Why not borrow at 4% and put it all into S and P?

[Retire-Canada]

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?

[maizefolk]

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

[Classical_Liberal]

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.

[Retire-Canada]

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.

[Classical_Liberal]

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.

[Car Jack]

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......

[ChpBstrd]

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.

[chasesfish]

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

[boarder42]

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. 

[ulrichw]

[...] 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.

[Retire-Canada]

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.

[ulrichw]

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...

[boarder42]

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.