Author Topic: Mortgage extra payment or invest in index funds?  (Read 2124 times)

bigote2032

  • 5 O'Clock Shadow
  • *
  • Posts: 66
Mortgage extra payment or invest in index funds?
« on: July 26, 2018, 10:37:37 PM »
I know there are multiple debates on this but wanted to expose my own case and see what people think.

Mortgage details:

30 year fixed mortgage
Mortage amount: $342,030.13
Balance: $308,193.63
Iterest rate: 4.62500%
25 years left to pay

I am currently paying extra $1,500 a month so I can pay it off in about 10 years.

Howver, 18K a year is a lot of money I can't deny that it hurts.  My heart tells me I want that money in Vanguard.

What do you think I should do? I plan to FIRE in about 5 to 8 years from now and don't like the idea of FIRE with mortgage.

Thanks for the advise!

RWD

  • Magnum Stache
  • ******
  • Posts: 3506
  • Location: Mississippi
Re: Mortgage extra payment or invest in index funds?
« Reply #1 on: July 26, 2018, 11:00:52 PM »
Are you maxing out your tax advantaged space? You should probably invest either way.
Investment Order guide
Join the club

bigote2032

  • 5 O'Clock Shadow
  • *
  • Posts: 66
Re: Mortgage extra payment or invest in index funds?
« Reply #2 on: July 27, 2018, 07:55:50 AM »
Yes, I am maxing out all my tax-advantaged accounts.

DS

  • Pencil Stache
  • ****
  • Posts: 678
Re: Mortgage extra payment or invest in index funds?
« Reply #3 on: July 27, 2018, 08:38:14 AM »

Financial.Velociraptor

  • Handlebar Stache
  • *****
  • Posts: 1457
  • Age: 47
  • Location: Houston TX
  • Devour your prey raptors!
    • Financial Velociraptor
Re: Mortgage extra payment or invest in index funds?
« Reply #4 on: July 27, 2018, 09:43:14 AM »
I think it depends on your risk tolerance.  Except for what I put in 401k to get company match, I invested 0 dollars until I extinguished my 6% fixed mortgage (in about 7 years).  I don't regret it.  Investing in the market has a range of returns from good to negative.  Paying off your mortgage has a guaranteed return.  It's more bond-like.  I liked that.  I was fixed income centric once I started investing heavily until I felt like I could squeak by on interest, dividends, and other distributions.  Only then did I go risk on to cover my inflation risk.  Still managed to retire at 40.

Really, the pay it off or invest it debate is just tweaking.  The difference to your retirement date is very small compared to increasing your savings rate, which is the number one driver of FI/RE.

BobTheBuilder

  • Stubble
  • **
  • Posts: 159
Re: Mortgage extra payment or invest in index funds?
« Reply #5 on: July 27, 2018, 11:26:39 AM »
In my opinion 4.625% is high enough to not worry about missing gains in stocks for the next 10 years.
Jack Bogle recently (Youtube, reasonable expectations for the next 10 years) made the case to expect average returns on stocks over the next 10 years to be 4% nominal, assuming current dividen yield, earnings growth rate and a reversion of P/E back towards historical mean values.

While you can argue about it being 4% or 5% or 6%, in order to really miss out on gains the P/E would need to stay very high.

So if you feel the pressure in your budget, maybe reduce the extra payments a bit, but I think you're doing the smart thing as your savings on interest is considerably high and has zero volatility.

inline five

  • Pencil Stache
  • ****
  • Posts: 675
Re: Mortgage extra payment or invest in index funds?
« Reply #6 on: July 27, 2018, 12:03:21 PM »
I would pay off the mortgage until you hit roughly $100k balance. 4.6% is pretty high to be honest considering where they were over the past year.

Rubbing salt in the wound but why didn't you refi back when rates were lower? A year or two ago you could've gotten a 15 yr for 3%.
« Last Edit: July 27, 2018, 12:04:52 PM by inline five »

Telecaster

  • Handlebar Stache
  • *****
  • Posts: 1906
  • Location: Seattle, WA
Re: Mortgage extra payment or invest in index funds?
« Reply #7 on: July 27, 2018, 06:51:14 PM »

Howver, 18K a year is a lot of money I can't deny that it hurts.  My heart tells me I want that money in Vanguard.


Follow your heart.  Paying down the mortgage is a high-risk, low-reward proposition. 

bacchi

  • Magnum Stache
  • ******
  • Posts: 3938
Re: Mortgage extra payment or invest in index funds?
« Reply #8 on: July 27, 2018, 07:01:19 PM »
A fixed rate mortgage is an inflation hedge.

chasesfish

  • Magnum Stache
  • ******
  • Posts: 3202
  • Age: 37
  • Location: Texas
Re: Mortgage extra payment or invest in index funds?
« Reply #9 on: July 28, 2018, 05:25:37 AM »
I've actually done both (and posted about it recently).

I prepaid my mortgage for the first six years, then when I moved houses I got a new mortgage at 80% and invested the difference and have been generally paying the minimum since then.

My opinion is unless you're in your "forever home" and want the hedge against inflation, peace of mind, ect, pay the minimum and invest the difference in an index fund if your rate is below 5.5%

js82

  • Stubble
  • **
  • Posts: 109
Re: Mortgage extra payment or invest in index funds?
« Reply #10 on: July 28, 2018, 07:58:06 AM »
In my opinion 4.625% is high enough to not worry about missing gains in stocks for the next 10 years.
Jack Bogle recently (Youtube, reasonable expectations for the next 10 years) made the case to expect average returns on stocks over the next 10 years to be 4% nominal, assuming current dividen yield, earnings growth rate and a reversion of P/E back towards historical mean values.

While you can argue about it being 4% or 5% or 6%, in order to really miss out on gains the P/E would need to stay very high.

So if you feel the pressure in your budget, maybe reduce the extra payments a bit, but I think you're doing the smart thing as your savings on interest is considerably high and has zero volatility.

I concur with this opinion.

One fundamental question to ask is: Do you believe a 4.625%(mortgage interest rate) rate of return is a good investment given the current market conditions, or do you believe that investing in stocks is a better investment?  I'd argue that in the current state of the economy(relatively late in an economic cycle, economy doesn't have a huge amount of room to run, high P/E's, ), a guaranteed 4.625% is a pretty decent investment.  Given how bonds etc. are priced, the market agrees with this.

Is there a risk that you miss out on upside?  Absolutely.  But considering my view on "likely" scenarios I would argue that barring an uptick in inflation, a guaranteed 4.625% is a pretty solid choice given the current state of the economy(in my decidedly non-professional opinion).  Were I in your position I'd take advantage of any employer matches or tax-deductible accounts first and foremost, but I would absolutely pay down the mortgage over stock investing in the immediate future.
« Last Edit: July 28, 2018, 08:03:14 AM by js82 »

Dicey

  • Senior Mustachian
  • ********
  • Posts: 10881
  • Age: 61
  • Location: NorCal
Re: Mortgage extra payment or invest in index funds?
« Reply #11 on: July 28, 2018, 09:33:10 AM »
Sorry, what an individual "believes" is largely irrelevant.

Study some compound interest charts and play with a few calculators until you really understand how it works with your own numbers.

Then play around with a few inflation calculators using your own mortgage numbers.

Once you understand compound interest and inflation, the answer is screamingly obvious.


Telecaster

  • Handlebar Stache
  • *****
  • Posts: 1906
  • Location: Seattle, WA
Re: Mortgage extra payment or invest in index funds?
« Reply #12 on: July 28, 2018, 10:15:51 AM »
I concur with this opinion.

One fundamental question to ask is: Do you believe a 4.625%(mortgage interest rate) rate of return is a good investment given the current market conditions, or do you believe that investing in stocks is a better investment?  I'd argue that in the current state of the economy(relatively late in an economic cycle, economy doesn't have a huge amount of room to run, high P/E's, ), a guaranteed 4.625% is a pretty decent investment.  Given how bonds etc. are priced, the market agrees with this.

Is there a risk that you miss out on upside?  Absolutely.  But considering my view on "likely" scenarios I would argue that barring an uptick in inflation, a guaranteed 4.625% is a pretty solid choice given the current state of the economy(in my decidedly non-professional opinion).  Were I in your position I'd take advantage of any employer matches or tax-deductible accounts first and foremost, but I would absolutely pay down the mortgage over stock investing in the immediate future.

 To properly compare the two scenarios (i.e. pay or not pay the mortgage) you must use the same time frame.  The mortgage term is 30 years.   That's the investing horizon you have to look at.  Looking at the immediate future is nonsensical in this case.

bacchi

  • Magnum Stache
  • ******
  • Posts: 3938
Re: Mortgage extra payment or invest in index funds?
« Reply #13 on: July 28, 2018, 10:33:09 AM »
Once you understand compound interest and inflation, the answer is screamingly obvious.

Yep, it's easy to become complacent with our low inflation.

https://www.inflationdata.com/inflation/Inflation/DecadeInflation.asp

The 100 year average is 3.18% and the current CPI-U is 2.87%,

Quote from: https://www.bls.gov/news.release/pdf/cpi.pdf
The all  items index  rose 2.9 percent for the 12 months  ending  June; this  was the largest 12-month increase since the period  ending  February 2012.
[emphasis added]

Even if inflation stays at 2.9%, the real return from the market only has to beat 1.75%. If inflation returns to the historical average, that's only a 1.47% real gain.

Expecting a 1.5% return over 30 years is equivalent to saving 67x your current spending level for FIRE. It would be the worst 30 year return in history.


Retire-Canada

  • Walrus Stache
  • *******
  • Posts: 6752
Re: Mortgage extra payment or invest in index funds?
« Reply #14 on: July 28, 2018, 07:34:35 PM »
What do you think I should do? I plan to FIRE in about 5 to 8 years from now and don't like the idea of FIRE with mortgage.

I would not pay down the mortgage faster. I'm on a 5yr mortgage term here in Canada and I plan to extend the amortization on my mortgage from 15yrs back to 25yrs in 2020. I would far far far rather have more liquid investments and an affordable mortgage than then fewer liquid investments and no mortgage. My house is probably worth something like $500K...last thing I want is 1/3rd of my net worth tied up in a single unproductive asset. 

You seem to recognize the problem and want to invest more in stocks. Give it some more thought. Build a spreadsheet and run some numbers to see what some of the possible outcomes look like. The fact you don't "like the idea" of something is not a compelling argument for making a huge financial decision. Put some mental energy into this and either decide you really really really want to pay off your mortgage before you FIRE or decide that directing those extra payments to index funds really makes a ton of sense.

DreamFIRE

  • Handlebar Stache
  • *****
  • Posts: 1596
Re: Mortgage extra payment or invest in index funds?
« Reply #15 on: July 28, 2018, 10:09:35 PM »
Jack Bogle recently (Youtube, reasonable expectations for the next 10 years) made the case to expect average returns on stocks over the next 10 years to be 4% nominal, assuming current dividen yield, earnings growth rate and a reversion of P/E back towards historical mean values.

Jack projected nominal to zero "real" returns over the next decade.  He made that projection 3 years ago.  He could still be right.

https://forum.mrmoneymustache.com/investor-alley/%27nominal-to-zero-returns%27-over-coming-decade-jack-bogle/

js82

  • Stubble
  • **
  • Posts: 109
Re: Mortgage extra payment or invest in index funds?
« Reply #16 on: July 29, 2018, 06:00:36 AM »
I concur with this opinion.

One fundamental question to ask is: Do you believe a 4.625%(mortgage interest rate) rate of return is a good investment given the current market conditions, or do you believe that investing in stocks is a better investment?  I'd argue that in the current state of the economy(relatively late in an economic cycle, economy doesn't have a huge amount of room to run, high P/E's, ), a guaranteed 4.625% is a pretty decent investment.  Given how bonds etc. are priced, the market agrees with this.

Is there a risk that you miss out on upside?  Absolutely.  But considering my view on "likely" scenarios I would argue that barring an uptick in inflation, a guaranteed 4.625% is a pretty solid choice given the current state of the economy(in my decidedly non-professional opinion).  Were I in your position I'd take advantage of any employer matches or tax-deductible accounts first and foremost, but I would absolutely pay down the mortgage over stock investing in the immediate future.

 To properly compare the two scenarios (i.e. pay or not pay the mortgage) you must use the same time frame.  The mortgage term is 30 years.   That's the investing horizon you have to look at.  Looking at the immediate future is nonsensical in this case.

Point taken.  A risk-free 4.625% over the next 5-10 years is a reasonable option given current market conditions - but over the 25 year time horizon(the remaining life of the mortgage in the original post) it does represent a near-certain loss of return versus equity.

I retract my previous suggestion.
« Last Edit: July 29, 2018, 09:25:56 AM by js82 »

bigote2032

  • 5 O'Clock Shadow
  • *
  • Posts: 66
Re: Mortgage extra payment or invest in index funds?
« Reply #17 on: July 29, 2018, 03:07:04 PM »
Thanks all for your replies and different perspectives.  I have decided to keep putting the extra money on the mortgage, ran numbers and it is the best course for my situation.

As much as I like the potential of making more money in the market, this is hypothetical, we are talking about the future, I don't know for sure what would be the rate of gains, I do have more certainty with the mortgage and it will be paid in 9 years.

MustacheAndaHalf

  • Handlebar Stache
  • *****
  • Posts: 1771
Re: Mortgage extra payment or invest in index funds?
« Reply #18 on: July 30, 2018, 02:10:55 AM »
Did you subtract any tax benefits of the mortgage from the rate?

If you deduct mortgage interest on your taxes, that could push the effective "after tax" rate to 3.x%, and it might be even less appealing to pay it off.  Most people are in the 22% income tax bracket, and if that's your situation, you're paying 3.6% on your mortgage after taxes.  Right now 30 year treasuries are paying 3.0%, and your mortgage is only 0.6% above that (after tax).

Future returns can't be predicted.  In a white paper from Vanguard various metrics were used and the best was CAPE 10 (P/E ratio averaged over 10 years, "cyclically adjusted price/earnings").  CAPE 10 was 0.4 correlated with future returns - not a good prediction.
https://personal.vanguard.com/pdf/s338.pdf

You've been putting $18,000 extra into your mortgage for 5 years, to avoid paying maybe 3.6% (my after tax estimate) in interest.  The stock market has gained about 13.3% per year, an almost +10% higher return than the choice you've been making.  Would you invest if the alternative cost you $150/month?
« Last Edit: July 30, 2018, 02:13:06 AM by MustacheAndaHalf »