Author Topic: The great "pay off mortage" vs "invest in stocks" debate - possible solution  (Read 71357 times)

BlueHouse

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The "ideal" mortgage situation is to refinance any existing mortgage into a 30-year, low interest rate mortgage immediately prior to FIRE.
When blanket statements like this are made, are there some assumptions about the size of the mortgage or the size of the payments?  I have a high payment and keeping that payment into retirement means that the income I would have to draw to make my monthly payments would throw me into a tax bracket that may also have negative consequences on capital gains. 
I'm trying to reduce my payments by recasting and vastly reducing my mortgage amount.  I also want to eliminate my mortgage payments prior to retiring just so I can keep expenses and taxes down.

forummm

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The "ideal" mortgage situation is to refinance any existing mortgage into a 30-year, low interest rate mortgage immediately prior to FIRE.
When blanket statements like this are made, are there some assumptions about the size of the mortgage or the size of the payments?  I have a high payment and keeping that payment into retirement means that the income I would have to draw to make my monthly payments would throw me into a tax bracket that may also have negative consequences on capital gains. 
I'm trying to reduce my payments by recasting and vastly reducing my mortgage amount.  I also want to eliminate my mortgage payments prior to retiring just so I can keep expenses and taxes down.

From the earlier posts in the thread, the context is that you have money to FI plus money to pay off your mortgage. And that the interest rate is relatively low. So it doesn't matter at all what your payment size is, because that will be directly related to the size of the cash pile you'd be sitting on that is dedicated to just your mortgage.

Eliminating your mortgage does not reduce your taxes at all. In fact, it might increase them.

Monkey Uncle

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We'll see how the adjusted numbers work out, but I'm thinking there's more going on here than just inaccuracies in the inputs.  When I look at the output graphs, all of the failure trajectories in the "keep mortgage" scenario began during the 1960s.  This suggests to me that having that mortgage payment for the first 9 years or so of the draw-down period increases sequence of return risk.  The final years of the mortgage coincide with the time period before SS and pension have fully kicked in.  So the portfolio is really getting hit hard for those first 9 years.  Having those years occur right before a falling/stagnant market is a recipe for failure. Those trajectories failed before the bull market of the '80s-90's ever got going.

Yeah, well, if investment returns are low enough or you get a bad enough sequence of returns, you will be worse off if you're leveraged.  But with a low enough mortgage rate and a long enough remaining life to maturity, the historical odds of coming out ahead can be significantly higher than the historical success rate associated with the standard 4% SWR plan that many people around here are comfortable retiring on.  It all depends on how aggressive you want to get -- leveraged-investing-via-mortgage can allow you to speed up your time to FIRE (or have money in retirement) with the same or better historical odds of success.  That is probably what you would see if you ran the numbers in your scenario for refinancing into a 30 year mortgage.  And leveraged-investing-via-mortgage mitigates other risks that are equally important, like inflation risk.

See my update in post #92.  In my personal situation, payoff is a wash when you look at the success rates (100% vs. 100%).  But the dips indicate keeping the mortgage has a slightly higher sequence of return risk.  The average ending value indicates that it also has the potential to generate a slightly larger final portfolio value.  I also just ran a scenario wherein I refinance my current mortgage balance for 30 years at 4%.  It was essentially indistinguishable from the "keep current mortgage" scenario.  I then ran a scenario where I refinance up to 80% of home value and invest the proceeds.  It also was very similar to the "keep current mortgage" scenario (100% success, 3.7MM ending value).  The dips were a little less severe, indicating some mitigation of sequence of return risk relative to the "keep current mortgage" scenario.  So refinancing and pulling out equity to invest does indeed seem to be the best of both worlds, albeit not by much.

But your post seemed to be advocating taking out a new 30 year mortgage on a primary residence for the purpose of generating capital to invest in stocks.  If that is indeed what you meant, I believe that is an extremely risky proposition, especially if that capital is used to create the appearance of a portfolio that is large enough to support FIRE.

How is taking out a new 30 year mortgage for the purpose of generating capital to invest in stocks any different than choosing not to prepay an existing mortgage when you have the funds to do so but instead leave them invested in the stock market?  (I do agree with your secondary point that you should not ignore your liabilities when evaluating your net worth in order to determine whether or not you are FI, but that's a separate issue.)

I'm not arguing that point, as long as we're not talking about taking on new leverage to make the portfolio appear FI.  But for me personally, I'd just as soon not have that extra monthly expense when it doesn't do a whole lot for me.

Cheddar Stacker

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The "ideal" mortgage situation is to refinance any existing mortgage into a 30-year, low interest rate mortgage immediately prior to FIRE.
When blanket statements like this are made, are there some assumptions about the size of the mortgage or the size of the payments?  I have a high payment and keeping that payment into retirement means that the income I would have to draw to make my monthly payments would throw me into a tax bracket that may also have negative consequences on capital gains. 
I'm trying to reduce my payments by recasting and vastly reducing my mortgage amount.  I also want to eliminate my mortgage payments prior to retiring just so I can keep expenses and taxes down.

From the earlier posts in the thread, the context is that you have money to FI plus money to pay off your mortgage. And that the interest rate is relatively low. So it doesn't matter at all what your payment size is, because that will be directly related to the size of the cash pile you'd be sitting on that is dedicated to just your mortgage.

Eliminating your mortgage does not reduce your taxes at all. In fact, it might increase them.

I believe Blue was stating: My with mortgage cash flow needs would require a higher level of income, thereby increasing my tax burden.

It's possible this could happen, and it should be a consideration. There are ways to avoid this, but it might not be possible for everyone to avoid depending on circumstances. You have to plan ahead a bit by creating some tax-free cash flow sources, like actual cash, or tax loss harvesting.

sol

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Yea, I'm in the same boat.  My mortgage is roughly half of my family expenses, so carrying it into retirement would require that I show twice as much taxable income.

That new higher taxable income level will incur a higher tax liability, as well as disqualify me for some additional tax breaks like ACA subsidies.

This is a very personal question, unique to each person's situation, so it's hard to give good blanket advice other than "do the math to see what's best for you".  In my case, I intend to pay it off to lower my total tax burden.

brooklynguy

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My mortgage is roughly half of my family expenses, so carrying it into retirement would require that I show twice as much taxable income.

Sol, you keep saying this even though every time you do I point out that there should not be a dollar-for-dollar increase in taxable income needed to cover the mortgage expense in retirement, which is starting to make me doubt my sanity.  Won't the funds that you will be using to pay off your mortgage be funds that would have otherwise been deployed to taxable investments (which, in turn, would have a cost basis, meaning that when you sell them to cover the mortgage expense some (and, in the early years, most) of each sale would represent non-taxable return of principal rather than taxable income)?

sol

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My mortgage is roughly half of my family expenses, so carrying it into retirement would require that I show twice as much taxable income.

Sol, you keep saying this even though every time you do I point out that there should not be a dollar-for-dollar increase in taxable income needed to cover the mortgage expense in retirement, which is starting to make me doubt my sanity.  Won't the funds that you will be using to pay off your mortgage be funds that would have otherwise been deployed to taxable investments (which, in turn, would have a cost basis, meaning that when you sell them to cover the mortgage expense some (and, in the early years, most) of each sale would represent non-taxable return of principal rather than taxable income)?

Ah, if only our lives were truly that simple.

In my case, we'll be selling rental real estate, and drawing down taxable and Roth contributions, to fund living expenses and clear the mortgage, and doing variable Roth conversions from the TSP up to the limits of our tax bracket.

It's that last step that generates the increased tax liability, not the sale of assets.  Keeping the mortgage would just mean selling the rentals a year or two later since our problem is insufficient non-sheltered funds for the first five years of the pipeline, and through all of this our Roth conversions would have to be larger to fund the future mortgage payments.

Just another example of "do the math to see what's best for you."  We will of course reevaluate every year to see what makes the most sense at the time, but right now the math favors ditching the mortgage due to the ancillary benefits of showing reduced income from Roth conversions.

forummm

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The "ideal" mortgage situation is to refinance any existing mortgage into a 30-year, low interest rate mortgage immediately prior to FIRE.
When blanket statements like this are made, are there some assumptions about the size of the mortgage or the size of the payments?  I have a high payment and keeping that payment into retirement means that the income I would have to draw to make my monthly payments would throw me into a tax bracket that may also have negative consequences on capital gains. 
I'm trying to reduce my payments by recasting and vastly reducing my mortgage amount.  I also want to eliminate my mortgage payments prior to retiring just so I can keep expenses and taxes down.

From the earlier posts in the thread, the context is that you have money to FI plus money to pay off your mortgage. And that the interest rate is relatively low. So it doesn't matter at all what your payment size is, because that will be directly related to the size of the cash pile you'd be sitting on that is dedicated to just your mortgage.

Eliminating your mortgage does not reduce your taxes at all. In fact, it might increase them.

I believe Blue was stating: My with mortgage cash flow needs would require a higher level of income, thereby increasing my tax burden.

It's possible this could happen, and it should be a consideration. There are ways to avoid this, but it might not be possible for everyone to avoid depending on circumstances. You have to plan ahead a bit by creating some tax-free cash flow sources, like actual cash, or tax loss harvesting.

Ah, I see how the taxes could go up from generating more "income" in one way of thinking about it (taking it from a TIRA). Although it's not necessarily true as BG indicates. For example in the scenario I provided, that income would be taken from a separate portfolio created by the new 30-year mortgage cashout+your existing funds to payoff the balance. So it would be all after-tax money, and the amount used would be minimally or not-at-all taxed. At first, nearly all of it would be prinicple. And as time went on, it would be mostly or entirely dividends. And at a mustachian level of spending, under current rates, those CGs and Divs would be 0%. You would have some complication for ACA calculations. But the tax credits scale with income, so it's not a cliff (unless you are very old and have a very high income for a retired mustachian).

brooklynguy

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In my case, we'll be selling rental real estate, and drawing down taxable and Roth contributions, to fund living expenses and clear the mortgage, and doing variable Roth conversions from the TSP up to the limits of our tax bracket.

It's that last step that generates the increased tax liability, not the sale of assets.  Keeping the mortgage would just mean selling the rentals a year or two later since our problem is insufficient non-sheltered funds for the first five years of the pipeline, and through all of this our Roth conversions would have to be larger to fund the future mortgage payments.

I still don't follow.  The funds that you will be using to pay off the mortgage (wherever they are coming from, including proceeds of the sale of your rental property) could, if you instead choose to carry the mortgage into retirement, be invested in a taxable account.  The investments in that taxable account would then be used to service your mortgage payments through maturity, so there should be no effect on your Roth conversion pipeline.  Am I missing something?

sol

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In my case, we'll be selling rental real estate, and drawing down taxable and Roth contributions, to fund living expenses and clear the mortgage, and doing variable Roth conversions from the TSP up to the limits of our tax bracket.

It's that last step that generates the increased tax liability, not the sale of assets.  Keeping the mortgage would just mean selling the rentals a year or two later since our problem is insufficient non-sheltered funds for the first five years of the pipeline, and through all of this our Roth conversions would have to be larger to fund the future mortgage payments.

I still don't follow.  The funds that you will be using to pay off the mortgage (wherever they are coming from, including proceeds of the sale of your rental property) could, if you instead choose to carry the mortgage into retirement, be invested in a taxable account.  The investments in that taxable account would then be used to service your mortgage payments through maturity, so there should be no effect on your Roth conversion pipeline.  Am I missing something?

Those funds are currently invested in real estate, which generates taxable income and cannot be drawn down slowly. You're suggesting I sell the RE and purchase index funds in my taxable account?

brooklynguy

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Those funds are currently invested in real estate, which generates taxable income and cannot be drawn down slowly. You're suggesting I sell the RE and purchase index funds in my taxable account?

Well, yeah (assuming your mortgage rate is low enough and your remaining life to maturity is long enough to justify that decision).  Investing dollars that would otherwise be used to pay down or pay off a mortgage in index funds is exactly the strategy we've been discussing in this thread and others like it, no?

If you're planning to sell your rental property to pay off your mortgage but want to run the numbers to see if the math favors retaining the mortgage, the two alternatives you should be comparing are (i) using the rental sale proceeds to pay off the mortgage and (ii) keeping the mortgage and investing the rental sale proceeds in a taxable investment account (which, as I've been saying, should result in minimal to zero increase in your income in the early years of your retirement (because most of the sales of the index funds in that account will represent return of principal, not capital gains), and, depending on opportunities for tax loss harvesting, may not significantly increase your income until many years into retirement (perhaps not even until you qualify for Medicare, when eligibility for ACA tax credits is no longer an issue)).

The other alternative to consider, if you have the appetite for it, is not only keeping your mortgage, but refinancing into a new 30 year mortgage to carry into retirement (which, if I had to guess without knowing your exact numbers and circumstances, is probably the mathematically optimal approach, based strictly on the ever-present underlying assumption that the future is no worse than the past).

sol

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The other alternative to consider, if you have the appetite for it, is not only keeping your mortgage, but refinancing into a new 30 year mortgage to carry into retirement (which, if I had to guess without knowing your exact numbers and circumstances, is probably the mathematically optimal approach, based strictly on the ever-present underlying assumption that the future is no worse than the past).

Even this is a hybrid approach, because we're discussing preparing some mortgages (i.e. selling) in order to carry a different mortgage.  From that perspective your strategy would argue for carrying them all and taking the tax hit on income by selling out of the TSP to cover expenses.

Duration matters.  We're only looking at 10 remaining years on the primary mortgage anyway, so the interest costs are already minimized.  Refinancing into a 30 or 40 might make the most sense, when the time comes, but on our current timeline managing the sequence of return risk is going to be key.  Prepaying it solves that problem by locking in a successful, if maybe suboptimal, strategy.

And as we've previously discussed, there are other benefits to hiding your net worth in your home equity, like shielding it from FAFSA calculations for three college age children.

brooklynguy

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Even this is a hybrid approach, because we're discussing preparing prepaying [?] some mortgages (i.e. selling) in order to carry a different mortgage.

Oh, the rental has a mortgage too?

Quote
From that perspective your strategy would argue for carrying them all and taking the tax hit on income by selling out of the TSP to cover expenses.

That would depend on whether the math still favors carrying the mortgage after you account for the tax hit on selling out of the TSP.  With that additional hurdle to clear, it may not.

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Duration matters.  We're only looking at 10 remaining years on the primary mortgage anyway, so the interest costs are already minimized.  Refinancing into a 30 or 40 might make the most sense, when the time comes, but on our current timeline managing the sequence of return risk is going to be key.  Prepaying it solves that problem by locking in a successful, if maybe suboptimal, strategy.

Yep.  Ultimately this is all about deploying capital in the direction most likely to result in success.  If you've already "won the game" without keeping a mortgage, there's no need to do so (in the same way that there's no need to hold an aggressive allocation in your portfolio).  The problem is you can't ever really be confident that you've "won the game" unless you've grossly oversaved and overworked (like, say, you have a portfolio that can support a sustainable 1% WR) -- so at the same time that you're locking in strategy that mitigates against sequence of return risk, you're also exposing yourself to greater longetivity/inflation risk (as you always do when you go more conservative with your portfolio).

Quote
And as we've previously discussed, there are other benefits to hiding your net worth in your home equity, like shielding it from FAFSA calculations for three college age children.

True dat.  Just another figure to plug into your analysis when running the numbers.

sirdoug007

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Following BrooklynGuy's method, I used cFIREsim to compare the performance of taking out a 30-year fixed-rate mortgage, investing the proceeds of that mortgage, and using only that mortgage-derived portfolio to pay your mortgage. This ignores the transaction costs of getting a mortgage, and may not equal exactly how your portfolio would be modeled because cFIREsim pulls a year's worth of spending all at once. This is based on a $100k mortgage (initial portfolio), uses a 0.05 ER, and the spending rate is not inflation adjusted (because your mortgage payments won't be either).

I thought the 30-year mortgage example would be a good way to model this because the term is sufficiently large to capture the expected long-term market returns, and if continuing to hold your mortgage and invest instead is a superior strategy, you'd want to maximize your ability to do that by refinancing right before you quit your job (and make getting a mortgage much harder). But obviously if by the time you are ready to FIRE you have 15 years left on a 3% loan and the market only offers 6% on a 30 year loan, it may not make sense to refi at that time.

The table headers don't line up exactly but I was too lazy to put it into the table code.
               
         100% stock         
Interest rate   Monthly   Annual   Success Rate   Lowest Portfolio   Median Portfolio   Highest Portfolio
3%   422   5064   98%   ($82,039.73)   $564,271.49    $2,385,890.76
4%   477   5724   95%   ($103,240.05)   $422,969.72    $2,212,153.09
5%   537   6444   88%   ($127,727.13)   $283,518.02    $2,022,621.13
6%   600   7200   66%   ($152,246.38)   $171,800.36    $1,823,612.79
7%   665   7980   54%   ($179,631.18)   $31,882.02    $1,618,286.93
8%   734   8808   39%   ($205,557.97)   ($60,733.21)   $1,400,325.52
                  
                  
         75% stock         
Interest rate   Monthly   Annual   Success Rate   Lowest Portfolio   Median Portfolio   Highest Portfolio
3%   422   5064   98%   ($51,919.39)   $388,154.91    $1,735,055.52
4%   477   5724   96%   ($82,050.56)   $290,397.43    $1,567,618.08
5%   537   6444   82%   ($107,102.73)   $183,596.70    $1,384,959.01
6%   600   7200   63%   ($132,364.73)   $78,870.69    $1,193,167.15
7%   665   7980   46%   ($159,006.49)   ($23,592.30)   $995,286.50
8%   734   8808   28%   ($186,045.61)   ($85,508.41)   $812,400.14


There's probably some correlation between prevailing market interest rates at the time you FIRE and future market returns. Obviously the methodology I used here does not take this into account.

Nice work Forummm!

I think this table bears another look.  At 3-4% 30 year mortgages, the win rate is above 95%.  However, beyond 4% the rate of failure becomes significant.

I don't know about you guys, but I'm just not willing to make a bet on the stock market vs. mortgage rates when I have already won.  I would not hold a mortgage at a rate higher than 4% into FIRE.  I'm just not interested in the potential upside given the risk of failure.  I'd sleep much better knowing I had no mortgage than thinking 80 something% of years I will make money (was the year I FIRE'd one of those 20something% of years???).

Take a look at a 30 year mortgage at 4% taken out at the height of the 2000's stock prices attached below. 

Invested 100% in the S&P500 in late 2000, your investment runs out of money early this year.  This gets back to the "how do we know we are not at the top" conversations that float around here.  I have faith that the 4% rule will get through the toughest of times (because it has) but betting on the stock market with a mortgage (unless it's a ridiculously cheap one) is not a good deal in my opinion.

forummm

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I don't know about you guys, but I'm just not willing to make a bet on the stock market vs. mortgage rates when I have already won.  I would not hold a mortgage at a rate higher than 4% into FIRE.  I'm just not interested in the potential upside given the risk of failure.  I'd sleep much better knowing I had no mortgage than thinking 80 something% of years I will make money (was the year I FIRE'd one of those 20something% of years???).

Take a look at a 30 year mortgage at 4% taken out at the height of the 2000's stock prices attached below. 

Invested 100% in the S&P500 in late 2000, your investment runs out of money early this year.  This gets back to the "how do we know we are not at the top" conversations that float around here.  I have faith that the 4% rule will get through the toughest of times (because it has) but betting on the stock market with a mortgage (unless it's a ridiculously cheap one) is not a good deal in my opinion.

I think it's important to include your feelings in this too--those can be worth paying for. However, I don't think the 2000 example is the best one to show. CAPE was 43 the date you picked to start the retirement. The market was very clearly dramatically overvalued. Even for those of us who are not market timers, the expectation would be for stocks to have terrible performance going forward. Anyone leveraging up at that point is a fool trying to chase returns from the greater fool. If I'd had any money back then and was paying attention I would have gone to the CDs paying 6% back then. Even Bogle sold his stocks. I think the total historical numbers are more illuminating because extreme outliers like 2000 are so rare.

forummm

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I redid some of the earlier analysis to show some better examples of failures:

For the 5% fixed rate and 100% stock scenario, the start years 1881-1887 failed (don't know what happened then) 1906-1910 had trouble, and 1929-1937 had trouble too. So nothing failed since the Great Depression* even with 100% stocks. Even the 1960s retirements (stagflation) that fail with some 4% SWR scenarios were fine. Likely due to the mortgage being a big inflation hedge.

I think it's another scenario where if you get very unlucky with your retirement year (like 1929), you'll know very quickly and can go back to work. And it would be unlikely that anyone cognizant of the markets would choose to retire in 1930 or 1931, etc. Or 2000 as I mention above.

*Obviously 2000 and perhaps some of the years around 2000 will be failures in the future once enough time has gone by to have a complete 30 year cycle.

sirdoug007

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I see what you are saying about 2000, and I fully admit to cherry picking that start date, but there are occasions when this strategy fails.  And by fail I mean that your investment pool you were paying your mortgage from goes to zero and you have to find other funds to pay your mortgage.

If I have enough money to pay off the mortgage I will do it.  The only exception would be if I had a mortgage at 3% or less.  That is the risk/reward balancing point for me personally.  Part of my conservatism is that at the point of FIRE I have already made it.  Why gamble for more when you already have enough?

K-ice

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It's is not about the mortgage!

I was looking at a 25y pay off versus doubling down on payments (so about 10y).
I also looked at various versions in between.
I assumed a mtg of 3% and investments of 7%.  In the 25y plan you are always investing something.  In the double down plan, after the mtg was paid you would invest aggressively for about 15y.

Ok. So it's a no brainer that 7% > 3% so paying slow is mathematically the way to go.
(You can argue my assumption in % but until they are equal slow mtg and constant investing is better.)
But the difference in your net worth 25 years from now really depends on how much OTHER money you have to invest.

If your mortgage is just a small part of your expenses and you are saving lots anyway the difference between the two doesn't really matter.  Evaluate your risk / gut feeling and do either.

If you are only saving a small portion it is way better to pay slow and at least save a little for a longer period time.

Psychologically paying slow, when things seam tight, is hard to do. But others have put the good argument that you are better to have more liquid investments vs all your money tied up in your house.

brooklynguy

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Part of my conservatism is that at the point of FIRE I have already made it.  Why gamble for more when you already have enough?

As I said above, in actuality it's hard to know whether or not you've "already won."  Following a 4%-Rule-type plan already means that in all likelihood you've already worked way too long and saved way too much (because it is designed to succeed under historical worst-case scenarios), but the reason most of us hold out for a 4% (or lower) withdrawal rate (rather than retiring as soon as our historical success rate tops 50%) is because we can't stomach anything greater than a miniscule history-based chance of failure.  We all worry about falling into a scenario like one of the 5% (or 1%, or what-have-you) failure cases.  You don't really know that you've "already won" when you amass 25x your expenses (or 33x, or what-have-you).  So, for most of us (who don't want to work much longer than reasonably necessary), investing aggressively (including leveraged-investing-via-mortgage) is not done for the sake of seeking additional upside beyond what is already "enough" (i.e., the idea of "continuing to play after you've already won"), but instead for the sake of increasing the likelihood of succeeding in the first place (because we're not sure whether we've already won, so we need to keep playing).

The year-2000-height-of-the-market sequence of return risk you identified is definitely magnified by adopting a leveraged-investing-via-mortgage strategy.  But the overall risk of outliving your portfolio and/or having it eaten away by inflation is mitigated by that same strategy.  And as forummm said, historically, the latter was the more prevalent danger to early retirements.  It's always important to define what risk(s) you are concerned about; depending on how you define "risk," retiring on too conservative a portfolio can be much riskier than retiring on too aggressive a portfolio, in that it is more likely to result in failure.  And amassing a conservative portfolio that has equal chances of success as a more aggressive portfolio generally comes at the cost (not the risk, but the certainty) of working longer and delaying retirement.

Cathy

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...Following a 4%-Rule-type plan already means that in all likelihood you've already worked way too long and saved way too much...

I don't know about this proposition. I spend less than $500 per month on non-housing expenses and I am a ridiculous overspender who barely even makes an effort to be frugal. By the 4% rule I only need $150,000 to cover everything other than housing. In many parts of the US, one can buy a condo for $50,000. Throw in a ridiculously huge buffer for other expenses and $250,000 should be more than enough to retire. By this math, I can already retire and I am much younger than MMM was when he retired. But I don't think that by continuing to save more I am being irrational, because that just doesn't sound like a lot of money to have for the rest of your life. Am I wrong? I honestly think we are all kidding ourselves about working only as much as "reasonably necessary", or you certainly would not be working either.

forummm

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...Following a 4%-Rule-type plan already means that in all likelihood you've already worked way too long and saved way too much...

I don't know about this proposition. I spend less than $500 per month on non-housing expenses and I am a ridiculous overspender who barely even makes an effort to be frugal. By the 4% rule I only need $150,000 to cover everything other than housing. In many parts of the US, one can buy a condo for $50,000. Throw in a ridiculously huge buffer for other expenses and $250,000 should be more than enough to retire. By this math, I can already retire and I am much younger than MMM was when he retired. But I don't think that by continuing to save more I am being irrational, because that just doesn't sound like a lot of money to have for the rest of your life. Am I wrong? I honestly think we are all kidding ourselves about working only as much as "reasonably necessary", or you certainly would not be working either.

Are you accounting for health insurance (which probably will get more expensive as you age, especially if the ACA is changed), taxes/HOA/insurance on the condo, possibly having kids one day, deciding to do something more expensive at some point (like traveling, etc)?

In my view, there's a big trade-off between quitting too early and having to go back to work at a much lower income/savings rate vs working until you're at a pretty strong level of historical success. You're trading OMY of something that's pretty lucrative and familiar (the inertia is also with you) vs some risk of needing to do something perhaps not very lucrative (like 6 years of part time work) because you pulled the trigger too soon. So people tend to work towards not needing to worry about money because it's OMY vs risk of sixMYs (or whatever it might be).

brooklynguy

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I don't know about this proposition. I spend less than $500 per month on non-housing expenses and I am a ridiculous overspender who barely even makes an effort to be frugal. By the 4% rule I only need $150,000 to cover everything other than housing. In many parts of the US, one can buy a condo for $50,000. Throw in a ridiculously huge buffer for other expenses and $250,000 should be more than enough to retire. By this math, I can already retire and I am much younger than MMM was when he retired. But I don't think that by continuing to save more I am being irrational, because that just doesn't sound like a lot of money to have for the rest of your life. Am I wrong? I honestly think we are all kidding ourselves about working only as much as "reasonably necessary", or you certainly would not be working either.

I'm not sure I understand your point.  As long as your current expenses are sustainable indefinitely, then, by definition, you are working longer than necessary if you have already amassed a large enough portfolio to cover those expenses forever plus a "ridiculously huge buffer."  It sounds like you're actually saying you don't expect your currently-low expenses to be sustainable in the long run; instead, you expect to have higher expenses in the future, and that's why a larger portfolio is needed before you can retire.

My point was simply that, once you've established an assumption for your lifelong expenses, amassing a portfolio that has a 95% chance of covering those expenses for the rest of your life necessarily means that you probably worked too long and saved too much (because the chances that you didn't work too long and save too much are only 5%).  (Of course, we are kidding ourselves when we engage in the SWR-based doublespeak of using historical success rates as a proxy for actual likelihood of success in the future, which only reinforces my original point that it's hard to know whether or not you've actually "already won the game.")

Cathy

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I'm not sure I understand your point.

The point is this: It's possible to retire with a low amount of assets. We can debate my exact figures (as forummm does in his post), but that doesn't matter because those figures were completely arbitrary anyway. If you are saving more than $250,000 (or whatever), you are doing it primarily because you want to spend more money in retirement, i.e., you are "seeking additional upside beyond what is already 'enough'", as you put it in your post. I don't think there's anything wrong with that, but it is what it is.

To put it another way, most people on this forum seem to approach things completely backward from me. They have a target level of spending and aim to save enough to support it. However, I use the exact opposite approach: I will simply work as long as I can stand it (which will probably be much less than most people on the forum), and then I will create my retirement based on the level of assets that I have at that point.

Or to put it another way, the uncertainty in your mind about whether you can retire is not really caused by market forces; it's caused by insisting on spending far more money than is really "reasonably necessary". Your choice not to prepay your mortgage is really about increasing the upside, not about ensuring you have enough. Again, I don't think there's anything wrong with that; in fact, I think it's the rational thing to do.

sol

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The point is this: It's possible to retire with a low amount of assets. We can debate my exact figures (as forummm does in his post), but that doesn't matter because those figures were completely arbitrary anyway.

Sure, this is the oft-quoted "cardboard box" theory of retirement.  Any amount of retirement spending above zero is clearly "more than is necessary" when you consider that somebody, somewhere, is living on less than that and doing just fine.  We all work and save in order to spend more than some internally-defined level of enough.

Regarding the relative safety of various withdrawal rates, I think people commonly misunderstand what they're really striving for.  No SWR is going to protect you from a terrorist attack or global pandemic or catastrophic personal injury lawsuit.  At some point, the risks outside of your portfolio success ratio begin to outweigh the risks you're otherwise trying to minimize.  For these risks, the ONLY safety margin is your flexibility to adapt to new circumstances, such as cutting your spending in half or learning to trade buttsex for personal protection in prison.  Humans are pretty good at adapting to new realities, but maybe not so good for planning for those realities they can't see clearly ahead of time. 

Focusing on growing your portfolio from 90% to 95% success is missing the forest for the trees.  I think many of us are too focused on the wrong details.

brooklynguy

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The point is this: It's possible to retire with a low amount of assets. We can debate my exact figures (as forummm does in his post), but that doesn't matter because those figures were completely arbitrary anyway. If you are saving more than $250,000 (or whatever), you are doing it primarily because you want to spend more money in retirement, i.e., you are "seeking additional upside beyond what is already 'enough'", as you put it in your post. I don't think there's anything wrong with that, but it is what it is.

To put it another way, most people on this forum seem to approach things completely backward from me. They have a target level of spending and aim to save enough to support it. However, I use the exact opposite approach: I will simply work as long as I can stand it (which will probably be much less than most people on the forum), and then I will create my retirement based on the level of assets that I have at that point.

Ah, I see your point now.  But I don't really agree with it -- let's say I decided my non-mortgage expenses will be $40k per year, and I decided I will be comfortable retiring when I have a stash equal to $1M to support those expenses (these are all made up numbers, but it will keep the math simple).  And let's say I have a low-rate, long-term $200M mortgage.  I would rather keep the mortgage and retire with a $1.2M portfolio than pay off the mortgage and retire with a $1M portfolio, not because I'm hoping that that approach will produce excess returns that will allow me to spend more than $40k per year, but because I'm hoping that that approach will make it more likely that I can in fact spend $40k per year for the rest of my life (as planned) without having to return to work, or cut expenses, etc.

(As an aside, even if I was confident that I had already "won the game" (like, say, a wealthy uncle just left me a $10M windfall), I still would invest aggressively (including leveraged-investing-via-mortgage), because I fall into the "might as well continue to let it ride" camp in the "already won the game" debate -- it just seems wasteful not to optimize and maximize, and I can give away excess returns to charity or whatever.  But that's beside the point.)

Quote
Or to put it another way, the uncertainty in your mind about whether you can retire is not really caused by market forces; it's caused by insisting on spending far more money than is really "reasonably necessary". Your choice not to prepay your mortgage is really about increasing the upside, not about ensuring you have enough. Again, I don't think there's anything wrong with that; in fact, I think it's the rational thing to do.

This, though, I definitely agree with.  But I don't think it's another way of saying what you said above; it's really a different point--namely, that most of us choose a level of spending (i.e., set our standard for what constitutes "enough") much higher than what is "reasonably necessary" and certainly much higher than what is truly necessary.  Most of us, even as mustachians who already have Spartan spending levels in comparison to mainstream consumerist society, would probably be just fine if forced to live on half of our self-imposed spending levels or less.  But this just relates to how to determine what constitutes "enough" -- it doesn't change the earlier point that, whatever "enough" actually happens to be, taking an aggressive investment position can be motivated by a desire to maximize the chances that you will be able to spend "enough" for the rest of your life rather than a desire to accumulate an amount that will enable you to spend more than enough (i.e., what I called "seeking additional upside").  Using the figures from the above example, let's say "enough" is really $15k (instead of $40k), which means I can retire on a stash of $375k (instead of $1M) to support those expenses using the same 25x multiple -- but I'd still rather do it by keeping the $200k mortgage with a total stash of $575k rather than paying off the mortgage and using a total stash of $375k, because that approach makes it more likely that I will be able to spend "enough" (i.e., $10k per year of non-mortgage expenses) without running out of money.

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Part of my conservatism is that at the point of FIRE I have already made it.  Why gamble for more when you already have enough?

As I said above, in actuality it's hard to know whether or not you've "already won."  Following a 4%-Rule-type plan already means that in all likelihood you've already worked way too long and saved way too much (because it is designed to succeed under historical worst-case scenarios), but the reason most of us hold out for a 4% (or lower) withdrawal rate (rather than retiring as soon as our historical success rate tops 50%) is because we can't stomach anything greater than a miniscule history-based chance of failure.  We all worry about falling into a scenario like one of the 5% (or 1%, or what-have-you) failure cases.  You don't really know that you've "already won" when you amass 25x your expenses (or 33x, or what-have-you).  So, for most of us (who don't want to work much longer than reasonably necessary), investing aggressively (including leveraged-investing-via-mortgage) is not done for the sake of seeking additional upside beyond what is already "enough" (i.e., the idea of "continuing to play after you've already won"), but instead for the sake of increasing the likelihood of succeeding in the first place (because we're not sure whether we've already won, so we need to keep playing).

The year-2000-height-of-the-market sequence of return risk you identified is definitely magnified by adopting a leveraged-investing-via-mortgage strategy.  But the overall risk of outliving your portfolio and/or having it eaten away by inflation is mitigated by that same strategy.  And as forummm said, historically, the latter was the more prevalent danger to early retirements.  It's always important to define what risk(s) you are concerned about; depending on how you define "risk," retiring on too conservative a portfolio can be much riskier than retiring on too aggressive a portfolio, in that it is more likely to result in failure.  And amassing a conservative portfolio that has equal chances of success as a more aggressive portfolio generally comes at the cost (not the risk, but the certainty) of working longer and delaying retirement.

I'm showing regency bias by being worried about a big stock market crash rather than high inflation.  We can't know what the biggest risk is for us the day we retire so we have to account for all the likely risks.

I agree that in general, and especially on this forum, people oversave for retirement but I don't think that there is any other prudent choice.  Pulling the ripcord with a 6+% withdrawal rate (~50% chance of making it) would be pretty aggressive but would work half the time.  Like you said, the problem is it is not possible to know before hand if you are in the half of years where it works or not.

brooklynguy

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Focusing on growing your portfolio from 90% to 95% success is missing the forest for the trees.  I think many of us are too focused on the wrong details.

I whole-heartedly agree with this sentiment, but I think in practice it really only applies to decisions that have the effect of delaying retirement.  Working extra years of your life to move the needle on your portfolio's success rate from 90% to 95% is arguably a stupid thing to do.  In the context of this thread's titular "great debate," however, the idea is to pick the alternative that allows you to either (i) retire on the same timeframe as the other with increased chances of success or (ii) retire earlier than the other with equal chances of success.

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We can debate my exact figures (as forummm does in his post)

Wasn't trying to debate. Just wondering if you've accounted for the things mentioned. It seems very difficult to have included those in the number you suggested. If you have ways of paying for those things or being certain you won't need to pay for them, it would be helpful to know about that.

I will simply work as long as I can stand it (which will probably be much less than most people on the forum), and then I will create my retirement based on the level of assets that I have at that point.

And if you have accounted for everything and you really do need only $250k, and you have more than that, you probably can retire well before you can't "stand" to work anymore. I personally could "stand" to work at something I hated for a lot longer than I financially need to. It doesn't seem optimal to follow that as a benchmark for when to retire though--I'd put in a lot more years of less-fulfilling time. Maybe you are ready to retire now?

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...Wasn't trying to debate. Just wondering if you've accounted for the things mentioned. It seems very difficult to have included those in the number you suggested. If you have ways of paying for those things or being certain you won't need to pay for them, it would be helpful to know about that....

As mentioned, the numbers were arbitrary in the sense of not representing an actual retirement plan. That said, it would be child's play to retire on US$250,000, if that represented my total net worth and I decided I wanted to retire right now. If this retirement were taking place right at this moment with that exact asset level, I would probably convert the assets to CAD and move back to Canada. (I am a citizen of Canada.) I would have CA$323,263 to play with.

To start, I would buy a condo for CA$150,000 (inclusive of any closing costs), leaving CA$173,263 for everything else. The condo association fee (usually referred to as "HOA fees" in the US) might be CA$250 per month, but for the sake of this post it will include some utilities such as trash, water, and sewer. Other utilities will be separately billed, including internet and mobile phone, and might add up to another CA$150 per month. For food, I would eat Kraft Dinner every day (the Canadian name for "Kraft Macaroni & Cheese"), at a cost of about CA$1 per day, or CA$30.5 per month. My transportation costs would be approximately zero because at low income, there are programs everywhere for reduced or free prices on public transit.

In some provinces of Canada, basic health insurance (covering medically necessary services) is free but more extended coverage costs money; whereas in other provinces, all insurance costs money (but usually not much by US standards). However, in all provinces there are programs to get basic and extended health care services for free at low income, and I would be low income, so we can assume the healthcare cost is zero.

Property tax and insurance will probably be less than another CA$2,000 per year. This brings my projected yearly expenses up to CA$8166, requiring roughly CA$180,000 to sustain, which is approximately covered by the CA$173,263 is non-real-estate assets. Introducing a mortgage loan would only make things safer, although as a practical matter I probably wouldn't actually be able to get a mortgage loan.

Are you accounting for ... possibly having kids one day ...?

"Having kids" would make the above plan dramatically safer and more luxurious. Children would only occur in the context of a romantic relationship, and I would only ever enter into a romantic relationship with somebody who had a similar financial philosophy and similar level of assets (which, for the purpose of this hypothetical retirement plan, is US$250,000). Therefore, entering into the relationship would add another CA$323,263 of assets to play with, representing with the 4% rule another CA$13,000 of spending per year. That would be more than enough to raise multiple children, even before considering the numerous government benefits of having children at low income.

...Maybe you are ready to retire now?

Maybe. I ask myself this question every day, but for various reasons, it probably won't happen just yet.

brooklynguy

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...I am much younger than MMM was when he retired...

Maybe. I ask myself this question every day, but for various reasons, it probably won't happen just yet.

Make sure to let us all know when it does happen, because you may set a new record.  As far as I know, the youngest person to retire known to the early retirement blogosphere is our own Rebel Spy, and he just barely squeaked through the "in his 20's" cutoff.  Anyone know of any younger early retiree?

sol

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As far as I know, the youngest person to retire known to the early retirement blogosphere is our own Rebel Spy, and he just barely squeaked through the "in his 20's" cutoff.  Anyone know of any younger early retiree?

I suspect the very earliest self-funded retirees are people like rebs who have jobs (like teaching) that they could theoretically return to in the future with very little hassle.  Having that option to return to work easily probably helps them punch out without exhausting their safety margin the way some of us appear to be doing.

forummm

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Wow Cathy. That's an interesting analysis. It caused me to look at my spreadsheets again. For me, it's definitely worth working longer to eat food that's healthy and still pretty cheap (you'll probably have some health problems if you only ate Kraft Dinner for the rest of your life). And I need at least 2x the calories that the box+milk+butter would provide. But even then I only spend about $4/day per person to eat luxuriously. But I see how the rest of it could be done. You're fortunate to have Canadian citizenship. What would you do with your time?
« Last Edit: July 28, 2015, 03:48:20 PM by forummm »

brooklynguy

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I suspect the very earliest self-funded retirees are people like rebs who have jobs (like teaching) that they could theoretically return to in the future with very little hassle.  Having that option to return to work easily probably helps them punch out without exhausting their safety margin the way some of us appear to be doing.

Maybe, though I think a bigger factor may be that the very earliest retirees, unlike you and I, have found ways of maximizing their wealth without deferring their working careers through excessive schooling (which enables them to retire at a younger age even with an equal-length working career, though, to be fair, we then have the "advantage" of being that much closer to death (and therefore needing fewer years of retirement expenses to be covered)).

sol

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Wow Cathy. That's an interesting analysis. It caused me to look at my spreadsheets again.

Sounds like someone needs to go re-read ERE, which is something I recommend everyone do about every six months anyway.

If you believe the MMM message about happiness not being tied to consumption, then Jacob's ERE blog will help remind you that MMM is a bedpan and catheter wimp, extravagantly and inefficiently wasting money left and right for no apparent reason, rather than pursuing his true life purpose.

sol

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to be fair, we then have the "advantage" of being that much closer to death (and therefore needing fewer years of retirement expenses to be covered)).

This totally doesn't bother me.  I'm fairly certain that the eight years I spent between college and and starting my working career were WAY better than any possible retirement plan. 

From that perspective, I just took eight years of my early retirement up front, while I was young and single and unencumbered.  No regrets.

Cathy

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...you may set a new record.  As far as I know, the youngest person to retire known to the early retirement blogosphere is our own Rebel Spy, and he just barely squeaked through the "in his 20's" cutoff.  Anyone know of any younger early retiree?

I'm already far too old to come close to setting any records. A formerly close friend of mine retired at age 22 with about US$100,000 per year in passive income. He only spends about 1/5 of that. He doesn't publicly talk about these matters (in fact, he likes to maintain an aura of not having much money), but he has us all beat by a large margin. He earned his money from starting a business.

In general, most actual early retirees probably do not participate in the community so we never learn about them.
« Last Edit: July 28, 2015, 05:06:23 PM by Cathy »

forummm

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Wow Cathy. That's an interesting analysis. It caused me to look at my spreadsheets again.

Sounds like someone needs to go re-read ERE, which is something I recommend everyone do about every six months anyway.

If you believe the MMM message about happiness not being tied to consumption, then Jacob's ERE blog will help remind you that MMM is a bedpan and catheter wimp, extravagantly and inefficiently wasting money left and right for no apparent reason, rather than pursuing his true life purpose.

I started with ERE before moving to MMM once Jakob quit the blog. I guess I'm only still here because of the forum. My target has quite a bit of cushion in it. We only spend about $25k right now with no children yet. But the post caused me to look at the targets again. It's hard to predict what will change with kids and how we'll evolve over the next 60-70 years. For one thing, we're thinking about moving to a HCOL for various enjoyment of life reasons--including what might be my true life purpose (or at least as it seems at the moment). I just have to decide if it's worth giving up the copper handcuffs for some iron ones :)

What is MMM's true life purpose that he's not pursuing?

to be fair, we then have the "advantage" of being that much closer to death (and therefore needing fewer years of retirement expenses to be covered)).

This totally doesn't bother me.  I'm fairly certain that the eight years I spent between college and and starting my working career were WAY better than any possible retirement plan. 

From that perspective, I just took eight years of my early retirement up front, while I was young and single and unencumbered.  No regrets.

I've thought about this too. I'm definitely way behind where I would have been if I'd just taken the kind of job I could have gotten right out of undergrad (I'd have made more money from day one of that job than with the one I took many years later). But I didn't want that job. I really enjoyed what I did during all the grad school years--it really helped me find my calling (which I have partially ignored ever since). If I did quit school after undergrad and retired early, I probably would have gone back to school for fun anyway. I don't regret doing it either.

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This totally doesn't bother me.  I'm fairly certain that the eight years I spent between college and and starting my working career were WAY better than any possible retirement plan. 

From that perspective, I just took eight years of my early retirement up front, while I was young and single and unencumbered.  No regrets.

That is a really interesting perspective.  My reason for retiring is essentially to recreate the life I had as a student (that is, free of the need to work for a living), so you could view pushing back the "working career block" of your life's continuum (as long as it remains of equal length) as six of one and half a dozen of the other.  And, as you said, that way you get to spend a portion of your retirement years while younger (and everything that comes along with youth).  On the other hand, we generally prefer bad things to precede good things in a sequence (if given the choice between ten minutes of intense pain followed by ten minutes of intense pleasure and vice versa, most people would prefer the former), so, if all else were equal, it would be better to get the working years out of the way as quickly as possible.  I have no regrets either, but to some extent that factor definitely counterbalances the benefits of taking some of your early retirement upfront.

sol

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we generally prefer bad things to precede good things in a sequence

I don't think most grad students or world travelers think of their future career as something to dread.  You work towards getting that professional job as a goal, not a punishment.  It's only after you've been doing it for a few years that you realize how much better off you were without it.

So maybe in this case the ignorance shelters you from that sequencing problem?

brooklynguy

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I don't think most grad students or world travelers think of their future career as something to dread.  You work towards getting that professional job as a goal, not a punishment.  It's only after you've been doing it for a few years that you realize how much better off you were without it.

So maybe in this case the ignorance shelters you from that sequencing problem?

Ha, good point, but I'm ashamed to say the same is not true for most law students (including myself).

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too long, didn't read.
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JustGettingStarted1980

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The point is this: It's possible to retire with a low amount of assets. We can debate my exact figures (as forummm does in his post), but that doesn't matter because those figures were completely arbitrary anyway. If you are saving more than $250,000 (or whatever), you are doing it primarily because you want to spend more money in retirement, i.e., you are "seeking additional upside beyond what is already 'enough'", as you put it in your post. I don't think there's anything wrong with that, but it is what it is.

To put it another way, most people on this forum seem to approach things completely backward from me. They have a target level of spending and aim to save enough to support it. However, I use the exact opposite approach: I will simply work as long as I can stand it (which will probably be much less than most people on the forum), and then I will create my retirement based on the level of assets that I have at that point.

Ah, I see your point now.  But I don't really agree with it -- let's say I decided my non-mortgage expenses will be $40k per year, and I decided I will be comfortable retiring when I have a stash equal to $1M to support those expenses (these are all made up numbers, but it will keep the math simple).  And let's say I have a low-rate, long-term $200M mortgage.  I would rather keep the mortgage and retire with a $1.2M portfolio than pay off the mortgage and retire with a $1M portfolio, not because I'm hoping that that approach will produce excess returns that will allow me to spend more than $40k per year, but because I'm hoping that that approach will make it more likely that I can in fact spend $40k per year for the rest of my life (as planned) without having to return to work, or cut expenses, etc.

(As an aside, even if I was confident that I had already "won the game" (like, say, a wealthy uncle just left me a $10M windfall), I still would invest aggressively (including leveraged-investing-via-mortgage), because I fall into the "might as well continue to let it ride" camp in the "already won the game" debate -- it just seems wasteful not to optimize and maximize, and I can give away excess returns to charity or whatever.  But that's beside the point.)

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Or to put it another way, the uncertainty in your mind about whether you can retire is not really caused by market forces; it's caused by insisting on spending far more money than is really "reasonably necessary". Your choice not to prepay your mortgage is really about increasing the upside, not about ensuring you have enough. Again, I don't think there's anything wrong with that; in fact, I think it's the rational thing to do.

This, though, I definitely agree with.  But I don't think it's another way of saying what you said above; it's really a different point--namely, that most of us choose a level of spending (i.e., set our standard for what constitutes "enough") much higher than what is "reasonably necessary" and certainly much higher than what is truly necessary.  Most of us, even as mustachians who already have Spartan spending levels in comparison to mainstream consumerist society, would probably be just fine if forced to live on half of our self-imposed spending levels or less.  But this just relates to how to determine what constitutes "enough" -- it doesn't change the earlier point that, whatever "enough" actually happens to be, taking an aggressive investment position can be motivated by a desire to maximize the chances that you will be able to spend "enough" for the rest of your life rather than a desire to accumulate an amount that will enable you to spend more than enough (i.e., what I called "seeking additional upside").  Using the figures from the above example, let's say "enough" is really $15k (instead of $40k), which means I can retire on a stash of $375k (instead of $1M) to support those expenses using the same 25x multiple -- but I'd still rather do it by keeping the $200k mortgage with a total stash of $575k rather than paying off the mortgage and using a total stash of $375k, because that approach makes it more likely that I will be able to spend "enough" (i.e., $10k per year of non-mortgage expenses) without running out of money.

We are getting into masters level philosophy shit here.   Should I be writing this stuff down? Might get some course credit eventually.... :)

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Wow, this thread actually got good in the last two days.

Off to re-read ERE!
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The issue I have with paying off a mortgage first instead of investing is that most people that do this don't have any extra cash and don't invest. The problem is they have 90% or (100%) of their entire net worth in 1 asset, their house. That's why I will always recommend investing first. You want to be diversified.

Bearded Man

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Quite the logical fallacy you created there with only two scenarios to lead people to the conclusion you want by limiting their options.

One man's "simplification by providing two reasonable examples out of an ~infinite number of possibilities" may be another's "logical fallacy"?

Some people may feel better owning their home.  Others may feel better having liquidity.  Once we get into feelings....

There are certainly infinite options. However, read the thread title again. 2 options there, and I like one better. I simply made a point that has been made on this forum 100 times, because some people think debt paydown is safer/conservative. I think it's riskeier for the reasons stated.

In the event of a foreclosure, you don't lose your equity. The amount you get back will be subpar due to fees and transaction costs versus selling it traditionally, but the bank doesn't just get to keep that equity.

True. It's possible to get all/most of your equity back. Maybe even likely. But people are irrational when it comes to their home.  Many will choose to stay far too long in dire straights when the better option is to cut your losses and sell. When backed into a corner by the bank there can be a substantial haircut. When a strong buyer like you sees foreclosure you know you aren't paying full price.


I read the thread title and the post. The OP doesn't sound like he has cash to pay it off, so keeping the cash in investments is best. But based on the thread title, which could mean "I have cash to pay off my mortgage or should I invest instead", I stand by my statement. A more appropriate thread title for this thread would have been, "Pay down mortgage or invest"

If one has cash to pay off their house, they should pay it off before speculating in the stock market, even in index funds. Now, the preferred method is to either pay cash or buy with a loan and save cash to pay it off in full when the time comes. That's what I do now. I don't put extra money into the house unless I can cover the mortgage and pay it off in full. So we are in agreement on one thing. On another note, as arebelspy pointed out, you get that equity back, so if you do pay down the mortgage, it is not like it's free money for the bank.

brooklynguy

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If one has cash to pay off their house, they should pay it off before speculating in the stock market, even in index funds. Now, the preferred method is to either pay cash or buy with a loan and save cash to pay it off in full when the time comes.

These are pretty bold conclusions to reach in the absence of any qualifying assumptions.  Does your advice apply equally whether the mortgage rate is 10% or 0.01%?  What if, once you've saved up enough to pay off the mortgage in full, you can buy treasury bonds that pay a higher rate of interest than the one your mortgage charges?  I would think in that situation even the most risk-averse homeowner would prefer to use their cash to buy treasuries (and thereby obtain a guarantee, backed by the full faith and credit of the U.S. government, to come out ahead by keeping their mortgage).  And why is it okay to incur debt when you lack the funds to pay it off but not okay to retain it once you no longer do?  You're just substituting your own individual preferences with respect to the risk/reward spectrum for everyone else's -- someone with an even lower risk tolerance may argue that one shouldn't buy a home in the first place until they've saved up enough to pay for it in full (and, of course, others would argue that properly-used leverage is an excellent wealth-building tool--see the three pages of thread above for examples).  Contrary to your unqualified assertions, there's no right or wrong answer here.

Cathy

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There is one major advantage to purchasing a property in cash rather than obtaining a mortgage loan or similar instrument: namely, you don't have to deal with the lending department of a bank or other institution. This may allow you to close on the purchase faster among other advantages. This is similar to how purchasing a property allows you to avoid dealing with a private "landlord", even if it might be financially suboptimal.
« Last Edit: August 19, 2015, 02:50:58 PM by Cathy »

brooklynguy

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This may allow you to close on the purchase faster...

You can always purchase the property without a financing condition and obtain a mortgage after closing (or before, if the timing allows) to address that specific concern.

Quote
...among other advantages

Of course, if you wish to avoid dealing with a lender at all for whatever other reasons you may have, this wouldn't help with those.

googily

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Re: The great "pay off mortage" vs "invest in stocks" debate - possible solution
« Reply #148 on: September 02, 2015, 01:34:15 PM »
Resurrecting this thread because I'm in the process of doing exactly what was discussed at the end of the thread, and have been wanting some opinions from folks here.

I recently bought a family home (should have inherited it, but that's a long story). I had to pay about $100k, but I had also just sold some inherited land for more than twice that.

My original plan had been to pay the $100k from the cash in the land sale, leaving me with another $150k+ in cash.

However, our primary residence has about $500k in equity, and we had just opened a line of credit for about $350k of that. So I decided to instead pay for the house from our HELOC, and have invested all money from the land sale in Vanguard stock and bond funds. (Not great timing on that, but oh well, I'm looking at the long game.)

At any point I can change my mind and take from the invested money to pay off the HELOC, if interest rates go nuts or whatever. (Current rate is 3.63%)

Our primary home is in a very high-value area that saw almost no loss in value during 2008. We don't plan on leaving soon. We are both max'xed out on 401ks, and have no kids, so feel quite comfortable with our retirement planning.

I've always felt like the fact that I have all the money on hand to pay off the second home makes it a little different from "investing instead of paying down." But I've also wondered if that was also because I like the idea of that bigger invested balance, even if I have a money payment now. :)

Thoughts?
« Last Edit: September 02, 2015, 01:37:21 PM by googily »

fishnfool

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Re: The great "pay off mortage" vs "invest in stocks" debate - possible solution
« Reply #149 on: September 02, 2015, 07:59:36 PM »
Resurrecting this thread because I'm in the process of doing exactly what was discussed at the end of the thread, and have been wanting some opinions from folks here.

I recently bought a family home (should have inherited it, but that's a long story). I had to pay about $100k, but I had also just sold some inherited land for more than twice that.

My original plan had been to pay the $100k from the cash in the land sale, leaving me with another $150k+ in cash.

However, our primary residence has about $500k in equity, and we had just opened a line of credit for about $350k of that. So I decided to instead pay for the house from our HELOC, and have invested all money from the land sale in Vanguard stock and bond funds. (Not great timing on that, but oh well, I'm looking at the long game.)

At any point I can change my mind and take from the invested money to pay off the HELOC, if interest rates go nuts or whatever. (Current rate is 3.63%)

Our primary home is in a very high-value area that saw almost no loss in value during 2008. We don't plan on leaving soon. We are both max'xed out on 401ks, and have no kids, so feel quite comfortable with our retirement planning.

I've always felt like the fact that I have all the money on hand to pay off the second home makes it a little different from "investing instead of paying down." But I've also wondered if that was also because I like the idea of that bigger invested balance, even if I have a money payment now. :)

Thoughts?

Are you planning to rent out the family home you purchased? If so, this sounds like a good plan as some rental income will offset that HELOC payment.

I paid off a HELOC I used for investment purposes at the beginning of this year and it is nice to have that monkey off my back.