Author Topic: Paying off Mortgage Early How bad is it for your FI Date?  (Read 226211 times)

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #300 on: March 24, 2015, 10:34:45 AM »
There has been comments about trapped equity which seems to be a bit of a fallacy

The owner with a 15yr mortgage can easily take out a HELOC now (before disaster strikes) to prepare for the inevitable rainy day (which includes buying stocks with proceeds of HELOC if stocks crash)

Additionally while making plans to keep a mortgage for 30yrs seems like a nice idea on paper, I think in practice for primary residences it happens a lot less often than most here might think.  Life gets in the way: most ppl move many times over the course of their life due to jobs, divorce, kids (having them and also pushing them out of the nest), change in financial circumstances (both for the better and worse), and even early retirement.

The practice of taking out a 30yr mortgage and never paying it down is only realistic for a small minority of homeowners who will never have to move OR are in the business of being a landlord.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #301 on: March 24, 2015, 10:38:55 AM »
There has been comments about trapped equity which seems to be a bit of a fallacy

The owner with a 15yr mortgage can easily take out a HELOC now (before disaster strikes) to prepare for the inevitable rainy day (which includes buying stocks with proceeds of HELOC if stocks crash)

Many HELOCs were shrunk or cancelled in the recession.  It's something that's nice to plan for, but I wouldn't count on.  And most people trying to pay down their mortgage aren't thinking about taking out a second mortgage (essentially).  And good luck trying to get it if you don't do it ahead of time, after you've lost your job.

The practice of taking out a 30yr mortgage and never paying it down is only realistic for a small minority of homeowners who will never have to move OR are in the business of being a landlord.

This is true.  Or smart Mustachians who read the arguments, do the math, and purposefully decide to hold their low-rate, fixed mortgage and invest everything they can instead.
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TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #302 on: March 24, 2015, 10:51:41 AM »
There has been comments about trapped equity which seems to be a bit of a fallacy

The owner with a 15yr mortgage can easily take out a HELOC now (before disaster strikes) to prepare for the inevitable rainy day (which includes buying stocks with proceeds of HELOC if stocks crash)

Many HELOCs were shrunk or cancelled in the recession.  It's something that's nice to plan for, but I wouldn't count on.  And most people trying to pay down their mortgage aren't thinking about taking out a second mortgage (essentially).  And good luck trying to get it if you don't do it ahead of time, after you've lost your job.

The practice of taking out a 30yr mortgage and never paying it down is only realistic for a small minority of homeowners who will never have to move OR are in the business of being a landlord.

This is true.  Or smart Mustachians who read the arguments, do the math, and purposefully decide to hold their low-rate, fixed mortgage and invest everything they can instead.

If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.  And yes my premise did assume the owner took out the HELOC while employed.

Additionally, those arguing so strongly for never paying down principal may have their dream house in the perfect location with the ideal family size for the next 30yrs (or may simply add it to a portfolio of rental properties if not) but I think it is fair to say that probably is not the case for most readers.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #303 on: March 24, 2015, 11:14:20 AM »
If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.  And yes my premise did assume the owner took out the HELOC while employed.

They aren't necessarily correlated, but even so, if you have the extra funds you can wait out a stock market crash.  If you're relying on a HELOC and don't have access to one, you can't necessarily wait that out.

Additionally, those arguing so strongly for never paying down principal may have their dream house in the perfect location with the ideal family size for the next 30yrs (or may simply add it to a portfolio of rental properties if not) but I think it is fair to say that probably is not the case for most readers.

Not necessarily.. as long as the investment beats the mortgage rate over whatever time period, it's worth it.  Even if you only have the house for 5 years, or 10.

Now, it's more likely (close to every time) when you're holding the whole 30 years, but even on a short time frame you're more likely than not to beat today's low rates. 

Some may not want to take that chance, and others might want to play the odds.  I'd prefer to maximize, even with risk, but it's okay if others want to play it different.  But the "only works if you have your dream home to hold for 30 years" simply isn't true.
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
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rpr

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #304 on: March 24, 2015, 11:19:28 AM »
^^^ Arabelspy -- well put. You and others have pretty much debunked all the arguments against prepaying such low rate mortgage loans. I realize that there is a risk but for those that are willing to take it, a payoff awaits.


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brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #305 on: March 24, 2015, 11:22:23 AM »

If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.

I disagree that that's a fair statement.  It doesn't matter if stocks are "massively underwater" (as compared to the "return" on mortgage prepayment) at any given point during the 30-year run; it only matters if the CAGR outperforms the mortgate rate over the entire 30-year period.  At the snapshot in time when HELOCS were cancelled during the financial crisis, stock performance would have been trailing mortgage prepayment performance for someone who started down that road right before the financial crisis, but now stock performance is back on track to outperform.  If you look at the entire history of the markets, with all the market crashes and calamities, there hasn't been a 30 year period where the markets didn't outperform today's super-low mortgage rates.

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #306 on: March 24, 2015, 12:14:28 PM »

If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.

I disagree that that's a fair statement.  It doesn't matter if stocks are "massively underwater" (as compared to the "return" on mortgage prepayment) at any given point during the 30-year run; it only matters if the CAGR outperforms the mortgate rate over the entire 30-year period.  At the snapshot in time when HELOCS were cancelled during the financial crisis, stock performance would have been trailing mortgage prepayment performance for someone who started down that road right before the financial crisis, but now stock performance is back on track to outperform.  If you look at the entire history of the markets, with all the market crashes and calamities, there hasn't been a 30 year period where the markets didn't outperform today's super-low mortgage rates.

The entire premise of needing a HELOC would be in the case of an unforeseen event (job loss, health issue) where immediate liquidity is needed - comparing apples to apples that means selling stocks in whatever mkt environment exists at the time vs drawing on the line of credit

If you want to compare a 30yr term where you never need the cash then it is true a high % of the time a passive equity index investment would beat a 3.5-4% annual rate.  More importantly, though, ppl should consider the correlation and likelihood of certain events occurring:
- what happens to stocks in times of high unemployment?
- what happens to stocks when real estate prices stagnate or drop?
- what happens to stocks when interest rates rise?
- what have realized returns been historically when rates are so low as they are now?

Take your personal situation into account, which includes likelihood of moving (and if so, what possible time period from now - the shorter it is, the less likely stocks will outperform even a 3% rate), stability of employment and income, expected expenses (marriage, college, rainy day).

This isn't a one-size-fits-all approach.  There are many ppl whose income is very highly correlated to the stock market.  I would argue they should never consider such a strategy until they are very close to FI and can weather almost any storm.  Others live in areas of the country (NY metro or Bay Area) where the strength of the equity market or tech companies is almost perfectly correlated with their employment as well as their home price.  It would seem silly to leverage up (which is what the strategy entails) for these individuals if financial ruin in the disaster scenario is a possibility.

I personally am interested in understanding what the long-term (even 30yr) historical return on equities has been from the starting point of current valuations, interest rates and profit margins.
« Last Edit: March 24, 2015, 12:31:00 PM by TheNewNormal2015 »

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #307 on: March 24, 2015, 01:19:08 PM »
NewNormal -

I agree with the overall sentiment in your post above.  You need to compare the risks associated with each strategy and pick your poison.  But I would say that for most people, all things considered, the odds will favor the strategy of carrying the mortgage.  If there's a strong chance you will be selling your house in the short-term, it would be stupid to leverage up and invest the proceeds in the stock market, but generally speaking it is a bad idea to buy property in the first place if there's a strong chance of selling in the short-term.  Yes, shit happens and unexpected circumstances may arise that force you to sell early, but generally you can control the timing of your sale -- so do you pick the plan that protects you against the remote risk of being forced to sell at a bad time, or do you pick the plan that protects against the very large risk of harming your chances of retirement success (i.e., requiring you to either work longer than what would otherwise be necessary, or cut expenses or seek alternative income in retirement, or some combination)?

But some of the bad outcomes in your list of correlated events argue against your point.  Instability of employment income is a good reason not to pay down your mortgage.  If you lose your job midway through an aggressive prepayment plan (which, as you said, will quite possibly happen at a time when your access to cash through other alternatives, including extraction of home equity, is also limited), you would have been better off had you been investing in lieu of prepaying (because even a depreciated pile of investments provides better liquidity than nothing).

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #308 on: March 24, 2015, 01:53:32 PM »
You are better off only after you've made it beyond what I'll call "the zone of risk", when your investments are not only large enough to support paying the mortgage, but large enough so that you don't deplete them. What is that, 12 years? 15 years?

In other words, with an SWR of 4% and let's say a mortgage of $2k/month and living expenses of, say, $1k/month ($3k/month total, $36,000 a year), you need $900,000.

But, oh no, he's lost his job with only, say, $100,000 in savings/investments and he's got to have $3k/month to live on . He's no longer contributing to the investments, so that gets stuck at $100,000 save for the yields.

He depletes his savings in less than four years. If he's not found a job in four years, he loses house, investments, etc.

I disagree with most of what you wrote but this bit is simply ridiculous.

#1-again this isn't apples to apples. You are completely ignoring the other side. Mr. Aggressive debt reducer loses his house within a month or two since his capital is trapped. At least Mr. Investor keeps it for a few years in your example.

#2-you don't need $900k and a 4% SWR. You need assets that support the 4% SWR on your $1k/month spending (so $300k) + assets to payoff the house when you lose your job. On a 30 yr note at 4.25% interest with $2k P&I, the note is ~400k at the start and declining every year. So you might need $500-600k at most. But that "zone of risk" as you called it is declining rapidly every month.

Please recognize the debt reducer is at a much higher risk to lose his house during the zone of risk period. Beyond the zone of risk it depends on ROR on investments, but as others have stated 95% of the time investor will be in a much better position at the end of the zone of risk if it's > 5-10 years. 

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #309 on: March 24, 2015, 03:04:29 PM »
NewNormal -

I agree with the overall sentiment in your post above.  You need to compare the risks associated with each strategy and pick your poison.  But I would say that for most people, all things considered, the odds will favor the strategy of carrying the mortgage.  If there's a strong chance you will be selling your house in the short-term, it would be stupid to leverage up and invest the proceeds in the stock market, but generally speaking it is a bad idea to buy property in the first place if there's a strong chance of selling in the short-term.  Yes, shit happens and unexpected circumstances may arise that force you to sell early, but generally you can control the timing of your sale -- so do you pick the plan that protects you against the remote risk of being forced to sell at a bad time, or do you pick the plan that protects against the very large risk of harming your chances of retirement success (i.e., requiring you to either work longer than what would otherwise be necessary, or cut expenses or seek alternative income in retirement, or some combination)?

But some of the bad outcomes in your list of correlated events argue against your point.  Instability of employment income is a good reason not to pay down your mortgage.  If you lose your job midway through an aggressive prepayment plan (which, as you said, will quite possibly happen at a time when your access to cash through other alternatives, including extraction of home equity, is also limited), you would have been better off had you been investing in lieu of prepaying (because even a depreciated pile of investments provides better liquidity than nothing).

I would normally not disagree with your logic, because rates are indeed low, which makes the hurdle rate for investment returns seem very beatable.  The current reality is assets which generate a return are expensive by almost any measure.  And the most important criteria in an investment decision is the price paid, irrespective of asset class or holding period.  A few observations:

- you need to have a HELOC set up before you need it; this speaks to the trapped liquidity aspect; additionally....

- most lenders will now allow you to recast or recapitalize your loan for little or no cost if you have paid down principal, while keeping the initial maturity date, thereby decreasing your monthly payment; this effectively reduces your monthly cash outflow going forward, which is really the key to avoiding insolvency when the sht hits the fan (which it inevitably does every so often)

- yes most ppl should think long and hard about the likely timeframe of selling before actually buying; but the reality is a lot of the reasons for selling are simply not predictable or deemed unlikely at the time of purchase:
1) divorce - no one gets married thinking it will end in tears, yet more than half of romantic mergers crumble
2) jobs - even successful executives sometimes get relocated against their will, and moving is sometimes the best way to move up the ladder
3) family - not all kids are planned, nor are all living situations expected: the boomerang millennials are a great example, as well as retirees who will eventually move back in with their children out of necessity; and of course downsizing is a major demographic trend among boomers now as their children leave the nest
4) financial circumstance (for better and worse) - few successful professionals in their late 30s and early 40s will be content to live the post-undergrad starter home lifestyle once they have tasted a bit of success; alternatively ppl who are "unlucky" at some point in their careers may need to recalibrate expectations to the downside

- the correlation of unfortunate circumstances you question (job loss + lower home prices + lower stocks) happened just 5-6 years ago!  and it caused financial ruin for many ppl who thought they had an adequate margin of safety; the truly amazing thing is there is actually skepticism this could happen again, and that ppl actually think having more leveraged exposure to common stocks is safer than having a lower amount of debt (leverage) in one's personal balance sheet

As an aside, I write about many of these things out of my own personal experience: I did not anticipate some of life's curveballs and of course did not think that something that had never happened in the history of markets would transpire leading to the financial crisis.  It delayed my FIRE date by many years, but I was lucky: others I knew on the cusp of FI or already there on paper were ruined with no chance of recovery

skyrefuge

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #310 on: March 24, 2015, 03:15:47 PM »
First, mefla, I'm about to talk some mid- to high-level shit here that doesn't actually impact the low-level stuff that brooklynguy and arebelspy are trying to help you to understand. So no need to read this until you understand everything they're saying.

Again, over a 30 year time horizon, with mortgage rates like those available today, investment performance would have failed to enable you to pay off the mortgage in accordance with its scheduled amortization and still have a pot of money left over at the end of the 30 year period less than 5% of the time (which includes all the recessions, depressions, market crashes, bear markets, etc., in the history of the markets).

Since we're looking at the historical record (which I agree is the correct approach here), isn't it at least slightly optimistic to universally apply today's historically-low mortgage rates to all historical periods, given that there is likely to be at least some correlation between interest rates and forward-looking 30-year equity/bond returns?

I'm trying not to be too much of a market-timer here, but it seems likely to me that the "equity risk premium" is a real thing that's at least somewhat constant. So the idea that today's low interest rates might result in lower-than-average returns going forward doesn't seem totally insane to me.

cFIREsim probably isn't the best tool for this, since it doesn't know anything about historical mortgage rates, but it would be interesting to see the success rate if "prevailing mortgage rate at the beginning of the 30-year cycle" was used as the rate rather than "4%". Maybe this has already been done? (maybe even in this thread sometime in the last 2 years it's been going, but I'm too lazy to go back and check!)

rpr

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #311 on: March 24, 2015, 03:27:56 PM »

This is my understanding thus far. There are two strategies  here.

I. If you are exceedingly risk-averse, go ahead and prepay your mortgage and get that guaranteed current sub-4% return on your prepayments over 30+ years.

II. If you are OK with the risk and have a long remaining investing life ahead of you, go ahead and invest for the higher returns. It will probably be higher than the 4% but no guarantees.

Mathematically (financially) over long durations (20-30 years)  investment ROR under II. will most likely beat I. It will be a bumpy ride. If you need the comfort, safety, and security, stay out of the ride.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #312 on: March 24, 2015, 03:41:15 PM »
NewNormal,

These are mostly valid points.  Like I said, one needs to weigh the risks and potential benefits of the two approaches against one another.

But I'm struggling to understand your point about the correlation of unfortunate circumstances leading to financial ruin.  I'm not questioning the correlation (it's the opposite -- I assumed it to be true for the sake of argument); I'm arguing that a person who loses his job during a financial crisis that simultaneously devalues both housing and stock prices and also cuts off normal methods of accessing liquidity will be worse off if he was in the middle of an aggressive mortgage prepayment plan (as opposed to the same person who instead never prepaid a penny), higher balance sheet leverage notwithstanding.  The first person at least has some depreciated investments to be liquidated.

Your point is really comparing the mortgage vs. no mortgage options (or mortgage vs. pay-off-in-full options).  And the person who is in a position to pay off their mortgage in its entirety but chooses not to is likely also a person whose other balance sheet assets are high enough to provide sufficient buffer to get through most any unexpected circumstance.

The considerations are similar to whether or not you should have an aggressive asset allocation for your portfolio.  If you want to retire as early as possible with the highest chances of retirement success, you need an aggressive allocation to do so.  By using an aggressive allocation, you do assume the risk that unexpected liquidity needs will arise and force you to liquidate some of your investments at a bad time.  Leveraging up your investments is doubling down on this approach.  For the reasons you and skyrefuge mentioned regarding the current market environment, there may be reasons to believe that right now we're in a situation like one of the 5% historical cases where investment returns sub-performed a mortgage with a 4% rate.  If you believe that, you also need to realize that you're going to need to plan your retirement around a super-low withdrawal rate, and the arguments in this thread have mostly been aimed at debunking [EDIT] revealing the intellectual inconsistency of believing in the safety of your supra-3% withdrawal rate of choice and at the same time believing that paying off your sub-4% mortgage reduces risk.

I want to give a proper response to skyrefuge's post, which I may do later tonight (I'm leaving the office shortly).
« Last Edit: March 24, 2015, 03:46:33 PM by brooklynguy »

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #313 on: March 24, 2015, 04:22:23 PM »
NewNormal,

These are mostly valid points.  Like I said, one needs to weigh the risks and potential benefits of the two approaches against one another.

But I'm struggling to understand your point about the correlation of unfortunate circumstances leading to financial ruin.  I'm not questioning the correlation (it's the opposite -- I assumed it to be true for the sake of argument); I'm arguing that a person who loses his job during a financial crisis that simultaneously devalues both housing and stock prices and also cuts off normal methods of accessing liquidity will be worse off if he was in the middle of an aggressive mortgage prepayment plan (as opposed to the same person who instead never prepaid a penny), higher balance sheet leverage notwithstanding.  The first person at least has some depreciated investments to be liquidated.

Your point is really comparing the mortgage vs. no mortgage options (or mortgage vs. pay-off-in-full options).  And the person who is in a position to pay off their mortgage in its entirety but chooses not to is likely also a person whose other balance sheet assets are high enough to provide sufficient buffer to get through most any unexpected circumstance.

The considerations are similar to whether or not you should have an aggressive asset allocation for your portfolio.  If you want to retire as early as possible with the highest chances of retirement success, you need an aggressive allocation to do so.  By using an aggressive allocation, you do assume the risk that unexpected liquidity needs will arise and force you to liquidate some of your investments at a bad time.  Leveraging up your investments is doubling down on this approach.  For the reasons you and skyrefuge mentioned regarding the current market environment, there may be reasons to believe that right now we're in a situation like one of the 5% historical cases where investment returns sub-performed a mortgage with a 4% rate.  If you believe that, you also need to realize that you're going to need to plan your retirement around a super-low withdrawal rate, and the arguments in this thread have mostly been aimed at debunking [EDIT] revealing the intellectual inconsistency of believing in the safety of your supra-3% withdrawal rate of choice and at the same time believing that paying off your sub-4% mortgage reduces risk.

I want to give a proper response to skyrefuge's post, which I may do later tonight (I'm leaving the office shortly).

Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #314 on: March 24, 2015, 04:29:51 PM »
NewNormal,

These are mostly valid points.  Like I said, one needs to weigh the risks and potential benefits of the two approaches against one another.

But I'm struggling to understand your point about the correlation of unfortunate circumstances leading to financial ruin.  I'm not questioning the correlation (it's the opposite -- I assumed it to be true for the sake of argument); I'm arguing that a person who loses his job during a financial crisis that simultaneously devalues both housing and stock prices and also cuts off normal methods of accessing liquidity will be worse off if he was in the middle of an aggressive mortgage prepayment plan (as opposed to the same person who instead never prepaid a penny), higher balance sheet leverage notwithstanding.  The first person at least has some depreciated investments to be liquidated.

Your point is really comparing the mortgage vs. no mortgage options (or mortgage vs. pay-off-in-full options).  And the person who is in a position to pay off their mortgage in its entirety but chooses not to is likely also a person whose other balance sheet assets are high enough to provide sufficient buffer to get through most any unexpected circumstance.

The considerations are similar to whether or not you should have an aggressive asset allocation for your portfolio.  If you want to retire as early as possible with the highest chances of retirement success, you need an aggressive allocation to do so.  By using an aggressive allocation, you do assume the risk that unexpected liquidity needs will arise and force you to liquidate some of your investments at a bad time.  Leveraging up your investments is doubling down on this approach.  For the reasons you and skyrefuge mentioned regarding the current market environment, there may be reasons to believe that right now we're in a situation like one of the 5% historical cases where investment returns sub-performed a mortgage with a 4% rate.  If you believe that, you also need to realize that you're going to need to plan your retirement around a super-low withdrawal rate, and the arguments in this thread have mostly been aimed at debunking [EDIT] revealing the intellectual inconsistency of believing in the safety of your supra-3% withdrawal rate of choice and at the same time believing that paying off your sub-4% mortgage reduces risk.

I want to give a proper response to skyrefuge's post, which I may do later tonight (I'm leaving the office shortly).

I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dodge

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #315 on: March 24, 2015, 04:51:13 PM »
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #316 on: March 24, 2015, 05:17:45 PM »
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Drew664

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #317 on: March 24, 2015, 05:23:28 PM »

This is my understanding thus far. There are two strategies  here.

I. If you are exceedingly risk-averse, go ahead and prepay your mortgage and get that guaranteed current sub-4% return on your prepayments over 30+ years.

II. If you are OK with the risk and have a long remaining investing life ahead of you, go ahead and invest for the higher returns. It will probably be higher than the 4% but no guarantees.

Mathematically (financially) over long durations (20-30 years)  investment ROR under II. will most likely beat I. It will be a bumpy ride. If you need the comfort, safety, and security, stay out of the ride.

Wouldn't the returns on I only be for the time it takes to paydown the mortgage, not 30+ years? After that, you'd have a lot of cash flow to pursue FI, RE, or both through whatever investment channels you desire. Nothing wrong with having principals that don't align with leveraging debt.

Good succinct summary post as this is how I understand it.

Eric

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #318 on: March 24, 2015, 05:31:18 PM »
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Oh boy!

Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #319 on: March 24, 2015, 05:31:43 PM »
Since we're looking at the historical record (which I agree is the correct approach here), isn't it at least slightly optimistic to universally apply today's historically-low mortgage rates to all historical periods, given that there is likely to be at least some correlation between interest rates and forward-looking 30-year equity/bond returns?

I'm trying not to be too much of a market-timer here, but it seems likely to me that the "equity risk premium" is a real thing that's at least somewhat constant. So the idea that today's low interest rates might result in lower-than-average returns going forward doesn't seem totally insane to me.

cFIREsim probably isn't the best tool for this, since it doesn't know anything about historical mortgage rates, but it would be interesting to see the success rate if "prevailing mortgage rate at the beginning of the 30-year cycle" was used as the rate rather than "4%". Maybe this has already been done? (maybe even in this thread sometime in the last 2 years it's been going, but I'm too lazy to go back and check!)

I thought about this my entire bike-ride home.  I think the best answer is the Churchillism you coined that history-based prediction is the worst form of retirement success prognostication we have, except for all the others.  The caveat that the future may not resemble the past applies to all the retirement planning we discuss in this forum.  As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.  Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?  Is there any reason to think it works in this context but not that context?

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #320 on: March 24, 2015, 05:42:43 PM »
Since we're looking at the historical record (which I agree is the correct approach here), isn't it at least slightly optimistic to universally apply today's historically-low mortgage rates to all historical periods, given that there is likely to be at least some correlation between interest rates and forward-looking 30-year equity/bond returns?

I'm trying not to be too much of a market-timer here, but it seems likely to me that the "equity risk premium" is a real thing that's at least somewhat constant. So the idea that today's low interest rates might result in lower-than-average returns going forward doesn't seem totally insane to me.

cFIREsim probably isn't the best tool for this, since it doesn't know anything about historical mortgage rates, but it would be interesting to see the success rate if "prevailing mortgage rate at the beginning of the 30-year cycle" was used as the rate rather than "4%". Maybe this has already been done? (maybe even in this thread sometime in the last 2 years it's been going, but I'm too lazy to go back and check!)

I thought about this my entire bike-ride home.  I think the best answer is the Churchillism you coined that history-based prediction is the worst form of retirement success prognostication we have, except for all the others.  The caveat that the future may not resemble the past applies to all the retirement planning we discuss in this forum.  As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.  Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?  Is there any reason to think it works in this context but not that context?

I understood his question to be similar to mine, which is what have realized historical returns been from low rate (use treasury yields as a proxy for mortgage rates) starting points.  It shouldn't be hard to calculate.

Intuitively, future rates of return for all asset classes should be depressed when rates are extremely low, as the price for assets is bid up to account for the low risk free rate set by global central banks.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #321 on: March 24, 2015, 05:43:35 PM »
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #322 on: March 24, 2015, 05:51:50 PM »
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #323 on: March 24, 2015, 05:54:16 PM »
I understood his question to be similar to mine, which is what have realized historical returns been from low rate (use treasury yields as a proxy for mortgage rates) starting points.  It shouldn't be hard to calculate.

Intuitively, future rates of return for all asset classes should be depressed when rates are extremely low, as the price for assets is bid up to account for the low risk free rate set by global central banks.

Somewhere in the neighborhood of current mortgage rates (maybe 3.5% or so), in every single historical 30-year period (including all of those with low-interest starting environments) the market returns would have outperformed the mortgage (if cfiresim were working, we would be able to confirm the exact level, and I've become so dependent on cfiresim as to have near-total incompetence at using other calculators).

The claim that we're in a new world, and have never before experienced low interest rates combined with other aspects of the current market climate, and therefore can't use history as a guide, is pessimistic perspective, similar to what Pfau argues.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #324 on: March 24, 2015, 05:57:25 PM »
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Oh boy!

Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/

The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #325 on: March 24, 2015, 06:03:17 PM »
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

Wow, no relevance? Did you even read the thread??

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #326 on: March 24, 2015, 06:06:21 PM »
I understood his question to be similar to mine, which is what have realized historical returns been from low rate (use treasury yields as a proxy for mortgage rates) starting points.  It shouldn't be hard to calculate.

Intuitively, future rates of return for all asset classes should be depressed when rates are extremely low, as the price for assets is bid up to account for the low risk free rate set by global central banks.

Somewhere in the neighborhood of current mortgage rates (maybe 3.5% or so), in every single historical 30-year period (including all of those with low-interest starting environments) the market returns would have outperformed the mortgage (if cfiresim were working, we would be able to confirm the exact level, and I've become so dependent on cfiresim as to have near-total incompetence at using other calculators).

The claim that we're in a new world, and have never before experienced low interest rates combined with other aspects of the current market climate, and therefore can't use history as a guide, is pessimistic perspective, similar to what Pfau argues.

I think it is your assertion, that future returns will look similar to the past, despite the recent massive run up in prices and valuations (some would argue the valuations are high BECAUSE OF low interest rates - although that ultimately begs the question what happens when rates normalize), is the one that may be a off base, considering we have almost 200 years of financial history showing mean reversion of asset prices based on valuations (pick your value indicator, they all give similar results).

If returns are always 7% real despite starting point I am happy to be disproved.

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #327 on: March 24, 2015, 06:10:04 PM »
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

Wow, no relevance? Did you even read the thread??

Yes

How is it relevant to my comment earlier of using dividend yield as a valuation measure for the market (similar to real yields on TIPS)?

Eric

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #328 on: March 24, 2015, 06:13:47 PM »
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Oh boy!

Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/

The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

Sure there is.  It's one example after another showing how dividends are mathematically equivalent to selling shares of stock.  Above you claimed that was incorrect.  So since they're equivalent, it's irrelevant to the withdrawal rate whether those withdrawals come from all dividends, all shares, or some combination.

Maybe I could've pointed you a little more directly.  Try here or here

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

I'm not sure what this has to do with the difference (or lackthereof) between dividends and sales of shares to fund your withdrawal.  It seems like a wholly different argument, so I'm not sure how it got tacked on here.  But if you don't think that your stocks are going to return greater than 3.5% per year over the next 30 years, then your proposed withdrawal rate will have to be extremely small, leaving you at work for a long long time. (basically the whole point of this thread)
« Last Edit: March 24, 2015, 06:24:39 PM by Eric »

Runge

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #329 on: March 24, 2015, 06:19:16 PM »
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

Wow, no relevance? Did you even read the thread??

Yes

How is it relevant to my comment earlier of using dividend yield as a valuation measure for the market (similar to real yields on TIPS)?

I don't want to derail this thread into yet another discussion on dividends so this will be my only reply on it.

You brought up dividend yields with the assumption that the valuation of a company changes depending upon their dividend payout. The link that Eric posted contains comments and links that are a direct response to this assumption as well as:
... whether selling a share of stock (index) is equivalent to receiving a dividend...

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #330 on: March 24, 2015, 06:26:51 PM »
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

Wow, no relevance? Did you even read the thread??

Yes

How is it relevant to my comment earlier of using dividend yield as a valuation measure for the market (similar to real yields on TIPS)?

I don't want to derail this thread into yet another discussion on dividends so this will be my only reply on it.

You brought up dividend yields with the assumption that the valuation of a company changes depending upon their dividend payout. The link that Eric posted contains comments and links that are a direct response to this assumption as well as:
... whether selling a share of stock (index) is equivalent to receiving a dividend...

Where did I say the valuation of a company changes depending upon their dividend payout?

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #331 on: March 24, 2015, 06:36:24 PM »
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Oh boy!

Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/

The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

Sure there is.  It's one example after another showing how dividends are mathematically equivalent to selling shares of stock.  Above you claimed that was incorrect.  So since they're equivalent, it's irrelevant to the withdrawal rate whether those withdrawals come from all dividends, all shares, or some combination.

Maybe I could've pointed you a little more directly.  Try here or here

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

I'm not sure what this has to do with the difference (or lackthereof) between dividends and sales of shares to fund your withdrawal.  It seems like a wholly different argument, so I'm not sure how it got tacked on here.  But if you don't think that your stocks are going to return greater than 3.5% per year over the next 30 years, then your proposed withdrawal rate will have to be extremely small, leaving you at work for a long long time. (basically the whole point of this thread)

You are referring to the financial theory of two identical companies A & B (one which pays dividends vs one that doesn't) and saying it doesn't matter if company A gives a dividend to shareholders while B doesn't bc you can simply sell shares in B to equate the dividend payout.  I agree with this theory.

That says nothing about the market multiple that is priced to company profits, which fluctuates over time, or the overall level of dividends paid by all stocks divided by their total price, or the yield, of the entire mkt.

Let me ask you: do you think the long term (say 30yr) return on the S&P will be the same irrespective of whether the dividend yield at the starting point is 2% vs 4%?  (EDIT: knowing that dividend payout ratios don't fluctuate that much over short time periods)
« Last Edit: March 24, 2015, 06:42:07 PM by TheNewNormal2015 »

Runge

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #332 on: March 24, 2015, 06:57:37 PM »
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.

What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.

In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.

HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #333 on: March 24, 2015, 07:02:15 PM »
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

Define risk.  Stocks are more volatile, but not more risky, IMO, over a long enough time period.

Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #334 on: March 24, 2015, 07:15:21 PM »
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.

What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.

In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.

HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
Nicely done. Great spreadsheet. I'll play with it some.

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #335 on: March 24, 2015, 07:30:56 PM »
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

Define risk.  Stocks are more volatile, but not more risky, IMO, over a long enough time period.

Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.

Your logic is valid as long as the risk of ruin is negligible, which is far from the case. I've already mentioned equity extraction methods (recast of loans, HELOC, even opening other credit lines) but you seem to ignore them in your "having less liquid assets" comment.

Another consideration which hasn't been mentioned is, if you are forced to sell your home for whatever reason in a down market, it is much easier to do so with positive equity as opposed to a short-sale situation.  People have been trapped and unable to relocate due to being upside down on a mortgage.

Perhaps an expert in credit (corporate spread investing) could chime in, as I am at a total loss as to how ppl actually believe adding stocks to a personal balance sheet over paying down debt (deleveraging) is less risky for the typical household, even for a 30yr period, if for no other reason than that there are a non-trivial number of paths that would cause a suboptimal outcome.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #336 on: March 24, 2015, 07:42:00 PM »
I thought about this my entire bike-ride home.

Ha, I know the feeling!

As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.

No, that'd be like saying "the inflation rate at the beginning of a 30-year cycle is irrelevant to the question of portfolio survival". If we just look at nominal investment returns (ignoring inflation), the 30-year cycle starting in 1966 would look just fine with a 4% WR. But we know that inflation affects real returns, so we include the historical inflation value when running the simulations, which reveals 1966 to be a bust.

So ignoring the historical inflation levels and using the current-but-historically-low 1.5% inflation rate for all cycles would cause cFIREsim to overestimate the success rate for portfolio survival. Likewise, I think it's probable that ignoring the historical mortgage rates and using a the current-but-historically-low 4% mortgage rate for all cycles would cause cFIREsim to overestimate the success rate for leveraged-investing-via-mortgage. Maybe the cycle starting in 1980 shows that it would have been a fantastic idea to borrow money to invest if you could have borrowed it at 4%, but a terrible idea if you had to borrow it at 10%. If so, the 1980 cycle would be a "false positive" in your cFIREsim results, since you couldn't actually borrow money at 4% in 1980.

Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?

No, those are different things. Something like CAPE would have no role in the cFIREsim model. It's not necessary to tell us what actual returns were like in a historical cycle. Inflation-adjusted prices are sufficient for that. While there are surely things that could be added to the cFIREsim model to refine its re-creation of history (the change of bond modeling was one such thing), CAPE is not one of those things. On the other hand, when you're using cFIREsim as a leveraged-investing-via-mortgage simulator, you're implicitly adding the need for more historical data, namely mortgage rates, and using a constant, current rate is a crude substitute when everything else is historically-accurate.

skyrefuge

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #337 on: March 24, 2015, 08:07:00 PM »
Where did I say the valuation of a company changes depending upon their dividend payout?

Er....right here: "The dividend yield is one of many ways to determine valuation".

Sure, it's a way to determine valuation, but it's a naive and worse-than-useless way to do so. You might as well use Facebook "likes". Looking at earnings makes a lot more sense, since a company can choose to stop distributing its earnings via dividends and distribute them via buybacks instead, and that wouldn't change anything about the company's value.

Let me ask you: do you think the long term (say 30yr) return on the S&P will be the same irrespective of whether the dividend yield at the starting point is 2% vs 4%?

It certainly could be. If the dividend yield was 4% because companies were distributing 100% of their earnings via dividends, and then changed to 2% because they started distributing their earnings 50% via dividends and 50% via buybacks, then yeah, the total return would be the same. It seems like you understand how this works for a single company, so it's a pretty small leap to see how it works the same way for a group of companies, aka, "the market". Or just imagine that "the market" is made up of a single giant company.

Ok, like Runge, to avoid derailing the thread, this is my last post on the matter of dividends. If you'd like to discuss it more, please post in the referenced thread about dividends.

But while I'm here going off-topic...

I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

No, the 4% SWR rule-of-thumb has absolutely nothing to do with average investment returns. See this post for the response I have already made to the exact same comment. (everything else in your post seemed cool but I couldn't let the screeching nails-on-the-chalkboard of that comment pass without complaint!)

Runge

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #338 on: March 24, 2015, 08:17:31 PM »
I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

No, the 4% SWR rule-of-thumb has absolutely nothing to do with average investment returns. See this post for the response I have already made to the exact same comment. (everything else in your post seemed cool but I couldn't let the screeching nails-on-the-chalkboard of that comment pass without complaint!)

My bad. Thank's for the clarification on my poor choice of words. :D

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #339 on: March 24, 2015, 08:21:33 PM »
Where did I say the valuation of a company changes depending upon their dividend payout?

Er....right here: "The dividend yield is one of many ways to determine valuation".

Sure, it's a way to determine valuation, but it's a naive and worse-than-useless way to do so. You might as well use Facebook "likes". Looking at earnings makes a lot more sense, since a company can choose to stop distributing its earnings via dividends and distribute them via buybacks instead, and that wouldn't change anything about the company's value.

Let me ask you: do you think the long term (say 30yr) return on the S&P will be the same irrespective of whether the dividend yield at the starting point is 2% vs 4%?

It certainly could be. If the dividend yield was 4% because companies were distributing 100% of their earnings via dividends, and then changed to 2% because they started distributing their earnings 50% via dividends and 50% via buybacks, then yeah, the total return would be the same. It seems like you understand how this works for a single company, so it's a pretty small leap to see how it works the same way for a group of companies, aka, "the market". Or just imagine that "the market" is made up of a single giant company.

Ok, like Runge, to avoid derailing the thread, this is my last post on the matter of dividends. If you'd like to discuss it more, please post in the referenced thread about dividends.

But while I'm here going off-topic...

I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

No, the 4% SWR rule-of-thumb has absolutely nothing to do with average investment returns. See this post for the response I have already made to the exact same comment. (everything else in your post seemed cool but I couldn't let the screeching nails-on-the-chalkboard of that comment pass without complaint!)

I reference dividend yields for the mkt as a form of valuation only wrt the entire mkt given payout ratios don't change much from year to year.  Taken in this context your theoretical scenario of 100% dividends is not only improbable (i.e. never before happened) but also not very useful for the discussion unless we wanted to continuously pontificate about the vast exceptions as opposed to likely events.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #340 on: March 24, 2015, 08:54:33 PM »
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

Define risk.  Stocks are more volatile, but not more risky, IMO, over a long enough time period.

Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.

Your logic is valid as long as the risk of ruin is negligible, which is far from the case. I've already mentioned equity extraction methods (recast of loans, HELOC, even opening other credit lines) but you seem to ignore them in your "having less liquid assets" comment.

I consider ROR of holding a market index fund to be very close to zero.  And in the case of total economic collapse, having a bit more equity in your house won't help you one bit.  And yes, equity extraction in a time of turmoil I consider much less liquid than selling a publicly traded stock.


Another consideration which hasn't been mentioned is, if you are forced to sell your home for whatever reason in a down market, it is much easier to do so with positive equity as opposed to a short-sale situation.  People have been trapped and unable to relocate due to being upside down on a mortgage.

If you have years of payments saved up that you haven't put into the mortgage, you won't need to sell.

Perhaps an expert in credit (corporate spread investing) could chime in, as I am at a total loss as to how ppl actually believe adding stocks to a personal balance sheet over paying down debt (deleveraging) is less risky for the typical household, even for a 30yr period, if for no other reason than that there are a non-trivial number of paths that would cause a suboptimal outcome.

If my mortgage balance at a given time should be 50k according to the standard amortization table when I got the loan, if I had just made all my regular payments, my PITI is $400/mo, and I've put an extra $30k into it, so it's actually only 20k, and I lose my job, I still have to make that $400 payment.  It doesn't matter one whit that I'm slightly less deleveraged.  But if I still owe 50k, and have that 30k extra in the bank (which is reduced by 30%, say, from a market drop to 21k), that extra 21k gives me over 4 years of payments in the bank.  That's lots of time to find a new job, wait for the stock market to correct, etc.

Not having being forced to sell low is less risky, IMO.

If instead my mortgage is only 20k at that point, but I have very little in the bank (say, a 1K emergency fund, or just over 2 months of mortgage payments) and I'm forced to sell the house to extract that equity (as my well prepared HELOC plan gets me a letter in the mail saying the bank has closed it due to economic times), I could be in quite a bad spot, start taking hits to my credit as I'm unable to make the payment in the meantime, etc.

I much favor the person with cash in the bank (even invested in equities that have dropped) over the one with it as equity in the house, even if that person is a bit more leveraged on paper.
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TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #341 on: March 24, 2015, 08:59:26 PM »
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

Define risk.  Stocks are more volatile, but not more risky, IMO, over a long enough time period.

Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.

Your logic is valid as long as the risk of ruin is negligible, which is far from the case. I've already mentioned equity extraction methods (recast of loans, HELOC, even opening other credit lines) but you seem to ignore them in your "having less liquid assets" comment.

I consider ROR of holding a market index fund to be very close to zero.  And in the case of total economic collapse, having a bit more equity in your house won't help you one bit.  And yes, equity extraction in a time of turmoil I consider much less liquid than selling a publicly traded stock.


Another consideration which hasn't been mentioned is, if you are forced to sell your home for whatever reason in a down market, it is much easier to do so with positive equity as opposed to a short-sale situation.  People have been trapped and unable to relocate due to being upside down on a mortgage.

If you have years of payments saved up that you haven't put into the mortgage, you won't need to sell.

Perhaps an expert in credit (corporate spread investing) could chime in, as I am at a total loss as to how ppl actually believe adding stocks to a personal balance sheet over paying down debt (deleveraging) is less risky for the typical household, even for a 30yr period, if for no other reason than that there are a non-trivial number of paths that would cause a suboptimal outcome.

If my mortgage balance at a given time should be 50k according to the standard amortization table when I got the loan, if I had just made all my regular payments, my PITI is $400/mo, and I've put an extra $30k into it, so it's actually only 20k, and I lose my job, I still have to make that $400 payment.  It doesn't matter one whit that I'm slightly less deleveraged.  But if I still owe 50k, and have that 30k extra in the bank (which is reduced by 30%, say, from a market drop to 21k), that extra 21k gives me over 4 years of payments in the bank.  That's lots of time to find a new job, wait for the stock market to correct, etc.

Not having being forced to sell low is less risky, IMO.

If instead my mortgage is only 20k at that point, but I have very little in the bank (say, a 1K emergency fund, or just over 2 months of mortgage payments) and I'm forced to sell the house to extract that equity (as my well prepared HELOC plan gets me a letter in the mail saying the bank has closed it due to economic times), I could be in quite a bad spot, start taking hits to my credit as I'm unable to make the payment in the meantime, etc.

I much favor the person with cash in the bank (even invested in equities that have dropped) over the one with it as equity in the house, even if that person is a bit more leveraged on paper.

Why do you once again assume you cannot extract equity or recast the loan (decreasing your minimum monthly pmt)?

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #342 on: March 24, 2015, 09:02:40 PM »
As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.

No, that'd be like saying "the inflation rate at the beginning of a 30-year cycle is irrelevant to the question of portfolio survival". If we just look at nominal investment returns (ignoring inflation), the 30-year cycle starting in 1966 would look just fine with a 4% WR. But we know that inflation affects real returns, so we include the historical inflation value when running the simulations, which reveals 1966 to be a bust.

So ignoring the historical inflation levels and using the current-but-historically-low 1.5% inflation rate for all cycles would cause cFIREsim to overestimate the success rate for portfolio survival. Likewise, I think it's probable that ignoring the historical mortgage rates and using a the current-but-historically-low 4% mortgage rate for all cycles would cause cFIREsim to overestimate the success rate for leveraged-investing-via-mortgage. Maybe the cycle starting in 1980 shows that it would have been a fantastic idea to borrow money to invest if you could have borrowed it at 4%, but a terrible idea if you had to borrow it at 10%. If so, the 1980 cycle would be a "false positive" in your cFIREsim results, since you couldn't actually borrow money at 4% in 1980.

Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?

No, those are different things. Something like CAPE would have no role in the cFIREsim model. It's not necessary to tell us what actual returns were like in a historical cycle. Inflation-adjusted prices are sufficient for that. While there are surely things that could be added to the cFIREsim model to refine its re-creation of history (the change of bond modeling was one such thing), CAPE is not one of those things. On the other hand, when you're using cFIREsim as a leveraged-investing-via-mortgage simulator, you're implicitly adding the need for more historical data, namely mortgage rates, and using a constant, current rate is a crude substitute when everything else is historically-accurate.

I don't think the analogy to ignoring inflation rates is quite right.  When we determine the success rate for leveraged-investing-via-mortgage using actual historical market performance but using today's prevailing mortgage rate, that is no different than determining the success rate of an equivalent non-mortgage-related spending plan (we are not purporting to be determining the actual historical success rate of leveraged-investing-via-mortgage, because, as you said, we are looking at the success rate using today's low-interest rates which were unavailable for most of history; we are just trying to determine the historical success rate of coming out ahead by investing a starting portfolio equal to the mortgage rate and spending it down according to a withdrawal plan that matches the mortgage's amortization schedule).

So when you run the cfiresim analysis to determine the leveraged-investing-via-mortgage success rate, just pretend you are doing a normal portfolio success/failure analysis where your projected living expenses coincidentally just happen to be equal to the principal + interest payments on the mortgage (your pretend projected living expenses are going to decline over time, which explains why they remain constant in nominal terms (and decrease in real terms) over the 30-year period).

There's no reason you can't use history-based cfiresim as the best (that is, the worst, but better than all the rest) predictive tool to determine the chances of success for this pretend spending plan, right?  And if the answer is no, because you want to take each historical period's actual interest rate environment into account, then why should that not be the case for all of the cfiresim analyses we ordinarily do?

What your argument implies (I think) is that some characteristic about a market exists (the prevailing mortgage rate?  a treasury yield benchmark?) from which it is possible to determine future returns.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #343 on: March 24, 2015, 09:29:49 PM »
Why do you once again assume you cannot extract equity or recast the loan (decreasing your minimum monthly pmt)?

My understanding is that lenders are not required to recast mortgages on request. This can especially happen if the loan has been sold to a different investor who may or may not be willing to recast. In fact, there is nothing I see in the usual mortgage agreement that contains a provision for recast. You can certainly prepay without penalties but the lender is not required to recast/re-amortize  the balance.

That said, my lender is willing to recast currently but their policy may change in the future. I'd rather on be dependent on the whims of my lender. It is a policy not within my control and no guarantee that I'll be able to when needed.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #344 on: March 24, 2015, 10:19:16 PM »
Why do you once again assume you cannot extract equity or recast the loan (decreasing your minimum monthly pmt)?

My understanding is that lenders are not required to recast mortgages on request. This can especially happen if the loan has been sold to a different investor who may or may not be willing to recast. In fact, there is nothing I see in the usual mortgage agreement that contains a provision for recast. You can certainly prepay without penalties but the lender is not required to recast/re-amortize  the balance.

That said, my lender is willing to recast currently but their policy may change in the future. I'd rather on be dependent on the whims of my lender. It is a policy not within my control and no guarantee that I'll be able to when needed.

This.  As we've mentioned multiple times, you may not be able to access that equity when you want.  Someone with control of the cash themselves is in a much better position than someone relying on the financial industry for access to it when they need it.

And even if you can recast to a lower payment, that still doesn't help you access the equity - in other words, you still need to make that payment, and have very little money with which to do so.
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Faraday

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #345 on: March 24, 2015, 10:45:37 PM »
And even if you can recast to a lower payment, that still doesn't help you access the equity - in other words, you still need to make that payment, and have very little money with which to do so.

This is profoundly true. I still need to make that payment.

But I have money, because I wasn't simple-mindedly writing a check to pay down the mortgage from my paycheck: I was funding my mortgage pre-payments through short-term liquid investments. So I have a stepwise liquid cash reserve I use, much like an FU FUND, until I find the next job, get the loan re-cast, or use the cash reserve to do a refi.

Faraday

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #346 on: March 24, 2015, 10:52:47 PM »
First, mefla, I'm about to talk some mid- to high-level shit here that doesn't actually impact the low-level stuff that brooklynguy and arebelspy are trying to help you to understand. So no need to read this until you understand everything they're saying.

Don't worry, I'll avert my eyes while you kiss their asses. Just wash up and let yourself out afterward, OK?

skyrefuge

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #347 on: March 24, 2015, 11:03:53 PM »
There's no reason you can't use history-based cfiresim as the best (that is, the worst, but better than all the rest) predictive tool to determine the chances of success for this pretend spending plan, right?  And if the answer is no, because you want to take each historical period's actual interest rate environment into account, then why should that not be the case for all of the cfiresim analyses we ordinarily do?

I suppose to the extent that your yearly expenses are attributable to historically-known factors, those factors should be incorporated into the simulation for ultimate accuracy. We just enter "$20,000" for our yearly expenses because it's easy. "100 lbs. of beef, 500 gallons of gasoline, 100GB of mobile data, interest payments on a $200k loan, etc" would actually be better, since our desire is not really to make a particular amount of dollars disappear, but to acquire products and services we need in our lives. But breaking things down that way would be a serious pain in the ass, both for us and the cFIREsim designer, so we don't do it that way. However, in the special case of leveraged-investing-via-mortgage, 100% of the expenses are easily attributable to a knowable factor, and furthermore, that factor is much more likely to be correlated with other cFIREsim factors than the price of beef is.

What your argument implies (I think) is that some characteristic about a market exists (the prevailing mortgage rate?  a treasury yield benchmark?) from which it is possible to determine future returns.

I would say more that I'm offering the hypothesis that prevailing mortgage rates have a correlation with future market returns, and plugging that data into cFIREsim would be an informative exploration of that hypothesis.

I mean, this is the reason why we (I think?) like historical simulators like cFIREsim vs. Monte Carlo simulations, because Monte Carlo simulations ignore the possibility of equity returns, bond returns, interest rates, and inflation being interrelated. The Fed (these days) directly connects inflation to interest rates, interest rates directly affect bond returns, and bond returns theoretically and indirectly affect equity returns. None of those links are ironclad, and the gross effect is pretty unpredictable, but the ability to at least recognize any interrelation is one big thing that differentiates cFIREsim from Monte Carlo simulations.

Say 4%-or-lower mortgage rates actually existed in only 20% of cFIREsim's start years. If it showed that the success rate of the leveraged-investing-via-4%-mortgage plan was 50% when looking at only those years, vs. the 96% success rate when you use 4% for all years, would you still say that the leveraged-investing-via-4%-mortgage plan has a 96% chance of beating the pay-off-your-mortgage plan? (for the record, if historical mortgage data was used, my random-ass guess is that the cFIREsim success rate would only be reduced to 80% or something; I'm not at all saying that the leveraged-investing-via-4%-mortgage plan is the wrong choice, just that it's possible that "there's a 96% chance of it being the right choice" could be overstating it a bit).

And yes, this is similar to the recent thread on CAPE and SWRs where I made the possibly-heretical admission that I feel the odds of success for someone retiring at today's high CAPE-levels may be slightly lower than the overall cFIREsim success rate indicates. But the historical mortgage rate information could (theoretically) be plugged into cFIREsim and applied to automatically affect the success rate, while incorporating CAPE requires us to arbitrarily create a filter to cherry-pick the "years like the current one" to include in the success-rate calculation.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #348 on: March 25, 2015, 07:35:15 AM »
I suppose to the extent that your yearly expenses are attributable to historically-known factors, those factors should be incorporated into the simulation for ultimate accuracy. We just enter "$20,000" for our yearly expenses because it's easy. "100 lbs. of beef, 500 gallons of gasoline, 100GB of mobile data, interest payments on a $200k loan, etc" would actually be better, since our desire is not really to make a particular amount of dollars disappear, but to acquire products and services we need in our lives.

I disagree.  We primarily are interested in merely determining the likelihood of success of a plan to make a particular amount of dollars disappear, taking into account the overall inflation rate but not the inflation rate as it pertains to a particular product or service.  When I run a cfiresim simulation, I want to find out the historical success rate of withdrawing $20k per year, and not the historical success rate of withdrawing an amount of money sufficient to purchase $20k worth of beef as of the date I run the simulation.  If the price of beef for whatever reason fluctuates in a non-correlated way with the overall inflation rate, I might decide to substitute more chicken for beef, or vice versa.

Take the hypothetical example of someone whose entire living expenditures does and will always consist of nothing but purchases of large quantities of pocket calculators.  When this person uses cfiresim to plan his retirement, should cfiresim take into account the actual historical cost of pocket calculators (which, I'm assuming, was extraordinarily higher in today's-dollars in 1965 than today)?

Quote
However, in the special case of leveraged-investing-via-mortgage, 100% of the expenses are easily attributable to a knowable factor, and furthermore, that factor is much more likely to be correlated with other cFIREsim factors than the price of beef is.

I don't see leveraged-investing-via-mortgage as a special case.  Yes, the reason the mortgage's amortization is what it is is because of the interest rate environment at the period start-date when the mortgage is obtained.  But that doesn't change the fact that the annual withdrawals, although in fact being used to service the mortgage, could just as easily be used to purchase beef, or pocket calculators.

Quote
I would say more that I'm offering the hypothesis that prevailing mortgage rates have a correlation with future market returns, and plugging that data into cFIREsim would be an informative exploration of that hypothesis.

I mean, this is the reason why we (I think?) like historical simulators like cFIREsim vs. Monte Carlo simulations, because Monte Carlo simulations ignore the possibility of equity returns, bond returns, interest rates, and inflation being interrelated. The Fed (these days) directly connects inflation to interest rates, interest rates directly affect bond returns, and bond returns theoretically and indirectly affect equity returns. None of those links are ironclad, and the gross effect is pretty unpredictable, but the ability to at least recognize any interrelation is one big thing that differentiates cFIREsim from Monte Carlo simulations.

Say 4%-or-lower mortgage rates actually existed in only 20% of cFIREsim's start years. If it showed that the success rate of the leveraged-investing-via-4%-mortgage plan was 50% when looking at only those years, vs. the 96% success rate when you use 4% for all years, would you still say that the leveraged-investing-via-4%-mortgage plan has a 96% chance of beating the pay-off-your-mortgage plan? (for the record, if historical mortgage data was used, my random-ass guess is that the cFIREsim success rate would only be reduced to 80% or something; I'm not at all saying that the leveraged-investing-via-4%-mortgage plan is the wrong choice, just that it's possible that "there's a 96% chance of it being the right choice" could be overstating it a bit).

I'm sure it's true that the number of leveraged-investing-via-mortgage success cases among only the subset of historical cases with a low-interest-rate-environment starting point is lower than 96% (bo knows, please bring cfiresim back online so we can stop hypothesizing!), but that calls into question not just the approach of using the overall historical leveraged-investing-via-mortgage success rate to predict one's current likelihood of leveraged-investing-via-mortgage success, but the entire approach of using overall historical success rates to predict one's current likelihood of success, which we have been doing for some time (in this thread, for example:  http://forum.mrmoneymustache.com/ask-a-mustachian/firecalc-and-cfiresim-both-lie/), and which is why you borrowed from Churchill to astutely observe that it's the worst approach we have, but better than all the rest.

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And yes, this is similar to the recent thread on CAPE and SWRs where I made the possibly-heretical admission that I feel the odds of success for someone retiring at today's high CAPE-levels may be slightly lower than the overall cFIREsim success rate indicates.

Most of us (myself included) share your schizophrenia about simultaneously believing in the inability to "time the market" or even "time your retirement" while also worrying about current pessimistic market indicators.  That is the reason we, on the one hand, speak about the absurdly ridiculous margins of safety built into our retirement plans (judging by historical SWR analysis) and, on the other hand, continue to worry that signs point to our own situation being like one of the historical 5%, or 2%, or 0.01% failure cases.  If we truly, honestly believed that the actual odds of success of our own retirement plans, with absolutely no corrective action or other external levels of safety margin needed, were greater than 95 out of 100, would any of us really have any legitimate concerns about the safety of the approach or succumb to OMY syndrome?

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #349 on: March 25, 2015, 07:51:48 AM »
This is profoundly true. I still need to make that payment.

But I have money, because I wasn't simple-mindedly writing a check to pay down the mortgage from my paycheck: I was funding my mortgage pre-payments through short-term liquid investments. So I have a stepwise liquid cash reserve I use, much like an FU FUND, until I find the next job, get the loan re-cast, or use the cash reserve to do a refi.

So now your previous plan to prepay in lieu of investing has morphed into a plan to invest in cash in lieu of investing in stocks/bonds?  That is not addressing the "carry mortgage vs. pay off mortgage" decision (which is the subject of this thread), and is instead addressing the question of the advisability of engaging in market timing.  Even the person with no mortgage has to decide whether to deploy excess cash towards their bank account or their brokerage/mutual fund account.  And, consistent with the upthread attempts to stymie the off-topic detours into the matter of dividends, that's all I'm going to say on the subject.