It is a moral duty:
https://xkcd.com/386/
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).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.
More!
Stamina.
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.
How do taxes affect the decision if all of a person's bonds are located inside a tax deferred account?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.
And, indeed, you SHOULD consider your AA to be the same in both scenarios: just don't ignore the real estate allocation.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.
UALflyer,UALflyer wrote: ↑Fri Apr 16, 2021 6:29 amYou 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).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 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.
Which risk? There are various types of risk that are inherent in every decision, so that you always have to balance them.
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.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.
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.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.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.
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."
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.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 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.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 will have to think on this perspective and see if I come around to it -- I want to.vineviz wrote: ↑Fri Apr 16, 2021 12:48 pmI 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.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.
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.
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.UALflyer wrote: ↑Fri Apr 16, 2021 12:59 pmI 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.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.
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.
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?vineviz wrote: ↑Fri Apr 16, 2021 12:48 pmIf 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.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.
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.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.)
And that's a good answer too.Kenkat wrote: ↑Fri Apr 16, 2021 1:19 pmDon’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?vineviz wrote: ↑Fri Apr 16, 2021 12:48 pmIf 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.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.
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.
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.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.
Yes, agree. It’s just different terminology explaining the same end result.vineviz wrote: ↑Fri Apr 16, 2021 1:43 pmAnd that's a good answer too.Kenkat wrote: ↑Fri Apr 16, 2021 1:19 pmDon’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?vineviz wrote: ↑Fri Apr 16, 2021 12:48 pmIf 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.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.
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.
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.
I completely agree. The only difference between the two is liquidity.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.
milktoast,
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.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.)
Yup. Liquidity improves returns when you end up needing liquidity. And hurts returns at all other times.
milktoast,
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.
vineviz,vineviz wrote: ↑Fri Apr 16, 2021 7:51 pmYou 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.
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.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.
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.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.
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.Coase wrote: ↑Fri Apr 16, 2021 10:17 pmLiquidity 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.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.
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.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.
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 pmYou 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.Coase wrote: ↑Fri Apr 16, 2021 10:17 pmLiquidity 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.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.
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 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.
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.
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.
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?
Because a mortgage is not the inverse of equity, but it’s the inverse of a bond.
No, i understand that premise when talking about definitions.vineviz wrote: ↑Sat Apr 17, 2021 10:01 amBecause 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.
Suppose an investor has a modest 60/40 portfolio ($300K/$200K) and no mortgage.coachd50 wrote: ↑Sat Apr 17, 2021 10:13 amNo, i understand that premise when talking about definitions.vineviz wrote: ↑Sat Apr 17, 2021 10:01 amBecause 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.
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?
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.Coase wrote: ↑Fri Apr 16, 2021 11:17 pmThat 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.
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.vineviz wrote: ↑Sat Apr 17, 2021 11:20 amEven 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.Coase wrote: ↑Fri Apr 16, 2021 11:17 pmThat 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.
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.
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.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?
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"alex_686 wrote: ↑Sat Apr 17, 2021 11:59 amYes - 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.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?
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.
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.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 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".vineviz wrote: ↑Sat Apr 17, 2021 4:39 pmI’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.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?
It’s accurate because the mortgage offsets the bonds in the asset allocation, not the stocks.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".
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.vineviz wrote: ↑Sat Apr 17, 2021 4:56 pmIt’s accurate because the mortgage offsets the bonds in the asset allocation, not the stocks.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".
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.