yielding bonds and a higher rate mortgage, are you really 100% stocks?

Seems like you are 55% stocks and 45% house - and you then have to think about the financial characteristics of the house and how do you classify them.

This is why I asked alex_686 if everything should be included - to which he answered yes, which makes sense to me.
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Re: "Mortgage is a negative bond" - please help me understand

Post by alex_686 »

USAFperio wrote: Thu Apr 15, 2021 9:29 pm 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.)
With the information that I have I would say that you have a net worth of 600k (exclusive of the home) and 100% equities. 600k equites + 400k bonds - 400k mortgage = 600k equity. 600k equity / 600k net worth = 100% equity.

Any amount that you pay down your mortgage from bonds won't change. i.e., if you pay down your mortgage by 200k, you are at: 600k equites + 200k bonds - 200k mortgage = 600k equity.

If you ignore liquidity and tax advantage space, I would pay off the mortgage if its rate is higher than the bond yield, which I suspect it is. FYI, I have no bonds in my tax advantage space. I use a HELOC and taxable equites to meet my liquidity needs. I do have about 15% of my investments split between my mortgage (negative bond) and bonds in my retirement accounts.

So, a critical question. How are you classifying your home? FYI, this is a point of debate amongst professionals who have to create model portfolios and delivery actionable plans to people.

Unlevered real estate has about the same level of risk and return as a BBB bond. So some people classify them as bonds.

But they tend to have a low correlation with bonds, plus illiquid, specific risk, etc. So while it is more complicated you should probably spit it off into its own asset class.

Owner occupied homes are tricky. The 2 mains sources of return from real estate are rents and property appreciation. You consume your own rent by living there. i.e., imputed rent. So that is consumption, not a return investment. Property appreciation is debated, but according to the Case-Shiller index the long term price appreciation of residential property is between 0% and 1% after inflation for the past 100 years.
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

Kenkat wrote: Fri Apr 16, 2021 1:19 pm
vineviz wrote: Fri Apr 16, 2021 12:48 pm
rudeboy wrote: Fri Apr 16, 2021 12:35 pm It justs seems to me that if someone is uncomfortable putting hundreds of thousands of dollars into a home (particularly if that would be a large chunk of one's portfolio), and is also uncomfortable with holding 100% stocks, then diversifying into a bond fund in addition seems a perfectly sensible third way, with the rationale than diversification is meant to reduce downside risk and not increase the upside.
If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.
Don’t you have $600k in stocks, $400k in bonds, $400k in mortgage, and $500k house? And while I get that the bonds and mortgage (negative bond) offset and it does not make sense to hold lower yielding bonds and a higher rate mortgage, are you really 100% stocks?

Seems like you are 55% stocks and 45% house - and you then have to think about the financial characteristics of the house and how do you classify them.

This is why I asked alex_686 if everything should be included - to which he answered yes, which makes sense to me.
And that's a good answer too.

The crucial point is that the asset allocation is the same with or without the mortgage, and so is the riskiness of the household portfolio.
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

rudeboy wrote: Fri Apr 16, 2021 1:15 pm Agreed with all but the bolded part. A house is an asset, not an asset class, and therefore is not a 1:1 comparison to a bond fund, much like an individual stock holding is not a 1:1 comparison to a mutual fund. But as I said above, I'll have to mull over this perspective.
Most people would call real estate an asset class, but that's not the comparison I was making. The mortgage, not the house, is like a bond. They are separate things.

Lots of people own houses without having a mortgage, and some (unfortunate) people end up having a mortgage without actually owning a house.
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Re: "Mortage is a negative bond" - please help me understand

Post by Kenkat »

vineviz wrote: Fri Apr 16, 2021 1:43 pm
Kenkat wrote: Fri Apr 16, 2021 1:19 pm
vineviz wrote: Fri Apr 16, 2021 12:48 pm
rudeboy wrote: Fri Apr 16, 2021 12:35 pm It justs seems to me that if someone is uncomfortable putting hundreds of thousands of dollars into a home (particularly if that would be a large chunk of one's portfolio), and is also uncomfortable with holding 100% stocks, then diversifying into a bond fund in addition seems a perfectly sensible third way, with the rationale than diversification is meant to reduce downside risk and not increase the upside.
If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.
Don’t you have $600k in stocks, $400k in bonds, $400k in mortgage, and $500k house? And while I get that the bonds and mortgage (negative bond) offset and it does not make sense to hold lower yielding bonds and a higher rate mortgage, are you really 100% stocks?

Seems like you are 55% stocks and 45% house - and you then have to think about the financial characteristics of the house and how do you classify them.

This is why I asked alex_686 if everything should be included - to which he answered yes, which makes sense to me.
And that's a good answer too.

The crucial point is that the asset allocation is the same with or without the mortgage, and so is the riskiness of the household portfolio.
Yes, agree. It’s just different terminology explaining the same end result.
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Re: "Mortgage is a negative bond" - please help me understand

Post by milktoast »

alex_686 wrote: Fri Apr 16, 2021 1:21 pm With the information that I have I would say that you have a net worth of 600k (exclusive of the home) and 100% equities. 600k equites + 400k bonds - 400k mortgage = 600k equity. 600k equity / 600k net worth = 100% equity.

Any amount that you pay down your mortgage from bonds won't change. i.e., if you pay down your mortgage by 200k, you are at: 600k equites + 200k bonds - 200k mortgage = 600k equity.
I completely agree. The only difference between the two is liquidity.

So the delta between mortgage interest rate and bond interest rate (after adjusting for taxes) reflects the premium that the investor is placing on liquidity.

Everyone values liquidity differently. Often in my opinion they over value liquidity.

There is a definite curve here. If you can't pay pills in two weeks without your next paycheck, you definitely should not be putting all of the money left over from that paycheck into extra principal payments.

On the other extreme, if you have five years of normal expenses (and eight years after belt tightening) in bonds. And are looking to buy more bonds rather than paying down mortgage, you are definitely harming your financial future for no good reason.
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Re: "Mortgage is a negative bond" - please help me understand

Post by KlangFool »

milktoast wrote: Fri Apr 16, 2021 1:57 pm
Everyone values liquidity differently. Often in my opinion they over value liquidity.
milktoast,

In every single recession / economy crisis, many folks without sufficient liquidity are wiped out before the recovery. Liquidity does not matter until it does.

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

Post by redmaw »

USAFperio wrote: Thu Apr 15, 2021 9:29 pm 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.)
The problem is you aren't 60/40. lets say you just bought the house, its worth 400k. You are 60 stocks/0 bonds/40 real estate. Is is true no matter how much bonds you trade for real estate, and became true as soon as you bought the house. When you took out the mortgage you traded money you didn't have for real estate. Acting like that didn't change your risk profile is the reason people keep coming up with apparent logical inconsistencies when considering a mortgage a negative bond.
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Re: "Mortgage is a negative bond" - please help me understand

Post by milktoast »

KlangFool wrote: Fri Apr 16, 2021 2:57 pm In every single recession / economy crisis, many folks without sufficient liquidity are wiped out before the recovery. Liquidity does not matter until it does.
Yup. Liquidity improves returns when you end up needing liquidity. And hurts returns at all other times.

So you have to guess how much liquidity you need to buy with reduced returns. Your guess is different than mine.
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Re: "Mortgage is a negative bond" - please help me understand

Post by KlangFool »

milktoast wrote: Fri Apr 16, 2021 4:48 pm
KlangFool wrote: Fri Apr 16, 2021 2:57 pm In every single recession / economy crisis, many folks without sufficient liquidity are wiped out before the recovery. Liquidity does not matter until it does.
Yup. Liquidity improves returns when you end up needing liquidity. And hurts returns at all other times.

So you have to guess how much liquidity you need to buy with reduced returns. Your guess is different than mine.
milktoast,

I don't guess because I do not need the return. I save 1 year of expense every year. At my saving rate, I can reach my goal with minimal REAL RETURN.

Personal finance is personal. More return does close to nothing for me. Liquidity RISK can wipe me out.

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

Post by vineviz »

KlangFool wrote: Fri Apr 16, 2021 4:52 pm Personal finance is personal. More return does close to nothing for me. Liquidity RISK can wipe me out.
Keeping a mortgage when you could pay it off increases your liquidity risk.
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Re: "Mortgage is a negative bond" - please help me understand

Post by KlangFool »

vineviz wrote: Fri Apr 16, 2021 7:27 pm
KlangFool wrote: Fri Apr 16, 2021 4:52 pm Personal finance is personal. More return does close to nothing for me. Liquidity RISK can wipe me out.
Keeping a mortgage when you could pay it off increases your liquidity risk.
This is simple math. 300K = 20 years of 15K per year payment. Paying off 300K mortgage and you lose the liquidity to pay the 15K per year mortgage for 20 years.

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

Post by vineviz »

KlangFool wrote: Fri Apr 16, 2021 7:33 pm
vineviz wrote: Fri Apr 16, 2021 7:27 pm
KlangFool wrote: Fri Apr 16, 2021 4:52 pm Personal finance is personal. More return does close to nothing for me. Liquidity RISK can wipe me out.
Keeping a mortgage when you could pay it off increases your liquidity risk.
This is simple math. 300K = 20 years of 15K per year payment. Paying off 300K mortgage and you lose the liquidity to pay the 15K per year mortgage for 20 years.
You also don't have a mortgage to pay, so at worst it's a wash. At best, it saves you from 20 years of bond market returns that are 200bps lower than your mortgage rate.

On $300k, the difference between your 3.5% mortgage and 1.3% bonds is $200k less in liquidity in the future. If you can't use the $200,000 for something constructive, you can always burn it for heat when the power goes out. That's not too dissimilar to what you're doing now.
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Re: "Mortgage is a negative bond" - please help me understand

Post by KlangFool »

vineviz wrote: Fri Apr 16, 2021 7:51 pm
KlangFool wrote: Fri Apr 16, 2021 7:33 pm
vineviz wrote: Fri Apr 16, 2021 7:27 pm
KlangFool wrote: Fri Apr 16, 2021 4:52 pm Personal finance is personal. More return does close to nothing for me. Liquidity RISK can wipe me out.
Keeping a mortgage when you could pay it off increases your liquidity risk.
This is simple math. 300K = 20 years of 15K per year payment. Paying off 300K mortgage and you lose the liquidity to pay the 15K per year mortgage for 20 years.
You also don't have a mortgage to pay, so at worst it's a wash. At best, it saves you from 20 years of bond market returns that are 200bps lower than your mortgage rate.

On $300k, the difference between your 3.5% mortgage and 1.3% bonds is $200k less in liquidity in the future. If you can't use the $200,000 for something constructive, you can always burn it for heat when the power goes out. That's not too dissimilar to what you're doing now.
vineviz,

<<You also don't have a mortgage to pay, so at worst it's a wash. >>

Not for the next 10+ years until my social security full retirement age.

<<On $300k, the difference between your 3.5% mortgage and 1.3% bonds is $200k less 7% 60/40 portfolio is more liquidity in the future. >>

The difference is an additional 3.5% annual return of 300K in my 60/40 portfolio. Hence, I would have greater liquidity in the future.

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

Post by vineviz »

KlangFool wrote: Fri Apr 16, 2021 8:14 pm vineviz,

<<You also don't have a mortgage to pay, so at worst it's a wash. >>

Not for the next 10+ years until my social security full retirement age.

You're confused. If you pay off the mortgage, then you no longer have to make a mortgage payment. This doesn't depend on your age or Social Security status.
KlangFool wrote: Fri Apr 16, 2021 8:14 pm <<On $300k, the difference between your 3.5% mortgage and 1.3% bonds is $200k less 60/40 portfolio is more liquidity in the future. >>

The difference is an additional 3.5% annual return of 300K in my 60/40 portfolio. Hence, I would have greater liquidity in the future.
Keeping a $300k mortgage at 3.5% and investing in bonds at 1.3%, and doing that for 20 years, leaves you with $200k less in liquid net worth by the end of the 20 years.
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Re: "Mortage is a negative bond" - please help me understand

Post by 000 »

rudeboy wrote: Fri Apr 16, 2021 1:09 pm I will have to think on this perspective and see if I come around to it -- I want to.
Good.... because vineviz is correct :D
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Re: "Mortgage is a negative bond" - please help me understand

Post by 000 »

KlangFool wrote: Fri Apr 16, 2021 4:52 pm More return does close to nothing for me. Liquidity RISK can wipe me out.
How? Can you explain what situation in your life might require the amount of liquidity we're talking about here?
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Re: "Mortgage is a negative bond" - please help me understand

Post by Coase »

Keeping a $300k mortgage at 3.5% and investing in bonds at 1.3%, and doing that for 20 years, leaves you with $200k less in liquid net worth by the end of the 20 years.
Liquidity risk KlangFool is talking about is losing your job during the 20 years (near the beginning of) not at the end of the 20th year. Presumably after 20 years you have plenty of liquidity in either choice.

With $300k in bonds after a job loss and during long term unemployment you could take out 30k per year living expenses including mortgage payments for 5 years and still have half of it left. You are extremely safe and secure from insolvency. It is trivial to make your mortgage payments indefinitely without fear as well as all other living expenses. It is fine for most people including me to have preferences for more risk than that and not need that extreme amount of liquidity.

As for "mortgage is a negative bond" i'll add my vote for that is exactly right. It is just that liquid risk due to possible job loss is a legitimate benefit from not paying off the mortgage with your bonds. Just need to compare benefit each year of having the better safety and liquidity from keeping bonds vs. cost per year of keeping bonds.

As for 60/40 at first thinking I disagreed with KlankFool that you can compare an non-dividable "package" of a 60/40 investment to your mortgage. You need to compare just the bond portion. But thinking deeper and adding in the liquidity factor maybe a 60/40 could keep a ton of liquidity while not losing return due to the equity side.

The return from the 60 increases your income relative to if you did not have that. If the the safety from having more near term liquidity is a 'normal good' then it is rational for a person with equity investments (and therefore higher income) to be willing to pay a higher price for the liquidity by holding bonds. On the other hand the equity ownership part it self has liquidity benefits so that may offset the need of some of the liquidity from having so many bonds. But overall you can't really say someone who prefers to have a 60/40 investment portfolio combined with a large mortgage is irrational.

Actually that is one of my pet peeves is "bad" economists calling someone's choice irrational due to a difference in preferences. Good economists don't tell people what their preferences should be. Some people like chocolate, others vanilla. Some like video games, others the opera. Some like a huge amount of liquidity and security, others like higher expected return, others have different opinions on correct values for 'expected return'. It is all rational.
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Re: "Mortgage is a negative bond" - please help me understand

Post by vineviz »

Coase wrote: Fri Apr 16, 2021 10:17 pm
Keeping a $300k mortgage at 3.5% and investing in bonds at 1.3%, and doing that for 20 years, leaves you with $200k less in liquid net worth by the end of the 20 years.
Liquidity risk KlangFool is talking about is losing your job during the 20 years (near the beginning of) not at the end of the 20th year. Presumably after 20 years you have plenty of liquidity in either choice.
You have a lot less liquidity after the 20 years if you've been borrowing at 3.5% and investing at 1.3% the entire time.

And if KlangFool loses the job near the beginning of the 20 years after paying off the mortgage, not only is his cash flow need lower (by the amount of the mortgage payments that no longer need to be made) but he also has $600k in stocks not to mention greater availability via a HELOC.

Coase wrote: Fri Apr 16, 2021 10:17 pm With $300k in bonds after a job loss and during long term unemployment you could take out 30k per year living expenses including mortgage payments for 5 years and still have half of it left. You are extremely safe and secure from insolvency. It is trivial to make your mortgage payments indefinitely without fear as well as all other living expenses. It is fine for most people including me to have preferences for more risk than that and not need that extreme amount of liquidity.
KlangFool has already chosen their risk level, so I am presuming they are comfortable with it. The thing they are overlooking is that they're taking on more risk by using a mortgage to leverage up their market portfolio, not less. At the very least, they've transformed liquidity risk into market risk and they're paying $6,000/year for the privilege.
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Re: "Mortgage is a negative bond" - please help me understand

Post by Coase »

vineviz wrote: Fri Apr 16, 2021 10:30 pm
Coase wrote: Fri Apr 16, 2021 10:17 pm
Keeping a $300k mortgage at 3.5% and investing in bonds at 1.3%, and doing that for 20 years, leaves you with $200k less in liquid net worth by the end of the 20 years.
Liquidity risk KlangFool is talking about is losing your job during the 20 years (near the beginning of) not at the end of the 20th year. Presumably after 20 years you have plenty of liquidity in either choice.
You have a lot less liquidity after the 20 years if you've been borrowing at 3.5% and investing at 1.3% the entire time.
That is irrelevant it is like you are just talking past what I wrote. In 20 years liquidity is irrelevant because it is plentiful in both choices and past the point of diminishing returns. Liquidity in the short and medium term is the concern in the context of KlangFool's choice.
vineviz wrote: Fri Apr 16, 2021 10:30 pm And if KlangFool loses the job near the beginning of the 20 years after paying off the mortgage, not only is his cash flow need lower (by the amount of the mortgage payments that no longer need to be made) but he also has $600k in stocks not to mention greater availability via a HELOC.
The cash flow needed for the monthly mortgage payment is irrelevant when you have $300k set aside to pay for it along with other expenses. You cannot seriously believe that for example with no job having $0 bonds + $0 mortgage payment is more secure than, everything else equal, having $300k bonds and a $1500 monthly payment.

vineviz wrote: Fri Apr 16, 2021 10:30 pm KlangFool has already chosen their risk level, so I am presuming they are comfortable with it. The thing they are overlooking is that they're taking on more risk by using a mortgage to leverage up their market portfolio, not less.
That is not how it works if having a lower risk is a normal good for KlangFool. Risk level preference is a variable dependent on KlangFool's income. So the more income KlangFool is generating from equities the more willingness to pay in terms of the lost money from the interest rate spread between bonds to mortgage.
vineviz wrote: Fri Apr 16, 2021 10:30 pm At the very least, they've transformed liquidity risk into market risk and they're paying $6,000/year for the privilege.
Agreed, a high price to pay for all that. Way different from my preferences. But still within the bounds of personal preference. Can't be called irrational.
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Re: "Mortage is a negative bond" - please help me understand

Post by coachd50 »

vineviz wrote: Fri Apr 16, 2021 12:48 pm

If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.

Why is that the default case? Why is it that $600k in stocks $400 in bonds and $400 in mortgage = 100% stocks, as opposed to saying that when holding a $400k mortgage a portfolio of $600k in stocks and $400k is REALLY a $360k in Stocks and $240k in bonds? Essentially if the investor has decided that it is in their best interest to choose a 60/40 portfolio- why do we say that having a mortgage "is really a different allocation" instead of saying "that is fine, but recognize that your 'effective balances' are lower than what is shown on your statement?
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

coachd50 wrote: Sat Apr 17, 2021 9:43 am
vineviz wrote: Fri Apr 16, 2021 12:48 pm

If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.

Why is that the default case? Why is it that $600k in stocks $400 in bonds and $400 in mortgage = 100% stocks, as opposed to saying that when holding a $400k mortgage a portfolio of $600k in stocks and $400k is REALLY a $360k in Stocks and $240k in bonds?
[
Because a mortgage is not the inverse of equity, but it’s the inverse of a bond.

A loan and a bond are two sides of the same transaction.
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Re: "Mortage is a negative bond" - please help me understand

Post by coachd50 »

vineviz wrote: Sat Apr 17, 2021 10:01 am
coachd50 wrote: Sat Apr 17, 2021 9:43 am
vineviz wrote: Fri Apr 16, 2021 12:48 pm

If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.

Why is that the default case? Why is it that $600k in stocks $400 in bonds and $400 in mortgage = 100% stocks, as opposed to saying that when holding a $400k mortgage a portfolio of $600k in stocks and $400k is REALLY a $360k in Stocks and $240k in bonds?
[
Because a mortgage is not the inverse of equity, but it’s the inverse of a bond.

A loan and a bond are two sides of the same transaction.
No, i understand that premise when talking about definitions.

However, when used in these examples of personal finance, estimating returns etc, I don't necessarily think it works that way. Because it is NOT the "same" transaction. A personal mortgage was not the SAME transaction that was involved in the debt that shareholders in a bond fund have interest in. Right?

The investor who has chosen a 60/40 portfolio has done so for reasons that are often stated here. Does having a mortgage negate those reasons?
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Re: "Mortage is a negative bond" - please help me understand

Post by LongRoad »

coachd50 wrote: Sat Apr 17, 2021 10:13 am
vineviz wrote: Sat Apr 17, 2021 10:01 am
coachd50 wrote: Sat Apr 17, 2021 9:43 am
vineviz wrote: Fri Apr 16, 2021 12:48 pm

If you have $600k in stocks, $400k in bonds, and have a $400k mortgage then you are already 100% stocks. Selling the bonds to pay down the mortgage, or taking out a mortgage to buy more bonds doesn't change that.

Why is that the default case? Why is it that $600k in stocks $400 in bonds and $400 in mortgage = 100% stocks, as opposed to saying that when holding a $400k mortgage a portfolio of $600k in stocks and $400k is REALLY a $360k in Stocks and $240k in bonds?
[
Because a mortgage is not the inverse of equity, but it’s the inverse of a bond.

A loan and a bond are two sides of the same transaction.
No, i understand that premise when talking about definitions.

However, when used in these examples of personal finance, estimating returns etc, I don't necessarily think it works that way. Because it is NOT the "same" transaction. A personal mortgage was not the SAME transaction that was involved in the debt that shareholders in a bond fund have interest in. Right?

The investor who has chosen a 60/40 portfolio has done so for reasons that are often stated here. Does having a mortgage negate those reasons?
Suppose an investor has a modest 60/40 portfolio ($300K/$200K) and no mortgage.

He then takes out a $500K mortgage and invests it at his preferred 60/40 ratio -- so he is now $600K/$400K stocks/bonds with a $500K mortgage.

It seems clear that his risk/reward proposition has changed dramatically, despite his investment account (in isolation) still being nominally 60/40.
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Re: "Mortgage is a negative bond" - please help me understand

Post by vineviz »

Coase wrote: Fri Apr 16, 2021 11:17 pm
vineviz wrote: Fri Apr 16, 2021 10:30 pm KlangFool has already chosen their risk level, so I am presuming they are comfortable with it. The thing they are overlooking is that they're taking on more risk by using a mortgage to leverage up their market portfolio, not less.
That is not how it works if having a lower risk is a normal good for KlangFool. Risk level preference is a variable dependent on KlangFool's income. So the more income KlangFool is generating from equities the more willingness to pay in terms of the lost money from the interest rate spread between bonds to mortgage.
Even if we premise that lower risk is a normal good for this investor, there's no way to get to specified example without crossing the boundary of rationality.

You're right, an investor might rationally put a premium on liquidity sufficiently high to justify a negative 2% spread between borrowing and lending.

But if you work through the demand curve necessary to make the 60/40 portfolio with a mortgage preferable to the equivalently risky portfolio without the mortgage, you'll find that there are other viable solutions that would increase utility EVEN more. For example, the loan-to-value ratio should be at the maximum limit (probably 100% assuming market rates for PMI) and the mortgage should have the maximum possible term (e.g. 30 years) given any plausible term structure for mortgage rates.

If those "improvements" strike you as more likely to be associated with risk-seeking behavior rather than risk-aversive behavior (generally speaking) then I'd have to agree with you. In other words, we've likely found an investor who is employing some sort of mental accounting instead of looking dispassionately at the overall risk profile of their entire household.
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Re: "Mortgage is a negative bond" - please help me understand

Post by Big Dog »

vineviz wrote: Sat Apr 17, 2021 11:20 am
Coase wrote: Fri Apr 16, 2021 11:17 pm
vineviz wrote: Fri Apr 16, 2021 10:30 pm KlangFool has already chosen their risk level, so I am presuming they are comfortable with it. The thing they are overlooking is that they're taking on more risk by using a mortgage to leverage up their market portfolio, not less.
That is not how it works if having a lower risk is a normal good for KlangFool. Risk level preference is a variable dependent on KlangFool's income. So the more income KlangFool is generating from equities the more willingness to pay in terms of the lost money from the interest rate spread between bonds to mortgage.
Even if we premise that lower risk is a normal good for this investor, there's no way to get to specified example without crossing the boundary of rationality.

You're right, an investor might rationally put a premium on liquidity sufficiently high to justify a negative 2% spread between borrowing and lending.

But if you work through the demand curve necessary to make the 60/40 portfolio with a mortgage preferable to the equivalently risky portfolio without the mortgage, you'll find that there are other viable solutions that would increase utility EVEN more. For example, the loan-to-value ratio should be at the maximum limit (probably 100% assuming market rates for PMI) and the mortgage should have the maximum possible term (e.g. 30 years) given any plausible term structure for mortgage rates.

If those "improvements" strike you as more likely to be associated with risk-seeking behavior rather than risk-aversive behavior (generally speaking) then I'd have to agree with you. In other words, we've likely found an investor who is employing some sort of mental accounting instead of looking dispassionately at the overall risk profile of their entire household.
And that mental accounting tells the investor that my 60/40 is not a true 60/40, but a 60/40 that is levered up. Nothing wrong with that, as long as the investor accepts that fact. Perhaps a BH sharper than me could model this and maybe find that a 60/40L (for levered) has a similar risk profile as perhaps a 65/35 or 70/30 unlevered.
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Re: "Mortage is a negative bond" - please help me understand

Post by alex_686 »

coachd50 wrote: Sat Apr 17, 2021 10:13 am However, when used in these examples of personal finance, estimating returns etc, I don't necessarily think it works that way. Because it is NOT the "same" transaction. A personal mortgage was not the SAME transaction that was involved in the debt that shareholders in a bond fund have interest in. Right?
Yes - It might literally be the same transaction. There are examples out there where people had a 401k bond fund that was holding the MBS that holds the persons's mortgage.

But even not here - yes. For practical purposes they are the same. Yes, there is a fair amount of nuance between a treasury, corporate bond, a MBS, and a mortgage. While the nuances are important, so are the fundamentals. And fundamentally a mortgage is a negative bond for personal finance. Think of a individuals exposure to interest rate and inflation rate risks. Mortgages offer the inverse exposure to bonds.
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 coachd50 »

alex_686 wrote: Sat Apr 17, 2021 11:59 am
coachd50 wrote: Sat Apr 17, 2021 10:13 am However, when used in these examples of personal finance, estimating returns etc, I don't necessarily think it works that way. Because it is NOT the "same" transaction. A personal mortgage was not the SAME transaction that was involved in the debt that shareholders in a bond fund have interest in. Right?
Yes - It might literally be the same transaction. There are examples out there where people had a 401k bond fund that was holding the MBS that holds the persons's mortgage.

But even not here - yes. For practical purposes they are the same. Yes, there is a fair amount of nuance between a treasury, corporate bond, a MBS, and a mortgage. While the nuances are important, so are the fundamentals. And fundamentally a mortgage is a negative bond for personal finance. Think of a individuals exposure to interest rate and inflation rate risks. Mortgages offer the inverse exposure to bonds.
Generally when I read these discussions on this site, people who have a mortgage but are also contributing into a 60/40 asset allocated portfolio say they do so for :1) Liquidity 2) Ballast against a market drop and to have the opportunity to rebalance. We often see discussions on this site where general situations are discussed such as "market dropping 50% means your portfolio value in a 60/40 portfolio drops by 30% but the same drop in a 80/20 results in a 40% loss etc"


On that basis, wouldn't it be more appropriate to tell a typical middle class investor who wants to contribute in a 60/40 manner to a portfolio while maintaining a mortgage - ESPECIALLY if he has the funds to pay off said mortgage--that his AA is 60/40 but the effective balances are lower than it is to say that this investor has a 100% stock asset allocation?
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

coachd50 wrote: Sat Apr 17, 2021 4:17 pm On that basis, wouldn't it be more appropriate to tell a typical middle class investor who wants to contribute in a 60/40 manner to a portfolio while maintaining a mortgage - ESPECIALLY if he has the funds to pay off said mortgage--that his AA is 60/40 but the effective balances are lower than it is to say that this investor has a 100% stock asset allocation?
I’m not sure what kind of message will break through the barrier, but in my mind the goal should to help people understand that they AREN’T ACTUALLY 60/40 if they have bonds and a mortage and further to understand why holding bonds and a mortgage is probably suboptimal.
"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 coachd50 »

vineviz wrote: Sat Apr 17, 2021 4:39 pm
coachd50 wrote: Sat Apr 17, 2021 4:17 pm On that basis, wouldn't it be more appropriate to tell a typical middle class investor who wants to contribute in a 60/40 manner to a portfolio while maintaining a mortgage - ESPECIALLY if he has the funds to pay off said mortgage--that his AA is 60/40 but the effective balances are lower than it is to say that this investor has a 100% stock asset allocation?
I’m not sure what kind of message will break through the barrier, but in my mind the goal should to help people understand that they AREN’T ACTUALLY 60/40 if they have bonds and a mortage and further to understand why holding bonds and a mortgage is probably suboptimal.
I realize it is probably just semantics, but I don't think it is accurate to say they "aren't actually 60/40" but rather say "hey, you are 60/40 but since you owe someone X amount of cash, those balances are effectively lower with regards to earning power than the nominal balances may reflect".

Because essentially, the $$$ spent on the future monthly P&I could be instead put into the 60/40.
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Re: "Mortage is a negative bond" - please help me understand

Post by vineviz »

coachd50 wrote: Sat Apr 17, 2021 4:48 pm
I realize it is probably just semantics, but I don't think it is accurate to say they "aren't actually 60/40" but rather say "hey, you are 60/40 but since you owe someone X amount of cash, those balances are effectively lower with regards to earning power than the nominal balances may reflect".
It’s accurate because the mortgage offsets the bonds in the asset allocation, not the stocks.

If you own $600k in stocks your market risk is the same regardless of whether you have $400k in bonds and a $400k mortgage or $0 in both: if stocks drop 50%, you’re down $300k in either scenario.
"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 coachd50 »

vineviz wrote: Sat Apr 17, 2021 4:56 pm
coachd50 wrote: Sat Apr 17, 2021 4:48 pm
I realize it is probably just semantics, but I don't think it is accurate to say they "aren't actually 60/40" but rather say "hey, you are 60/40 but since you owe someone X amount of cash, those balances are effectively lower with regards to earning power than the nominal balances may reflect".
It’s accurate because the mortgage offsets the bonds in the asset allocation, not the stocks.

If you own $600k in stocks your market risk is the same regardless of whether you have $400k in bonds and a $400k mortgage or $0 in both: if stocks drop 50%, you’re down $300k in either scenario.
I get that, but in what way does it "offset" the bond allocation relative to the investors desire to hold $400 in bonds for liquidity and rebalancing purposes? I don't see how that answer fits.
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