Author Topic: Mortgage Payoff = Bond Allocation?  (Read 1194 times)

ReadySetMillionaire

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Mortgage Payoff = Bond Allocation?
« on: November 07, 2018, 12:26:37 PM »
I'm married, 31, with a kid on the way.  I just started my own solo law practice and it's taking off to such a degree that I'm humbly and surprisingly confused with setting goals for 2019.  Here's the basic numbers of what my goals are for 2019:

$225,000 -- Gross Income
$18,500 -- Wife 401k
$18,500 -- My 401k (as employee)
$35,000 -- My 401k (as employer)
$6,900 -- HSA
$20,000 -- Deductible Law Firm Expenses

--

$126,000 Adjusted Gross Income

($30,000 in anticipated taxes -- no state taxes for me since I'm self-employed)

--

$96,000 -- Cash Flow (for Expenses)

--

$45,000 -- Actual Yearly Household Expenses

--

$51,000 left over

--

This $51,000 is a big, big number.  We are currently in 100% equities, and all the above investments will also go into 100% equities.

If we put this $51,000 in additional funds toward the mortgage, then I'd basically be able to pay off half our mortgage, which is currently at about $114,000 at 4.5% interest. The thought of not having a mortgage after just two more years is of huge psychological value to me, and also math wise -- it would lower our yearly expenses to about $39,000, thus creating more cash flow each year and each month.

I'm viewing this as a bond allocation at 4.5% guaranteed return, but also being able to pull out the equity on this amount as well (i.e., a HELOC) if needed.  I also think payoff of the mortgage is fine when I'm taking up all other available tax-advantaged space. 

Is thinking of this as a bond allocation mental gymnastics on my part, or does this make sense?

daverobev

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Re: Mortgage Payoff = Bond Allocation?
« Reply #1 on: November 07, 2018, 12:38:08 PM »
It's a valid way to see it. Instead of paying 4.5% after tax and getting 3% (say?) pre tax, you're not paying the 4.5% and not getting the 3%. Win!

The only thing is that you have to separate the debt from the asset (ie, the house) - the house will go up and down with market crashes and whatnot, while the bonds would in theory do the opposite and cash would stay still. Once the cash is gone into the mortgage you can't pull it out to cover expenses (cost of living - incl. the mortgage!) if you happen to want/need to do so while the financial world is crummy.

In other words - I'd still keep a small emergency cash pile, until you're at the point even a massive market crash can't cause you to sell in a down market (which is theoretically never, because if you did that you'd have faaar too much money).

RWD

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Re: Mortgage Payoff = Bond Allocation?
« Reply #2 on: November 07, 2018, 12:44:11 PM »
There was a thread on this a few years ago and it's come up a few times in tangentially related threads. General consensus seems to be that they are not interchangeable.
https://forum.mrmoneymustache.com/investor-alley/asset-allocation-no-bonds-if-you-have-debt/

harvestbook

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Re: Mortgage Payoff = Bond Allocation?
« Reply #3 on: November 07, 2018, 01:39:55 PM »
Never underestimate psychological value, since most investing mistakes are psychological.

Boofinator

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Re: Mortgage Payoff = Bond Allocation?
« Reply #4 on: November 07, 2018, 03:25:02 PM »
How much liquidity do you have? How close to FIRE? If the answer (1) low or (2) long, I would invest in taxable equities before paying off the mortgage at that interest rate. If the market tanks, take the tax loss harvest silver lining and keep DCAing.

To comment on the question in the title: Despite some structural differences mentioned, yes, I feel bonds are a good comparison. The major difference is that bonds are liquid (and of course have variable returns).
« Last Edit: November 07, 2018, 03:27:28 PM by Boofinator »

ChpBstrd

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Re: Mortgage Payoff = Bond Allocation?
« Reply #5 on: November 09, 2018, 03:28:41 PM »
This used to be a more complicated discussion before the standard deduction was raised out of reach for most of us. Now it's safe to say mortgage interest = bond yield times one minus your marginal tax rate.

Also, if you live in a state where you can walk away from the mortgage if the house loses too much value, there may be some option value there. You'll know the rules on that contingency.

Boofinator

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Re: Mortgage Payoff = Bond Allocation?
« Reply #6 on: November 09, 2018, 06:13:30 PM »
This used to be a more complicated discussion before the standard deduction was raised out of reach for most of us. Now it's safe to say mortgage interest = bond yield times one minus your marginal tax rate.

Also, if you live in a state where you can walk away from the mortgage if the house loses too much value, there may be some option value there. You'll know the rules on that contingency.

Good point on the tax rate, I forgot to mention that. I have 0% bonds in taxable (and nontaxable) so it tends to slip off the radar.

Much Fishing to Do

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Re: Mortgage Payoff = Bond Allocation?
« Reply #7 on: November 10, 2018, 08:07:10 AM »
I did think of my additional payments to mortgage as a sort of allocation to my portfolio, and one that was more like a bond allocation (or really more like a very good paying cash allocation) than equities, though not interchangeable.

Because of this I personally don't think it makes much sense to pre-pay the mortgage if your stash is still small.  I was at about 10x spending before I focused on paying it off b/c I see 100% equities as good when your stache is still that small.

Of course don't lose sight that the much more important numbers in all of this is that your mortgage (and so I assume overall value of your house?) is less than what you make in a year (so your house is not killing you like it does many), and your spending rate is wonderfully tiny, so whether you knock out the mortgage faster or invest the savings instead is kind of a small detail in your overall success right now.


RecoveringCarClown

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Re: Mortgage Payoff = Bond Allocation?
« Reply #8 on: November 10, 2018, 11:21:26 PM »
2019 401k limit has been increased to 19k.

Blueberries

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Re: Mortgage Payoff = Bond Allocation?
« Reply #9 on: November 13, 2018, 10:17:46 AM »
Never underestimate psychological value, since most investing mistakes are psychological.

Seconded.

effigy98

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Re: Mortgage Payoff = Bond Allocation?
« Reply #10 on: November 13, 2018, 01:17:42 PM »
Never underestimate psychological value, since most investing mistakes are psychological.

I think my last bonus and raises was mostly from my carefree attitude at work. I am more aggressive and less giving a F so I probably stand out more and get stuff done faster (less careful). The bonus dwarfed my last 2 years of stock gains so I would say at least in my case, the mortgage payoff was the best use of that money for me.

kenmoremmm

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Re: Mortgage Payoff = Bond Allocation?
« Reply #11 on: November 13, 2018, 06:15:17 PM »
there are about a dozen recent threads on early mortgage payoff on this board. there's also the "don't payoff your mortgage early" thread that had a lot of traction.

i think the tl;dr version is that if you dump your $51k into your mortgage, you've increased your risk, short term. so, it would be better to put it into a high yield savings account until you save enough to pay it off in one fell swoop. the delta in interest savings is probably a few thousand, but you would get a tremendous safety net in the meantime until you save for 2.5 years to payoff.

Telecaster

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Re: Mortgage Payoff = Bond Allocation?
« Reply #12 on: November 13, 2018, 09:53:56 PM »
The only rational way to look at this is to view it as it really is:  Paying off the mortgage results in a future savings.  That's not the same as a bond, it is a future savings.

JAYSLOL

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Re: Mortgage Payoff = Bond Allocation?
« Reply #13 on: November 14, 2018, 08:44:53 AM »
Good theory, I'd be tempted to treat my mortgage (if/when I buy a house) like buying bonds too, the challenge is that you can't easily/cheaply rebalance your stock/mortgage payoff allocation when things go out of whack.  I would still go something like 80/20 to be able to rebalance and keep a smoother portfolio.