The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: andysandp on April 03, 2017, 07:23:09 PM
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Why not borrow $100,000 from a mortgage at 4% 30 years, and put it all into S and P?
Chances are the S and P will do better then the 4% mortgage after 30 years, and the Interest in Tax deductible.
Any thoughts?
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If the re-fi/HEL costs aren't high, it's a great idea. I've done it.
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HELOC interest payment would be $477/month. $100K would buy you about 425 SPY. Trailing 12-month dividend is $4.52 for a monthly yield of $160. So you're paying $317/month.
Not a lot different from buying SPY on margin or holding S&Ps in a futures account. Except in a margin or futures account, when your balance gets too low they come after you for extra cash or sell the stock -- that is, everything stays within the account. But if you're using your house as collateral -- virtually in this case, as the broker doesn't know about it -- if you can't come up with the spread you either sell your SPY or bye bye housie.
SPY might not be your cheapest option compared to say VFIAX but it is probably the easiest to trade. One S&P future controls 250*index, or around $580K right now. One E-mini future controls one-fifth that, or around $120K. Also you have to roll over the contract every three months. Probably beyond the scope of what you're trying to do.
If the stock market crashes or if an entire sector blows out (banks/housing in 2008, oil in 2014/15), companies will start cutting dividends.
Consider how you will pay the spread now and if your life situation changes. Oh and this is a fixed-rate HELOC, right? HELOCs have been at 6-7% in the recent past.
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What if my original plan was to invest $477 a month into Vanguard 500 fund for the next 30 years anyways?
The HELOC would also be $477, so instead of dumping $477 a month into Vanguard 500 Fund, I would be paying $477 a month to the Bank.
The pros are I would be able to put $100,000 into Vanguard 500 fund right away, and I also get to deduct the Interest each month I give to the Bank.
I should be ahead in 30 years right?!
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Yes carrying noon callable fixed interest debt at a low rate is the correct call when using it to invest.
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Your tax savings is above what you'd get with the standard deduction, times your marginal tax rate. At the 25 or 28% tax brackets this lets you write off somewhere around $100-120/month... math left as an exercise to the reader.
So you still have to come up with a couple hundred a month. Dividends grow 4%/year or so, but mortgage interest will decline (takes longer).
BTW $100K is exactly the limit of how big a HELOC you can deduct for non-house purposes. The deduction doesn't scale at $500K say.
A lot of talk about tax reform right now relates to limiting the mortgage interest deduction, and you're hoping tax laws don't change over 30 years anyway.
Say you did this in 1999-20 when the S&P was at 1500 (not even the high back then). You'd be about $56K ahead on the SPY (666 SPY * $235). Average dividends would be *very* roughly $2k/yr ($1k then, $3k now), HELOC payment net of interest might be $4k/year so some $35K behind from carrying cost -- that's not the exact number but it's the ballpark. So some $20k ahead overall or 1%/year nominal (1%^17 = 18.4%). I think best case wouldn't be much more than $40K ahead if say you refied at the bottom.
You'd be near flat or slightly behind in real terms... doing it in 1999/2000 is probably the worst case scenario and assumes you stayed solvent through 2008.
Extra Credit: Instead of SPY, buy MO in early 2000 and figure return. Yielded 8% at the time and has split into four companies since. (AAPL was all over the place in 99-2000, but say you got in at $50, so 2000 shares but no dividends. That would be 28,000 shares now at $143 or $4 million, but higher carrying cost.)
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Why not borrow $100,000 from a mortgage at 4% 30 years, and put it all into S and P?
With tax-deductible interest, that could be closer to 3% and would make sense. The closer your interest rate gets to the market return, the more risk you take with this approach.
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Say you did this in 1999-20 when the S&P was at 1500 (not even the high back then). You'd be about $56K ahead on the SPY (666 SPY * $235). Average dividends would be *very* roughly $2k/yr ($1k then, $3k now), HELOC payment net of interest might be $4k/year so some $35K behind from carrying cost -- that's not the exact number but it's the ballpark. So some $20k ahead overall or 1%/year nominal (1%^17 = 18.4%). I think best case wouldn't be much more than $40K ahead if say you refied at the bottom.
You'd be near flat or slightly behind in real terms... doing it in 1999/2000 is probably the worst case scenario and assumes you stayed solvent through 2008.
Extra Credit: Instead of SPY, buy MO in early 2000 and figure return. Yielded 8% at the time and has split into four companies since. (AAPL was all over the place in 99-2000, but say you got in at $50, so 2000 shares but no dividends. That would be 28,000 shares now at $143 or $4 million, but higher carrying cost.)
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When you are using an example from 1999/2000 return, you are only giving a 17 years return.
The 30 year return of S and P should give closer to 10% with dividends.
That's why I like 30 year mortgage. It's almost like you promise to invest into S and P for 30 years because you have to make monthly payments to the bank.
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correct i have a thread i started called the DONT pay off your mortgage club for this exact reason it is mathmatically optimal to invest vs paying down a low fixed rate 30 year mortgage. Check it out
https://forum.mrmoneymustache.com/throw-down-the-gauntlet/dont-payoff-your-mortgage-club/?topicseen
it makes too much sense to not pay it down.
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I'm doing the same thing for $50k. Though its through a HELOC advance 10 years fixed @ 3.75. After taxes is gets down to the 3.1% range.
I don't have any cash flow problems with the required $500 monthly payment.
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Why not borrow $100,000 from a mortgage at 4% 30 years, and put it all into S and P?
Chances are the S and P will do better then the 4% mortgage after 30 years, and the Interest in Tax deductible.
Any thoughts?
I'm essentially doing that. I have over $100K [outside of retirement accounts]I could use to pay down my mortgage, but I invest it instead. I'd much rather have that money working for me and available for any need vs. have $100K smaller low interest mortgage.
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Everyone who uses money to invest instead of pay down their mortgage is effectively doing that. Which is a lot of people (myself included).
For me personally, it's not worth the hassle of setting up a HELOC to invest another $100k or whatever. In the event of a big market crash I'd consider it, though.
-W
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Is this a case for market timing?
As in, for me somehow I make mental gymnastics that in a market downturn it would be easier for me to pull the trigger on this. (Borrowing 100k at low rates to invest)
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Is this a case for market timing?
If there was suddenly a 30% market drop I would do whatever I could to buy as much discounted stock as I could:
- reduce non-essential spending like travelling
- delay essential spending as practical [say patch the roof instead of replacing it]
- take on extra work
- access whatever credit facilities I had available
- sell bonds [if I had any]
And yes that would be market timing, but the many flavours of market timing it's not as problematic as the folks sitting on piles of cash waiting for the "big one".
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A HELOC is not always going to be available if we face a recession or economic shock of some kind.
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A HELOC is not always going to be available if we face a recession or economic shock of some kind.
I've had a HELOC since 2005. We went through the worst recession since the 30's and it remained outstanding with me taking draws on it as needed.
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A HELOC is not always going to be available if we face a recession or economic shock of some kind.
I'd rather have a LOC or two and take the risk that something happens to them vs. not having them as options. My LOC was not affected during the 2008 crisis.
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If you've done risk profiling to understand what you'd do and how you'd feel if the market dropped, then play the numbers and roll the dice.
Me, I would never set myself up for that kind of leverage, but everyone is different and there is no right or wrong, only tolerance for risk.
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This is exactly what all the leveraged-up banks, hedge funds etc do.
Except they get to borrow money at the Fed rate (or close to it) because they are more special and important.
And when they blow up, we bail them out, it's how crony capitalism works.
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Seems to me like a good move. Guess I'm doing the same because my home equity is only about 25%.
One caveat: Do the math assuming no mortgage deduction. With my interest expense as low as it is (3.65% which adds up to about $5k/yr for me) I have only ever taken the $12k standard deduction. My mortgage costs me exactly my mortgage rate and I'm leveraged about as much as possible.
Just keep in mind the "lose" scenario: The US enters a Japanese-style flat market for 25 years! Or a financial crisis reoccurs and you panic near the bottom because of your leverage!
Also keep in mind that InteractiveBrokers.com offers margin at about 2%, but it's callable. Also keep in mind that some closed-end-funds offer leverage, with annual expense ratios of about 2-3%.
These alternatives also offer you a way to double down or triple down to some degree, if you really like gambling. E.g. Take out the HELOC. Add 25% broker leverage. Put it all in a 10% leveraged CEF (locate on cefconnect.com).
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Also for your consideration, the transfer of risk. Your home is a single asset, in a single state, in a single neighborhood of a single city. If you own it outright, all risk regarding the future value of that asset is yours. If the neighborhood suddenly becomes a haven for crack houses your asset loses value, big-time. If it's mortgaged at 80% and it loses half of its value, you can walk away and let the bank take the hit (in most states). Your S&P investment would remain intact. OTOH if your property appreciates at more than the interest rate you are paying the bank (even if the S&P stays flat), you keep the capital gains free profit as long as you can cash flow long enough to sell.
win-win-win
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win-win-win
Yes!
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We did this with a few 0% credit card offers in the late 90's. Only did it with $3000 or so, it was fun, exciting and profitable. In hindsight of course we wished we had down it with mega amounts. It really is fun when the bubble is getting bigger. I imagine not so fun when it pops.
We are not paying down our 3% mortgage for this reason.
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Haha, I think I would do this if I could, too.
I get credit card "balance transfer" offers which include "cash this check in your bank account (for up to 8k)." But despite the 2% transfer fee and 0% APR, the 15-month horizon means that really is still gambling. 30-year plans, though, could definitely be worth it.
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So what is your strategy we have a another 2008-2009?
In 2009 our house was down 20% from the price we bought it at in 2001, our stocks were down 50%, and my DH had no job (his job was 65-70% of our income). We would have been in deep s@$t in your scenario. Instead we hunkered down in our paid for house and lived off one part time job.
I'm not 100% anti leverage but I am sure we would have lost our house and thrashed our credit. Instead we squeaked by, eventually moved, rented awhile, and bought a different house with cash (mostly with capital gains from the stocks we bought with the proceeds of the previous house.
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So what is your strategy we have a another 2008-2009?
We bought a house that either one of us could pay for on a single salary with room to spare. That's key. Whomever lost their job would get a new job even if it was in retail or something low paying to add to the household cashflow. Even if our investments were down 50% we have so many assets that there is zero chance we'd go broke or not be able to pay our bills. We'd reduce our spending to the minimum and keep investing whatever we could even if it was just dividends on the way down and the way up.
Psychologically it might feel awful, but the actual risk to our financial fortress was and would be zero in the scenario you describe.
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So what is your strategy we have a another 2008-2009?
In 2009 our house was down 20% from the price we bought it at in 2001, our stocks were down 50%, and my DH had no job (his job was 65-70% of our income). We would have been in deep s@$t in your scenario. Instead we hunkered down in our paid for house and lived off one part time job.
I'm not 100% anti leverage but I am sure we would have lost our house and thrashed our credit. Instead we squeaked by, eventually moved, rented awhile, and bought a different house with cash (mostly with capital gains from the stocks we bought with the proceeds of the previous house.
Good points. The risk would be if the O.P. lost the other sources of income that were being used to pay the house note. In that case, selling a few shares at the bottom to make a few months' payments would be the logical thing to do. The losses from foreclosure would exceed the losses from selling at the bottom - and the OP also gets a tax loss to harvest.
We can compare the O.P.'s hypothetical risk to the risk a person with 80% equity faces when they lose income. Their mortgage payment might be the same as a person with 20% equity, so a cash flow problem could result in foreclosure just the same. The difference would be that the OP would have a (somewhat diminished) portfolio to tap and the person with 80% equity would not.
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In academic theory this is almost always the "correct" choice, but in practice it is less attractive. Most theory assumes you can borrow at rf which would be about 1% - the numbers don't look nearly as good at 4%.
I would only be comfortable doing this if you can avoid ruin even in the worst plausible outcome (say markets down 50% + lose your job). Of course, if you are maintaining that kind of financial security the leverage is probably tiny relative to your overall net worth.
Risky decisions are most attractive when you are only exposed to the upside (moral hazard). Taking on leverage has a high expected value if your parents will bail you out in the case of complete ruin.
It sounds very unethical when evaluated rationally, but a lot of high risk entrepreneurship/startup work performed by recent graduates is done at no risk for this reason.
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What if my original plan was to invest $477 a month into Vanguard 500 fund for the next 30 years anyways?
The HELOC would also be $477, so instead of dumping $477 a month into Vanguard 500 Fund, I would be paying $477 a month to the Bank.
The pros are I would be able to put $100,000 right away into Vanguard 500 fund and I also get to deduct the Interest each month I give to the Bank.
I should be ahead in 30 years right?!
I think it depends on other factors as well, such as how much home equity you are working with and how sure you are that you will be able to produce the anticipated investment amount of $477/ month for your holding period of the mortgage.
You're question essentially comes down to: "should I use leverage to invest in stocks." Using leverage has the effect of drastically increasing your volatility. It will make the good times better, but I could severely make the bad times much much worse. Only you can decide what you are comfortable with it and how much financial pain you could absorb. In this case, the question you should ask yourself is not whether it is likely to be better over the long run, but can you sustain a bad outcome in the intermediate? What would happen if we enter a recession and the S&P drops 20-30%, you loose your job (or 1 of your incomes if a 2 income household) and need to cut costs, and your house goes dow in value by 15-20%? What would that look like under your strategy? Would you survive it financially or would it wipe you out? If you get wiped out in the intermediate it doesn't matter what the most likely expected value of your strategy is over 30 years...
Definitely check out market timer's saga on Bogleheads. He isn't working with home equity so its not exactly the same as what you are proposing. But the story should act as a warning to anyone pursuing a leveraged strategy.
https://www.bogleheads.org/forum/viewtopic.php?t=5934
I'm grateful to see someone link to the famous Market-Timer forum on Bogleheads. I read that through entirely a year ago, and it cured me of a desire to leverage myself super-aggressively.
The problem with leverage is that it makes rebalancing into something that scares me rather than reassures me. When my stocks go up 10%, I love selling 1/10 of that to put into bonds. Leveraged investing would require that I do the opposite.
Assume I borrow 60K to put alongside my 100K nut and buy $160,000 of stocks. When they appreciate 25%, maintaining the same allocation requires that I locate $15,000 of new debt, which will make me sleep MORE uneasily.
If my stocks decrease by 25%, now I have to sell at the bottom to pay down $15,000 of debt. Since these decreases are frequent, it seems as though I will inevitably have to sell at the bottom quite frequently.
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The problem with leverage is that it makes rebalancing into something that scares me rather than reassures me. When my stocks go up 10%, I love selling 1/10 of that to put into bonds. Leveraged investing would require that I do the opposite.
Assume I borrow 60K to put alongside my 100K nut and buy $160,000 of stocks. When they appreciate 25%, maintaining the same allocation requires that I locate $15,000 of new debt, which will make me sleep MORE uneasily.
If my stocks decrease by 25%, now I have to sell at the bottom to pay down $15,000 of debt. Since these decreases are frequent, it seems as though I will inevitably have to sell at the bottom quite frequently.
I wouldn't leverage with a margin loan. If you don't use a margin loan you don't have to sell at the bottom.
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Lots of people did this in 2001 and 2008 too !!
Woo Hoo! It's a party!
This market is scary when I read posts like this...
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Lots of people did this in 2001 and 2008 too !!
Woo Hoo! It's a party!
This market is scary when I read posts like this...
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No they didn't. They did take out HELOCs, but they spent them on their houses/boats/lifestyles.
-W
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Lots of people did this in 2001 and 2008 too !!
Woo Hoo! It's a party!
This market is scary when I read posts like this...
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No they didn't. They did take out HELOCs, but they spent them on their houses/boats/lifestyles.
-W
That too :)
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The problem with leverage is that it makes rebalancing into something that scares me rather than reassures me. When my stocks go up 10%, I love selling 1/10 of that to put into bonds. Leveraged investing would require that I do the opposite.
Assume I borrow 60K to put alongside my 100K nut and buy $160,000 of stocks. When they appreciate 25%, maintaining the same allocation requires that I locate $15,000 of new debt, which will make me sleep MORE uneasily.
If my stocks decrease by 25%, now I have to sell at the bottom to pay down $15,000 of debt. Since these decreases are frequent, it seems as though I will inevitably have to sell at the bottom quite frequently.
I wouldn't leverage with a margin loan. If you don't use a margin loan you don't have to sell at the bottom.
That's what market timer said ;)
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That's what market timer said ;)
So why would you sell at the bottom if there was no margin call?
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That's what market timer said ;)
So why would you sell at the bottom if there was no margin call?
In theory - that's what he planned to do (only using noncallable debt). In reality, he went in waaaaaayyyy too deep trying to maintain his preferred allocation, ran out of noncallable credit, used a bunch of high interest and callable debt and ultimately failed to accomplish his stated goal: diversifying across time periods to reduce risk.
I'm not saying that's exactly what will happen to everyone who tries but it did happen to market timer. That guy seems 10x smarter than I am so I'm sticking with the idiot's version of leveraged investing. I'm holding a mortgage while I dump every spare penny in the market.
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I'm holding a mortgage while I dump every spare penny in the market.
That's ^^^ what I am doing.
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So what is your strategy we have a another 2008-2009?
We bought a house that either one of us could pay for on a single salary with room to spare. That's key. Whomever lost their job would get a new job even if it was in retail or something low paying to add to the household cashflow. Even if our investments were down 50% we have so many assets that there is zero chance we'd go broke or not be able to pay our bills. We'd reduce our spending to the minimum and keep investing whatever we could even if it was just dividends on the way down and the way up.
Psychologically it might feel awful, but the actual risk to our financial fortress was and would be zero in the scenario you describe.
Hopefully you both don't get laid off at the same time.
Yea that happened to us too. Different time, different story.
On further remembering I don't think we would have lost the house. we would have been cash flow negative and I would have died of a panic attack.
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A problem I believe has not yet been mentioned is that you don't get to keep your mortgage if you sell your house.
You can end up "stuck" - let's say you want to upsize or downsize your home, but your equities have just been hit by a downswing. Let's also say mortgage interest rates have gone up a couple of percentage points to 6%.
Basically you're either increasing the financing costs of your investments from 4% to 6% or you're forced to sell low. Either way, what looked like a good deal up front ends up not being such a great deal.
If you're absolutely certain that you'll keep your mortgage for 30 years, this isn't a concern, but it does seem that you're reducing your flexibility a little.
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Hopefully you both don't get laid off at the same time.
Yea that happened to us too. Different time, different story.
On further remembering I don't think we would have lost the house. we would have been cash flow negative and I would have died of a panic attack.
Even if we both lost our jobs at the same time nothing awful would have happened. We would have simply cut spending, found new jobs as fast as possible [again not too proud to work retail for a stretch if needed] and sold a minimal amount of stocks if needed. That's why you build a financial fortress so that it's very very hard to get into trouble even for rare occurrences like a double job loss.
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Hopefully you both don't get laid off at the same time.
Yea that happened to us too. Different time, different story.
On further remembering I don't think we would have lost the house. we would have been cash flow negative and I would have died of a panic attack.
Instead of focusing on how bad things will be when the worst happens, focus on the legs of your stool that will snap under the weight of that circumstance. These are the areas for improvement in your FIRE plan, even if they are personal/emotional there are likely things that can be done to help compensate. I am guilty of focusing too much on the "savings" leg of my stool, often to my detriment, both in time to FIRE and anti-fragility of the FIRE plan. If leverage can can reduce the amount of savings required, focus can and should be placed on the weaker legs. IOW, if the math clearly shows leverage in the form of a low fixed rate mortgage works. However, it's possible that leverage would put my plan at risk, I should fix the part of my plan that creates the risk failure, rather than poo-poo a virtually guaranteed win.
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I replied to someone in another post who had a paid-off $600k home but virtually all their investments were trapped in pretax IRAs with 10% penalties for early withdraws. They couldn't figure out how to bridge the 5 or so years between their current age and 59.5. A lot of people talked about starting a Roth pipeline, but it was generally too late for that.
I said, hell, why not take out a HELOC for 5 years of living expenses. Invest the proceeds in a bond portfolio yielding the same or slightly more than the HELOC. Live off the account, drawing it down for 5 years. Then, pay off the HELOC when you turn 59.5 and can access your IRAs. Or... just keep doing what you're doing until the bond portfolio erases the HELOC at basically no net cost. Take the mortgage interest deduction in the meantime, and pay virtually no taxes on investment proceeds.
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Is this a case for market timing?
If there was suddenly a 30% market drop I would do whatever I could to buy as much discounted stock as I could:
- reduce non-essential spending like travelling
- delay essential spending as practical [say patch the roof instead of replacing it]
- take on extra work
- access whatever credit facilities I had available
- sell bonds [if I had any]
And yes that would be market timing, but the many flavours of market timing it's not as problematic as the folks sitting on piles of cash waiting for the "big one".
It's the difference between guessing what the market is going to do in the near future in an already up market, and recognizing you are already at a 30-50% drop from the highs.
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I'm grateful to see someone link to the famous Market-Timer forum on Bogleheads. I read that through entirely a year ago, and it cured me of a desire to leverage myself super-aggressively.
The problem with leverage is that it makes rebalancing into something that scares me rather than reassures me. When my stocks go up 10%, I love selling 1/10 of that to put into bonds. Leveraged investing would require that I do the opposite.
Assume I borrow 60K to put alongside my 100K nut and buy $160,000 of stocks. When they appreciate 25%, maintaining the same allocation requires that I locate $15,000 of new debt, which will make me sleep MORE uneasily.
If my stocks decrease by 25%, now I have to sell at the bottom to pay down $15,000 of debt. Since these decreases are frequent, it seems as though I will inevitably have to sell at the bottom quite frequently.
It seems the real pitfall is trying to maintain a certain debt:equity ratio.
A more viable strategy seems to be opportunistically using a single injection of cash from noncallable debt (HELOC) when the market has crashed.
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It's the difference between guessing what the market is going to do in the near future in an already up market, and recognizing you are already at a 30-50% drop from the highs.
Yes, timing the market is always best... If you can manage to do it. If you can't do it, taking a 30 yr mortgage at 4% to invest is going to be a win in almost any possible long term scenario. Even in a 30 year net-zero real growth situation with a low inflation rate of 2%, over those thirty years you win. Plus, a portion of risk on one of your two assets is transferred to the bank. If inflation is just a smidgen higher and there is 3% real return on the S&P, you win big-time. Run the numbers.
I really don't understand how the folks on a forum who regularly comment they are willing to be near 100% US stocks with their life savings suddenly have a problem with that level of risk when leverage is involved. Either you have faith in a your portfolio or you do not. If you don't, I think the problem isn't leveraging real estate, but rather the composition of your portfolio and/or cash flow expectations.
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TomTX-
prompted by this thread, I reread the MarketTimer saga on bogleheads, and he actually advocates something more like what you describe.
see the discussion about sharpe ratio here: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=5934&start=100
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Its a fair strategy to most likely accellerate your wealth accumulation.
Just be sure to:
* understand the risks
* be prepared to stick with the plan if you get underwater due to a market drop
* have enough liquidity, earning power confidence, and/or backup source of emergency funds, such that you are not missing payments and lose the house if a life event happens (uninsured damage, medical bills, death of family member, etc)
Good luck.
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Its a fair strategy to most likely accellerate your wealth accumulation.
Just be sure to:
* understand the risks
* be prepared to stick with the plan if you get underwater due to a market drop
* have enough liquidity, earning power confidence, and/or backup source of emergency funds, such that you are not missing payments and lose the house if a life event happens (uninsured damage, medical bills, death of family member, etc)
Good luck.
Yep. If the market crashed 50% tomorrow, I would likely take a $100k HELOC, but only put $90k in the market* to ensure I could keep up the payments on the HELOC for a long time. Interest cost on that $10k would be under $200/year (presuming the extra $10k is sitting in a 1% account) and that's low enough cost for a hedge to prevent me getting screwed by a market continued sideways for years... leaves resilience in the plan.
The really interesting thing about "market timer" in the other thread is that he really didn't try to time the market. He was already 4-5 years into a bull run when he went 200% (800%?) into the market.
He also apparently didn't build resilience into the plan.
*Except I'm currently sitting on an "extra" buffer of cash, so it likely WOULD be the full HELOC amount. The extra cash isn't really sitting idle - it's going from bank to bank for signup bonuses for various accounts. The above illustration was to take the HELOC method in isolation.
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For me, i am at my wealth target, so i dont need to use leverage to fund my retirement. While i have faith in stocks, i have hedged my bets with some portion of tax free muni bonds and cash equivalents like CDs. I would rather lose half my wealth under the worst case scenario, because i would still be fine. Leverage would likely earn money that i dont need. This is why this advice fits someone in the early asset accumulation phase. Some of us dont have a 30 year time horizon anymore anyway. A 90 year old should be spending that stash, not borrowing to invest.
I get what you are saying, as long as you have a balanced portfolio that will meet your needs, why risk it. I also get why it may be a bad idea to invest in many(most) of the typical passive vehicles at this moment in time.
My issue is the logic does not follow for the standard Mustachian portfolio of almost all equities. If someone is concerned about the future long term returns of the S&P, then diversify and don't use leverage. I thinks that's a great idea with current asset prices. However, please don't state market timing is wrong for all of your portfolio, or that a 90/10 portfolio is the best possible at all times for passive portfolio survivability in one breath, then say this plan is wrong in another. If one believes those things to be true, it is impossible to justify not using noncallable, long term, low interest leverage even at today's CAPE.
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Investing is the art of thinking two contradictory thoughts at once: the market may go down and the market may go up. If one cannot think in probabilities, they would be better off in bonds. From a probabilistic point of view, one can balance the risk of leaving years on the table by earning returns that are too low vs. the risk of losing it all in a bear market. The financial markets offer a chance to buy or assemble portfolios at whichever level on the gradient you choose.
There are lottery tickets hidden in the options and futures markets that would make you a millionaire three months from now on a 100k investment. But the risks involved in that gamble are astronomical. Similarly, there are treasury bonds that all but guarantee return of your capital with interest, but they don't pay enough to retire on. Neither extreme is a particularly rational plan for those who want a high-probability escape from financial dependency.
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From a probabilistic point of view, one can balance the risk of leaving years on the table by earning returns that are too low vs. the risk of losing it all in a bear market.
Are you really risking "losing it all" or just delaying FIRE and ending up in an even stronger position as you continue to invest through the bear?
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Investing is the art of thinking two contradictory thoughts at once: the market may go down and the market may go up. If one cannot think in probabilities, they would be better off in bonds. From a probabilistic point of view, one can balance the risk of leaving years on the table by earning returns that are too low vs. the risk of losing it all in a bear market.
This. Human beings, myself included,* are really bad at thinking about risk and probability. We're even worse at thinking about extremely small probabilities of extremely good or extremely bad things.**
This doesn't mean people cannot make good judgement calls when probability and risk is involved, but it takes work, figuring out the best ways to present and think about different types of data and evidence, the best ways to judge ones own tolerance for different types of risk and uncertainty, and not being scared of numbers or thinking quantitatively.
*I mean technically there's no way to prove I'm not an AI, but chat bots aren't that convincing yet ... are they?
**Hence: gambling, fear of flying but not of driving, etc
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This. Human beings, myself included,* are really bad at thinking about risk and probability. We're even worse at thinking about extremely small probabilities of extremely good or extremely bad things.**
This plus cognitive bias is really at the heart of the leverage issue. Someone is willing to put all of there savings in an asset class they truly believe (with good reason) will provide 4+% real returns over the long haul. However, they are not willing to leverage their house on the same premise, even knowing if the assumptions are correct it will seriously compound returns.
"If I'm wrong at least I'm debt free and still have my house". People have a tendency to choose what they believe to be the middle ground, even if it doesn't make logical sense.
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Yes.
While the probability is low, it is there. Optimism and backtesting do not eliminate it. Even T-bills and cash have a risk of 100% loss, under very rare kiss your FIRE goodbye scenarios, as you have pointed out.
If if the US stockmarket goes to zero there will be bigger problems for you to worry about than your retirement being delayed.
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but owing debt at a fixed rate is a very tough place to be.
When that debt is secured by a deflated asset which one can walk away from if up-side-down, then it seems its a tough place for the bank, less so me.
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Extra Credit: Instead of SPY, buy MO in early 2000 and figure return. Yielded 8% at the time and has split into four companies since. (AAPL was all over the place in 99-2000, but say you got in at $50, so 2000 shares but no dividends. That would be 28,000 shares now at $143 or $4 million, but higher carrying cost.)
Or Enron......
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The question for a person leveraged at 4% interest is what happens if market returns do not exceed 4%? The answer is, this account changes by returns minus cost of capital.
The same question could be asked of the unleveraged investor, paying 0% interest: What happens if market returns do not exceed 0%. The answer is, this account changes by returns minus cost of capital.
Plug in various numbers and you will get various profit/loss curves, crossing the zero line at zero market returns for the unleveraged investor and at 4% for the leveraged investor.
The odds of returns being below zero long term are less than the odds of returns being below 4% long term. At 3% ROI, the unlevered investor experiences a +3% change while the levered investor (paying 4% interest to earn 3% ROI) experiences a -1% change.
Yes, if I was 100% certain markets would rise, I would mortgage my house to the hilt and use the proceeds not to go long, but to by call options. This is exactly why people who think in absolutes instead of probabilities go broke.
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I've kind of done it. Nearly paid off house #2, but went back and did an 80% mortgage the next two times I bought. It's also nice peace of mind to have 100k plus in a taxable account, that's a few years worth of a mortgage payment to absorb market volatility
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The question for a person leveraged at 4% interest is what happens if market returns do not exceed 4%? The answer is, this account changes by returns minus cost of capital.
The same question could be asked of the unleveraged investor, paying 0% interest: What happens if market returns do not exceed 0%. The answer is, this account changes by returns minus cost of capital.
Plug in various numbers and you will get various profit/loss curves, crossing the zero line at zero market returns for the unleveraged investor and at 4% for the leveraged investor.
The odds of returns being below zero long term are less than the odds of returns being below 4% long term. At 3% ROI, the unlevered investor experiences a +3% change while the levered investor (paying 4% interest to earn 3% ROI) experiences a -1% change.
Yes, if I was 100% certain markets would rise, I would mortgage my house to the hilt and use the proceeds not to go long, but to by call options. This is exactly why people who think in absolutes instead of probabilities go broke.
if market returns dont excede 4% or in my case my mortgage of 3.25% which is 2.245% adjusted for taxes, then my FIRE plans will fail and many others FIRE plans will fail. I'm already betting on normal market returns on avg for over 50 years of FIRE. its highly unlikely i wont get those returns the first 5 years, on the outside chance i do then variable spending with supplemental jobs and buying and selling to backfill lost income will accomodate that. During the earning phase if one is planning on some version of the 4% rule then its highly detrimental to FIRE date to pay down the mortgage and if the income were to go away it would be safer to have kept the mortgage than a half paid off house, it makes a lot of sense to keep it.
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[...] It's also nice peace of mind to have 100k plus in a taxable account, that's a few years worth of a mortgage payment to absorb market volatility
That may be a false peace of mind and illustrates the biggest (IMO) risk of a levered strategy.
Assuming you're invested in equities you have liquidity exposure: Specifically, let's say your equities go down by 30%. If you're forced to dip into your now $70k account to make payments on your debt, you're going to have to sell depressed stock. Even if the market recovers after a short time and has great overall returns, your forced liquidation can have a severe effect on returns (because you were forced to sell at the worst time possible).
Hedging against this requires maintaining a larger cash (or near-cash) emergency fund, which has a cost itself (not accounted for in calculations I've seen in this thread so far).
Sizing this fund is tough, too, because the market could stay depressed for years.
I'm not saying the leverage investment is necessarily a bad idea, but it's not as simple as just assuming because stock market returns are greater than interest rates, it's a sure thing.
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Assuming you're invested in equities you have liquidity exposure: Specifically, let's say your equities go down by 30%. If you're forced to dip into your now $70k account to make payments on your debt, you're going to have to sell depressed stock.
You could well have paper gains such that a 30% drop still leaves in the black and you only sell if you actually need the money so you may not have to "dip" into these investments at all.
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Assuming you're invested in equities you have liquidity exposure: Specifically, let's say your equities go down by 30%. If you're forced to dip into your now $70k account to make payments on your debt, you're going to have to sell depressed stock.
You could well have paper gains such that a 30% drop still leaves in the black and you only sell if you actually need the money so you may not have to "dip" into these investments at all.
You are correct. But my point was to illustrate a *risk* that wasn't mentioned that you would not have without leverage. This doesn't necessarily make leverage incorrect, as I said, but should be incorporated into one's decision-making when assessing how much risk to assume.
If you're confident in your job or have other ways of covering the additional cash flow to service the debt, you can minimize this risk. If you don't...
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Assuming you're invested in equities you have liquidity exposure: Specifically, let's say your equities go down by 30%. If you're forced to dip into your now $70k account to make payments on your debt, you're going to have to sell depressed stock.
You could well have paper gains such that a 30% drop still leaves in the black and you only sell if you actually need the money so you may not have to "dip" into these investments at all.
You are correct. But my point was to illustrate a *risk* that wasn't mentioned that you would not have without leverage. This doesn't necessarily make leverage incorrect, as I said, but should be incorporated into one's decision-making when assessing how much risk to assume.
If you're confident in your job or have other ways of covering the additional cash flow to service the debt, you can minimize this risk. If you don't...
even in FIRE the faster failure accompanied by having a mortgage presents itself very early. with in the first 5 years and will present itself mortgage or no mortgage. Having a mortgage accelerates failure faster, but historically if one can simply spend 10% less as a floor or make up the 10% you need to reduce your withdrawal by you will be safe forever - based on historic returns. and keeping the mortgage even in this scenario ensures you will not find out you need more income 20-30 years into FIRE - again based on historic returns. for those FIREing in their 30s or 40s making an extra 2-5k depending on spending in a given year shouldnt be much of an issue. for those looking for more traditional "never work again retirement" b/c they found the light much later in life and are in their 50s or 60s for retirement, then they may want to work an extra couple years and pay off the mortgage and save a little extra down to a 3.5% or lower to 100% secure their future based on historic returns. i personally dont consider that FIREing but just retiring but to each their own.