Why Do you do ....... AND pay off your mortgage early?

[FIreDrill]

Time for some number crunching on the scenario presented above.

I'd like everyone to meet Bob.  Bob is a nice dude, like most mustachians, and cant wait to call it quits ASAP and FIRE.

Bob is 35 and his base yearly living expenses are 25k a year, NOT including his Mortgage principal and interest payments.

Bob owns a home worth 250k, he took out a 30 year mortgage on 200k at a nice rate of 4% and he has been accelerating his mortgage payoff.  The balance is now  down to a cool 50k.  Bob also has 625K invested and wonders if he could obtain FIRE via the 4% rule faster if he mortgaged his home or if he paid it off and dropped his expenses.  So he starts crunching numbers.

Scenario 1: Pay off mortgage.
Bob works hard and throws 50k at his mortgage to be mortgage free.
Bob's total expenses are now truly 25k a year which means he needs a stache of 625K giving him a withdrawal rate of 4%

Scenario 2: Refinance at 4% up to 200k and put 200k in the market (150k from the refinance and 50k from Bobs hard work)
Bob works hard and throws 50k at investments.
Bob refinances his home to 200k 30yr @4% and puts the 150k cash out refinance in the market.
Bob's total yearly expenses including the mortgage PRINCIPAL and interest is now at 36,457.
But now Bobs stache is at 825k giving him a withdrawal rate of 4.41%!  WTF?!?!?!?!

But then Bob realizes he included principal payments into his calculation which aren't considered an outflow.  Just a transfer of assets from one account to another (investments to home equity)

So Bob re-runs the numbers using the Average yearly amount of interest paid on the mortgage over a 30 year period.

Bob will pay 143,739 dollars in interest over the 30 year term of the loan.  So he divided that number by 30 in order to get his average yearly mortgage expense of 4,791 and re-runs the scenario.


Scenario 2b: Refinance at 4% up to 200k and put 200k in the market (150k from the refinance and 50k from Bobs hard work)
Bob works hard and throws 50k at investments.
Bob refinances his home to 200k 30yr @4% and puts the 150k cash out refinance in the market.
Bob's total average yearly expenses, over the 30 year term, including ONLY the mortgage interest is now at 29,791.
Now Bobs stache is at 825k but giving him a withdrawal rate of 3.61%! Now that's what I'm talking about!!!

Bob proceeds with scenario 2b and lives a happily FIRE'd life.




Alright, in all seriousness, I was really just curious what the numbers would come out to running it this specific way.  I still highly recommend looking at CFirsim for calculating mortgage pay off verses investing.  To do this, you simply set the term to 30 years, put your mortgage balance of 80% LTV as if you cashed it out for investments, and then your spending is only the principal and interest portion of your Mortgage.  Also, make sure to run this with non-inflation adjusted returns since we know the PI portion of the mortgage will remain fixed over the 30 year term.

If your asset allocation is 100% stocks you should get a 93% success rate with an average ending balance of 400k.. Plus your home is paid off at that point.  Although, I'd just cash out refinance and invest again if rates were at 4%

Frozen bits -  your example hits very close to home. Can you help me understand why to factor in just mortgage interest alone? And not principle part of payment? 

Paying down debt is an outflow. It is not a transfer off assets from one account to another. Paying down debt is very different from investing; these concepts should not be confused.

I'm going to have to respectfully disagree with you on that.  As others have pointed out, a mortgage is a debt backed by an asset that historically increases with inflation.  If this was a loan on a long term depreciating asset I would agree with you, but it's not.  This is not a student loan, car loan, or unsecured debt. It is also a payment that is not affected by inflation and will drop off after the 30 year term.



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[EnjoyIt]

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

did you post this in the other thread or is this someone else b/c this is the second place i've seen this form of badassity.

I've seen this before too.  I would think the AMT would hit before savings of this magnitude could be realized.

My apologies, I thought I tried posting it in this thread and it never registered.  I guess I posted it in the other one.

As for AMT, that person makes enough money to be past AMT and therefor it does not affect them. 

[BoonDogle]

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

did you post this in the other thread or is this someone else b/c this is the second place i've seen this form of badassity.

Now why again is it badass to buy much more house than he needs?  Because he maximized the tax deduction?  Is that better than buying a small home and paying off the mortgage early?  Just sayin.

[boarder42]

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

did you post this in the other thread or is this someone else b/c this is the second place i've seen this form of badassity.

Now why again is it badass to buy much more house than he needs?  Because he maximized the tax deduction?  Is that better than buying a small home and paying off the mortgage early?  Just sayin.

assuming its a HCOL area and house prices in many are increasing very quickly much faster than inflation.  he could be coming out way way ahead with this strategy.  Is it a gamble yes its a bit of a gamble but highly profitable esp. if you REFI alot most likely.  buy a 2MM dollar house that increases at 10%+ a year as many HCOL markets are doing. you have 400k invested and you're making 200k per year on 400k invested in the houses and your effective interest rate is sub 2%.  making intresest around 32k i'd say its extremely badass to leverage the system in this way.

also a 2MM dollar house in San Fran or NYC is probably comprable to MMMs 400k house in boulder.

[Midwest]

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

did you post this in the other thread or is this someone else b/c this is the second place i've seen this form of badassity.

Now why again is it badass to buy much more house than he needs?  Because he maximized the tax deduction?  Is that better than buying a small home and paying off the mortgage early?  Just sayin.

assuming its a HCOL area and house prices in many are increasing very quickly much faster than inflation.  he could be coming out way way ahead with this strategy.  Is it a gamble yes its a bit of a gamble but highly profitable esp. if you REFI alot most likely.  buy a 2MM dollar house that increases at 10%+ a year as many HCOL markets are doing. you have 400k invested and you're making 200k per year on 400k invested in the houses and your effective interest rate is sub 2%.  making intresest around 32k i'd say its extremely badass to leverage the system in this way.

also a 2MM dollar house in San Fran or NYC is probably comprable to MMMs 400k house in boulder.

Unless you are in a non-recourse state and/or $2M represents a reasonable portion of your net worth, that's a huge concentration of risk into 1 asset.  In addition, you only get to deduct interest on the first $1M of mortgage debt.  Lastly, if you are in a high income bracket you may or may not be getting the full interest deduction due to phase outs. 

[BoonDogle]

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

did you post this in the other thread or is this someone else b/c this is the second place i've seen this form of badassity.

Now why again is it badass to buy much more house than he needs?  Because he maximized the tax deduction?  Is that better than buying a small home and paying off the mortgage early?  Just sayin.

assuming its a HCOL area and house prices in many are increasing very quickly much faster than inflation.  he could be coming out way way ahead with this strategy.  Is it a gamble yes its a bit of a gamble but highly profitable esp. if you REFI alot most likely.  buy a 2MM dollar house that increases at 10%+ a year as many HCOL markets are doing. you have 400k invested and you're making 200k per year on 400k invested in the houses and your effective interest rate is sub 2%.  making intresest around 32k i'd say its extremely badass to leverage the system in this way.

also a 2MM dollar house in San Fran or NYC is probably comprable to MMMs 400k house in boulder.

To each his own.  I'm certainly not interested in gambling in the housing market with that much money.  I still think the better way is to buy small, invest the rest, and then whether you pay off your mortgage a little early or refinance indefinitely is just a footnote and not the major strategy of your wealth building.

[BlueHouse]

As for AMT, that person makes enough money to be past AMT and therefor it does not affect them.

Well, I must have a misunderstanding of what the Alternative Minimum Tax (AMT) is then.  Just how much money do you have to earn to move beyond a requirement to keep wealthy taxpayers from using loopholes to avoid paying taxes?  (italicized portion is from Turbotax website). 

[Midwest]

As for AMT, that person makes enough money to be past AMT and therefor it does not affect them.

Well, I must have a misunderstanding of what the Alternative Minimum Tax (AMT) is then.  Just how much money do you have to earn to move beyond a requirement to keep wealthy taxpayers from using loopholes to avoid paying taxes?  (italicized portion is from Turbotax website).

If you are middle high income with a lot of certain types of deductions you pay AMT @ 26% or 28%.  If you are really high income with few deductions relative to your income, you won't pay AMT because you are taxed at a 39.6% rate.

[BlueHouse]

Re: Why Do you do ....... AND pay off your mortgage early?

I do it to troll boarder42.

I love this.  Thanks for the laugh Nora! 

[BlueHouse]

[/quote]

As for AMT, that person makes enough money to be past AMT and therefor it does not affect them.

Well, I must have a misunderstanding of what the Alternative Minimum Tax (AMT) is then.  Just how much money do you have to earn to move beyond a requirement to keep wealthy taxpayers from using loopholes to avoid paying taxes?  (italicized portion is from Turbotax website).

If you are middle high income with a lot of certain types of deductions you pay AMT @ 26% or 28%.  If you are really high income with few deductions relative to your income, you won't pay AMT because you are taxed at a 39.6% rate.

I'm not quite following and don't understand this in relation to the original comment:

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

Isn't your friend claiming the mortgage interest deduction? And if the deduction is so beneficial, then wouldn't that put him into a category where AMT came into play?  Where and how is your friend saving money if he's still paying at the max tax bracket? 
Sorry if I'm being thick, but I must be completely missing the point here.

[Midwest]

As for AMT, that person makes enough money to be past AMT and therefor it does not affect them.

Well, I must have a misunderstanding of what the Alternative Minimum Tax (AMT) is then.  Just how much money do you have to earn to move beyond a requirement to keep wealthy taxpayers from using loopholes to avoid paying taxes?  (italicized portion is from Turbotax website).

If you are middle high income with a lot of certain types of deductions you pay AMT @ 26% or 28%.  If you are really high income with few deductions relative to your income, you won't pay AMT because you are taxed at a 39.6% rate.

I'm not quite following and don't understand this in relation to the original comment:

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

Isn't your friend claiming the mortgage interest deduction? And if the deduction is so beneficial, then wouldn't that put him into a category where AMT came into play?  Where and how is your friend saving money if he's still paying at the max tax bracket? 
Sorry if I'm being thick, but I must be completely missing the point here.

The OP was claiming the govt is picking up half the tab on the giant mortgage and you questioned the impact on AMT.  If you are not into AMT, mortgage interest on debt used to buy, build or improve your home will not put you into AMT.

There is the question of limited itemized deductions that may or my not be relevant.  it's entirely possible the OP's friend is not getting nearly the benefit they think they are due to that.

Here's a basic primer on AMT if you want to understand better - https://turbotax.intuit.com/tax-tools/tax-tips/IRS-Tax-Return/Alternative-Minimum-Tax--Common-Questions/INF12072.html

[BlueHouse]

As for AMT, that person makes enough money to be past AMT and therefor it does not affect them.

Well, I must have a misunderstanding of what the Alternative Minimum Tax (AMT) is then.  Just how much money do you have to earn to move beyond a requirement to keep wealthy taxpayers from using loopholes to avoid paying taxes?  (italicized portion is from Turbotax website).

If you are middle high income with a lot of certain types of deductions you pay AMT @ 26% or 28%.  If you are really high income with few deductions relative to your income, you won't pay AMT because you are taxed at a 39.6% rate.

I'm not quite following and don't understand this in relation to the original comment:

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

Isn't your friend claiming the mortgage interest deduction? And if the deduction is so beneficial, then wouldn't that put him into a category where AMT came into play?  Where and how is your friend saving money if he's still paying at the max tax bracket? 
Sorry if I'm being thick, but I must be completely missing the point here.

The OP was claiming the govt is picking up half the tab on the giant mortgage and you questioned the impact on AMT.  If you are not into AMT, mortgage interest on debt used to buy, build or improve your home will not put you into AMT.

There is the question of limited itemized deductions that may or my not be relevant.  it's entirely possible the OP's friend is not getting nearly the benefit they think they are due to that.

Here's a basic primer on AMT if you want to understand better - https://turbotax.intuit.com/tax-tools/tax-tips/IRS-Tax-Return/Alternative-Minimum-Tax--Common-Questions/INF12072.html

Thanks Midwest.  I have to pay the AMT, and so was wondering how the OP's friend was able to have the type of benefit described without hitting the limits on itemized deductions.  Your wording cleared things up for me.  So basically, I'm still in the camp of "I don't buy it". 

[Midwest]

As for AMT, that person makes enough money to be past AMT and therefor it does not affect them.

Well, I must have a misunderstanding of what the Alternative Minimum Tax (AMT) is then.  Just how much money do you have to earn to move beyond a requirement to keep wealthy taxpayers from using loopholes to avoid paying taxes?  (italicized portion is from Turbotax website).

If you are middle high income with a lot of certain types of deductions you pay AMT @ 26% or 28%.  If you are really high income with few deductions relative to your income, you won't pay AMT because you are taxed at a 39.6% rate.

I'm not quite following and don't understand this in relation to the original comment:

I recently met someone in the 39.6% tax bracket plus 8% state. His family buys a very expensive house and refinances regularly. Because the first few years most of the payments are interest and tax deductible, they are effectively paying about 47.6% less to lease their home from the bank. That is some extreme mortgage holding.

Isn't your friend claiming the mortgage interest deduction? And if the deduction is so beneficial, then wouldn't that put him into a category where AMT came into play?  Where and how is your friend saving money if he's still paying at the max tax bracket? 
Sorry if I'm being thick, but I must be completely missing the point here.

The OP was claiming the govt is picking up half the tab on the giant mortgage and you questioned the impact on AMT.  If you are not into AMT, mortgage interest on debt used to buy, build or improve your home will not put you into AMT.

There is the question of limited itemized deductions that may or my not be relevant.  it's entirely possible the OP's friend is not getting nearly the benefit they think they are due to that.

Here's a basic primer on AMT if you want to understand better - https://turbotax.intuit.com/tax-tools/tax-tips/IRS-Tax-Return/Alternative-Minimum-Tax--Common-Questions/INF12072.html

Thanks Midwest.  I have to pay the AMT, and so was wondering how the OP's friend was able to have the type of benefit described without hitting the limits on itemized deductions.  Your wording cleared things up for me.  So basically, I'm still in the camp of "I don't buy it".

If the mortgage debt exceeds $1M, the interest is non-deductible regardless.  Most people in complicated tax situations don't understand all that because its.. complex.  I was giving you a simplified view of AMT.

[EnjoyIt]

Let's say a person's income is $750K/yr. their effective tax rate will be somewhere in the 33% range even if they deduct $50k in mortgage interest. As for the utilized deduction phase out. I believe it comes out to no different than paying an extra 3% in taxes by not being able to deduct 100% of your deductions. Either way if you make enough earned income your taxes become much higher than what AMT demands.

[Midwest]

Let's say a person's income is $750K/yr. their effective tax rate will be somewhere in the 33% range even if they deduct $50k in mortgage interest. As for the utilized deduction phase out. I believe it comes out to no different than paying an extra 3% in taxes by not being able to deduct 100% of your deductions. Either way if you make enough earned income your taxes become much higher than what AMT demands.

The deduction phase out is the lesser of 3% of the AGI over the threshold or 80% of eligible itemized deductions.  If you are in the 80% camp, you could be losing 80% of the mortgage interest deduction.  Using your $750k of income and $30,000 of mortgage interest, you could lose roughly $13,000 of the deduction under the right circumstances (no other deductions and low tax state comes to mind). 

Under that scenario, their marginal tax savings would be 17/30 x 39.6% = 22%.

[shawndoggy]

The deduction phase out is the lesser of 3% of the AGI over the threshold or 80% of eligible itemized deductions.  If you are in the 80% camp, you could be losing 80% of the mortgage interest deduction.  Using your $750k of income and $30,000 of mortgage interest, you could lose roughly $13,000 of the deduction under the right circumstances (no other deductions and low tax state comes to mind). 

Under that scenario, their marginal tax savings would be 17/30 x 39.6% = 22%.

$30k is a lot of interest!  What if you have a more modest house payment and are paying in the 1000-1500/mo in interest?

[Midwest]

The deduction phase out is the lesser of 3% of the AGI over the threshold or 80% of eligible itemized deductions.  If you are in the 80% camp, you could be losing 80% of the mortgage interest deduction.  Using your $750k of income and $30,000 of mortgage interest, you could lose roughly $13,000 of the deduction under the right circumstances (no other deductions and low tax state comes to mind). 

Under that scenario, their marginal tax savings would be 17/30 x 39.6% = 22%.

$30k is a lot of interest!  What if you have a more modest house payment and are paying in the 1000-1500/mo in interest?

In that scenario at $18,000 of interest, math would be 5/30 x 39.6% = 6%.  The deduction loss in this case stays at $13k because it's based on AGI, not the deduction. 

This is a complete hypothetical.  You could have significant other deductions that eat up the limitation first.  In which case, the result would be different. You need to understand your situation in making these decisions.

[Valhalla]

The 4% rule is based on 30 year periods, so if you have a 30 mortgage that you just took out you should consider the entire P&I payment subjected to the 4% rule.

The 4% rule is also based on annual withdrawals in constant inflation-adjusted dollars, which is not the case for the payment stream required by a mortgage loan's amortization schedule (which is in constant nominal dollars).  That's why the cFIREsim backtest described in the penultimate paragraph of FrozenBits' long post reports a historical success rate for the leveraged-investing-via-mortgage strategy to be in the same ballpark as the historical success rate for a traditional 4% SWR spending plan, even though the portfolio size in the former (i.e., an amount equal to the total outstanding principal amount of the mortgage loan) is significantly less than 25x the initial annual expenditure (i.e., 25x the total annual required mortgage payments).

Damn, this is a huge gem of a post.  I see no one responded to this post, perhaps it was too technical and went over the heads of most people reading this.

This is pretty epic.  You've raised some points that are hard to argue with, especially if people understood what you just said, lol.

I'll wait to see if anyone else understands what you've said and appreciates the magnitude of this post.

[FIreDrill]

Don't believe me, try transferring your assets back into your checking account after you make a payment. I am sure the banker face that you ask would be amusing. 

You mean like accessing the funds via HELOC or Refinance ;)

[PizzaSteve]

The 4% rule is based on 30 year periods, so if you have a 30 mortgage that you just took out you should consider the entire P&I payment subjected to the 4% rule.

The 4% rule is also based on annual withdrawals in constant inflation-adjusted dollars, which is not the case for the payment stream required by a mortgage loan's amortization schedule (which is in constant nominal dollars).  That's why the cFIREsim backtest described in the penultimate paragraph of FrozenBits' long post reports a historical success rate for the leveraged-investing-via-mortgage strategy to be in the same ballpark as the historical success rate for a traditional 4% SWR spending plan, even though the portfolio size in the former (i.e., an amount equal to the total outstanding principal amount of the mortgage loan) is significantly less than 25x the initial annual expenditure (i.e., 25x the total annual required mortgage payments).

Damn, this is a huge gem of a post.  I see no one responded to this post, perhaps it was too technical and went over the heads of most people reading this.

This is pretty epic.  You've raised some points that are hard to argue with, especially if people understood what you just said, lol.

I'll wait to see if anyone else understands what you've said and appreciates the magnitude of this post.

I am glad you had the epiphany, but it is basic and pretty obvious to me.

In laymen terms:

1) the strategies discussed for FIRE rely on portfolio returns 'above x' for a stache of 'size y or greater'  to fuel the income needed to retire.
2) leverage can accellerate the time required for your model to achieve 'size y or greater'
3) optimistic/realistic assumptions about stock returns (depending who you talk to) are critical to the success rates of BOTH the 'leverage is faster' strategy and the 'stache size y is enough to quit early' strategy, because the '4% rule as a historically successful amount' hypothesis relies upon exactly the same general set of financial assumptions as the 'leverage is better than morgage payoff' advice.  They achieve success in the simulations, under specific assumptions.

This seems obvious to me.

The failure rates you will get from simulations will depend on your assumptions.  Similar assumptions drive a somewhat consistent set of best practices.

Different people will want to input different assumptions.  I would suggest various tries based on how conservative you would like to be and what you think you might need as a cushion to survive the likelihood of a black swan, model breaking event is.  It is really a bet on your portfolio strategy and how resilient you think your life situation will be.

Those with kids that want to leave wealth to heirs tend to be more conservative (e.g. want assume t-bill returns, later retirement, lower draw rates, etc.) Those who are young and hell bent to retire at 30 will tend to be agressive (assume market returns, max withdraws) with likely the backup plan to return to work or cut spending.

[Spork]

Debt payments are not normally affected by inflation but they are all outflows of funds. Not just the interest, the entire payment. They are not "transfers of assets." Don't believe me, try transferring your assets back into your checking account after you make a payment. I am sure the banker face that you ask would be amusing. 

This is exactly what happens when you sell the house.

[FIreDrill]

Debt payments are not normally affected by inflation but they are all outflows of funds. Not just the interest, the entire payment. They are not "transfers of assets." Don't believe me, try transferring your assets back into your checking account after you make a payment. I am sure the banker face that you ask would be amusing. 

This is exactly what happens when you sell the house.

Yep....

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[Spork]

Debt payments are not normally affected by inflation but they are all outflows of funds. Not just the interest, the entire payment. They are not "transfers of assets." Don't believe me, try transferring your assets back into your checking account after you make a payment. I am sure the banker face that you ask would be amusing. 

This is exactly what happens when you sell the house.

Yep....

Sent from my SM-G935F using Tapatalk

Transferring money between my checking account and savings account is a very different transaction than selling a house. To sell a house you need a counter party, typically 30+ days for the transaction, and etc. Additionally, you are selling your house so the gross sales price is not affected by the amount of debt on the property, what changes is the amount of money you have to send to the bank to pay-off your loan.

Yes, different than transferring between checking and savings... but you are STILL is transferring an asset.
Yes there are time restrictions.... heck, I've got restrictions moving from my money market account to my checking account.  CDs have even more restrictions.

Selling a stock also requires a counter party and some amount of time for the transaction.  That amount of time is not really anything of consequence if it is a fortune 500 stock.  But, for example, I have a few shares of a privately held stock.  You can offer to sell it exactly once a year.  If no one bids equal to your asking price... it doesn't attempt to sell again until the next year.  But that stock is still an asset (albeit in my case, an asset that isn't worth very much.)

And what changes from month to month is the amount of money you have to send to the bank to pay-off your loan AND the amount of equity you get back in a big fat check. 

[brooklynguy]

Example:

Non-mortgage Expenses 2,000 x 4% = $600,000
Mortgage (P&I) 1,000 x 4.3 = $279,000
Total stash needed for fire = $879,000

If you used a 4% rate on the mortgage you would get $300,000 an immaterial difference when deciding if you are targeting $879,000 or $900,000. That difference of $21,000 equates to a difference in spending of $70 per month. I would argue 4% is in the right ballpark to use to estimate the needed stash including the mortgage (Assuming beginning of 30 year mortgage).

You're comparing apples (a standard 4% SWR spending plan, which has a ~95% historical success rate) and oranges (a leveraged-investing-via-mortgage strategy having a 100% historical success rate).  If you use cFIREsim to find the leveraged-investing-via-mortgage strategy that has an identical historical success rate to a standard 4% SWR spending plan (which is much easier to do using the old CFIREsim site, because the "Investigate" functionality is not yet fully implemented on the new site), you will see that the requisite original portfolio size for the leveraged-investing-via-mortgage strategy is merely 17.28 times (substantially less than 25 times) the amount of the non-inflation-adjusted annual expenditures.  For a mortgage with an interest rate of 4%, that translates into a requisite portfolio size of less than the total principal balance of the mortgage loan, which is drastically less than the nearly 150% of the total principal balance of the mortgage loan that using an approach of "25x the annual expenditures of the mortgage's amortization schedule" would necessitate.

[FIreDrill]

Debt payments are not normally affected by inflation but they are all outflows of funds. Not just the interest, the entire payment. They are not "transfers of assets." Don't believe me, try transferring your assets back into your checking account after you make a payment. I am sure the banker face that you ask would be amusing. 

This is exactly what happens when you sell the house.

Yep....

Sent from my SM-G935F using Tapatalk

Transferring money between my checking account and savings account is a very different transaction than selling a house. To sell a house you need a counter party, typically 30+ days for the transaction, and etc. Additionally, you are selling your house so the gross sales price is not affected by the amount of debt on the property, what changes is the amount of money you have to send to the bank to pay-off your loan.

Yes, selling a house takes time but you will still get your principal payments back. You originally implied that principal pay down should be counted as an expense because you will never have access to that money again, which is obviously not the case....  Also, selling or refinancing a house in this scenario isn't going to be very often.  We are talking about a long term strategy with a 30 year timeline in which we use a debt to leverage our investments.  Realistically, no one in this scenario would want to access the principal pay down nor would they have a reason to assuming they have the value of the home in a taxable investment account.

As far as having debt on a property when I sell it, well I'm not going to give a shit assuming I stick to my plan and have hundreds of thousands in accessible investments.  Plus, the sale price of the property, in most cases, will be higher than the outstanding mortgage, so I wouldn't be sending anything to the bank.  They would be cutting me a check.

[FIreDrill]

Debt payments are not normally affected by inflation but they are all outflows of funds. Not just the interest, the entire payment. They are not "transfers of assets." Don't believe me, try transferring your assets back into your checking account after you make a payment. I am sure the banker face that you ask would be amusing. 

This is exactly what happens when you sell the house.

Yep....

Sent from my SM-G935F using Tapatalk

Transferring money between my checking account and savings account is a very different transaction than selling a house. To sell a house you need a counter party, typically 30+ days for the transaction, and etc. Additionally, you are selling your house so the gross sales price is not affected by the amount of debt on the property, what changes is the amount of money you have to send to the bank to pay-off your loan.

Plus, the sale price of the property, in most cases, will be higher than the outstanding mortgage, so I wouldn't be sending anything to the bank.  They would be cutting me a check.

This shows the misunderstanding perfectly. The bank will never cut you a check when you sell your house, and I mean never. What happens is the buyer cuts you a check and during the closing process that check is split if their is a mortgage.

Haha, ok you got me! Seriously though, my point still holds...  You will still be walking away with the money that you paid towards principal paydown....

[FIreDrill]

Example:

Non-mortgage Expenses 2,000 x 4% = $600,000
Mortgage (P&I) 1,000 x 4.3 = $279,000
Total stash needed for fire = $879,000

If you used a 4% rate on the mortgage you would get $300,000 an immaterial difference when deciding if you are targeting $879,000 or $900,000. That difference of $21,000 equates to a difference in spending of $70 per month. I would argue 4% is in the right ballpark to use to estimate the needed stash including the mortgage (Assuming beginning of 30 year mortgage).

You're comparing apples (a standard 4% SWR spending plan, which has a ~95% historical success rate) and oranges (a leveraged-investing-via-mortgage strategy having a 100% historical success rate).  If you use cFIREsim to find the leveraged-investing-via-mortgage strategy that has an identical historical success rate to a standard 4% SWR spending plan (which is much easier to do using the old CFIREsim site, because the "Investigate" functionality is not yet fully implemented on the new site), you will see that the requisite original portfolio size for the leveraged-investing-via-mortgage strategy is merely 17.28 times (substantially less than 25 times) the amount of the non-inflation-adjusted annual expenditures.  For a mortgage with an interest rate of 4%, that translates into a requisite portfolio size of less than the total principal balance of the mortgage loan, which is drastically less than the nearly 150% of the total principal balance of the mortgage loan that using an approach of "25x the annual expenditures of the mortgage's amortization schedule" would necessitate.

This is a good point but the rate you use really depends on which decision you are trying to make. If you are thinking about the difference between paying off the mortgage and investing to cover the mortgage payment you should use a SWR with 100% chance of success. This is because paying off the mortgage has a 100% success rate of covering your mortgage payment. Actually a SWR of 4.3% is aggressive in that, although it never failed in the past, it could fail in the future where the mortgage pay-off could never fail.

You will never have a SWR of 100%.  There is always a possibility that shit hits the fan and the world implodes.  I would gladly take a several percent risk of not meeting the 30 year withdrawal rate for a 50% chance of coming out 400k ahead after 30 years.

Now to the bolded part.  This is the exact issue many people have with the mindset of paying off a mortgage early versus investing.  If your planning on FIREing on the 4% rule there is basically no reason to argue. You are already betting much more on the accuracy of the 4% rule.

No you are not transferring an asset between buckets or accounts. You are paying off a debt which is a cash outflow, reduction in an asset, and a reduction in a liability. Buying stock is a transfer of assets, between cash and ownership in a company. Any credible accounting textbook will define these transactions as described.

No....  Let's say Bob has a mortgage balance of 200k on a home worth 400k and it is his only asset.

Bobs NW is 200k.

Now lets say Bob is around the middle of a 30 year term and his payment is 1500.  Bob makes the 1500 payment on the first of the month, 750 to interest and 750 to principal.

Bob has an outflow of 1500 but his current mortgage balance has changed to 199,250 while the home is still worth 400k.

Bobs NW is 200,750.

Bob had an outflow of 1500 but 750 of that was mortgage principal pay down which is a transfer from his bank to his home equity.  So I will continue to argue his true outflow is 750 and not 1500.

[JLee]

You will never have a SWR of 100%.  There is always a possibility that shit hits the fan and the world implodes.  I would gladly take a several percent risk of not meeting the 30 year withdrawal rate for a 50% chance of coming out 400k ahead after 30 years.

Now to the bolded part.  This is the exact issue many people have with the mindset of paying off a mortgage early versus investing.  If your planning on FIREing on the 4% rule there is basically no reason to argue. You are already betting much more on the accuracy of the 4% rule.

Your right that a SWR will never have a 100% of success except in the instance of paying-off the mortgage. 100% of the time, paying off your mortgage will eliminate your mortgage payment (P&I).
 
Your risk tolerance is yours to decide.

Keep in mind when we look back at the 115 rolling 30 year periods over last 145 years, paying off the mortgage succeeded in all 115 periods. The 4% rule only succeeded in 109 of the periods. That means that the SWR of 4% failed in 1 in 19 rolling 30 year periods in the past. Is it reasonable to think economic troubles could be as bad in the future as in the past? I believe this is a reasonable possibility and thus paying off your house early or aiming for a SWR below 4% is a rational pursuit.

I would estimate paying off the mortgage early would have an average expected value of $15,500 (In today's dollars) below investing the lump sum, much less than your estimated $400,000.

Assumptions:
$150,000 mortgage
Investor has $150,000 to invest and pay mortgage payment or pay-off mortgage
30 year mortgage
4% interest rate
High end of Vanguards projected stock market returns over the next 10 years
15% tax on investment returns

$107,804.26 interest paid over 30 years.

How do you expect a $150k investment to only return $145,063.84 over a 30 year period?

[Lmoot]

Example:

Non-mortgage Expenses 2,000 x 4% = $600,000
Mortgage (P&I) 1,000 x 4.3 = $279,000
Total stash needed for fire = $879,000

If you used a 4% rate on the mortgage you would get $300,000 an immaterial difference when deciding if you are targeting $879,000 or $900,000. That difference of $21,000 equates to a difference in spending of $70 per month. I would argue 4% is in the right ballpark to use to estimate the needed stash including the mortgage (Assuming beginning of 30 year mortgage).

You're comparing apples (a standard 4% SWR spending plan, which has a ~95% historical success rate) and oranges (a leveraged-investing-via-mortgage strategy having a 100% historical success rate).  If you use cFIREsim to find the leveraged-investing-via-mortgage strategy that has an identical historical success rate to a standard 4% SWR spending plan (which is much easier to do using the old CFIREsim site, because the "Investigate" functionality is not yet fully implemented on the new site), you will see that the requisite original portfolio size for the leveraged-investing-via-mortgage strategy is merely 17.28 times (substantially less than 25 times) the amount of the non-inflation-adjusted annual expenditures.  For a mortgage with an interest rate of 4%, that translates into a requisite portfolio size of less than the total principal balance of the mortgage loan, which is drastically less than the nearly 150% of the total principal balance of the mortgage loan that using an approach of "25x the annual expenditures of the mortgage's amortization schedule" would necessitate.

This is a good point but the rate you use really depends on which decision you are trying to make. If you are thinking about the difference between paying off the mortgage and investing to cover the mortgage payment you should use a SWR with 100% chance of success. This is because paying off the mortgage has a 100% success rate of covering your mortgage payment. Actually a SWR of 4.3% is aggressive in that, although it never failed in the past, it could fail in the future where the mortgage pay-off could never fail.

You will never have a SWR of 100%.  There is always a possibility that shit hits the fan and the world implodes.  I would gladly take a several percent risk of not meeting the 30 year withdrawal rate for a 50% chance of coming out 400k ahead after 30 years.

Now to the bolded part.  This is the exact issue many people have with the mindset of paying off a mortgage early versus investing.  If your planning on FIREing on the 4% rule there is basically no reason to argue. You are already betting much more on the accuracy of the 4% rule.

No you are not transferring an asset between buckets or accounts. You are paying off a debt which is a cash outflow, reduction in an asset, and a reduction in a liability. Buying stock is a transfer of assets, between cash and ownership in a company. Any credible accounting textbook will define these transactions as described.

No....  Let's say Bob has a mortgage balance of 200k on a home worth 400k and it is his only asset.

Bobs NW is 200k.

Now lets say Bob is around the middle of a 30 year term and his payment is 1500.  Bob makes the 1500 payment on the first of the month, 750 to interest and 750 to principal.

Bob has an outflow of 1500 but his current mortgage balance has changed to 199,250 while the home is still worth 400k.

Bobs NW is 200,750.

Bob had an outflow of 1500 but 750 of that was mortgage principal pay down which is a transfer from his bank to his home equity.  So I will continue to argue his true outflow is 750 and not 1500.

Everyone involved in this conversation is smarter than me, but based on what I read here, I agree with Virtus. The principle mortgage is a liability/expense, not a deposit. "Building equity" is not the same thing as increasing a portfolio. Equity is not a savings vehicle, or an asset; it's a marketing ploy which makes paying back a large debt sound appealing. In fact the definition of equity is "the difference between the value of an asset, and the amount owed on a debt. When you contribute to a fund, you are increasing the value. Paying your mortgage increases your equity, but not the value of the property. It may increase your networth, but so does paying down consumer credit card debt.

[shawndoggy]

Keep in mind when we look back at the 115 rolling 30 year periods over last 145 years, paying off the mortgage succeeded in all 115 periods. The 4% rule only succeeded in 109 of the periods. That means that the SWR of 4% failed in 1 in 19 rolling 30 year periods in the past. Is it reasonable to think economic troubles could be as bad in the future as in the past? I believe this is a reasonable possibility and thus paying off your house early or aiming for a SWR below 4% is a rational pursuit.

What does the economy of 1870 have to do with today tho?  Is there any risk at looking at too short of a time horizon where basically you're talking about going from zero education horse and buggy days where people died at 45 to today and saying that the the period that began back then did [____].  Why don't we do a 500 year lookback?  Oh, wait, there wasn't a stock market then?  But how did all of the moustachians retire in the 1700s then?

Methinks there's a lot of confidence in an analysis based on a blink of human history.  Is that rational?

[rpr]

Posting to follow :)

[Scortius]

Keep in mind when we look back at the 115 rolling 30 year periods over last 145 years, paying off the mortgage succeeded in all 115 periods. The 4% rule only succeeded in 109 of the periods. That means that the SWR of 4% failed in 1 in 19 rolling 30 year periods in the past. Is it reasonable to think economic troubles could be as bad in the future as in the past? I believe this is a reasonable possibility and thus paying off your house early or aiming for a SWR below 4% is a rational pursuit.

What does the economy of 1870 have to do with today tho?  Is there any risk at looking at too short of a time horizon where basically you're talking about going from zero education horse and buggy days where people died at 45 to today and saying that the the period that began back then did [____].  Why don't we do a 500 year lookback?  Oh, wait, there wasn't a stock market then?  But how did all of the moustachians retire in the 1700s then?

Methinks there's a lot of confidence in an analysis based on a blink of human history.  Is that rational?

That's the whole point... the world has changed remarkably in 150 years, yet if you plot a stock market index on a semilogy plot, it looks amazingly straight over that period.  It goes to show that over long periods of time across periods of remarkable change, the stock market keeps ticking away.

[JLee]

Keep in mind when we look back at the 115 rolling 30 year periods over last 145 years, paying off the mortgage succeeded in all 115 periods. The 4% rule only succeeded in 109 of the periods. That means that the SWR of 4% failed in 1 in 19 rolling 30 year periods in the past. Is it reasonable to think economic troubles could be as bad in the future as in the past? I believe this is a reasonable possibility and thus paying off your house early or aiming for a SWR below 4% is a rational pursuit.

What does the economy of 1870 have to do with today tho?  Is there any risk at looking at too short of a time horizon where basically you're talking about going from zero education horse and buggy days where people died at 45 to today and saying that the the period that began back then did [____].  Why don't we do a 500 year lookback?  Oh, wait, there wasn't a stock market then?  But how did all of the moustachians retire in the 1700s then?

Methinks there's a lot of confidence in an analysis based on a blink of human history.  Is that rational?

If it doesn't work out and I realize I will run out of money, I'll go back to work.

It's really a simple concept. : )

[shawndoggy]

That's the whole point... the world has changed remarkably in 150 years, yet if you plot a stock market index on a semilogy plot, it looks amazingly straight over that period.  It goes to show that over long periods of time across periods of remarkable change, the stock market keeps ticking away.

Haha no that is actually MY point. 150 years in the arc of human existence is still a pretty short period. In that time span humans' impact on the planet has grown exponentially. I'm not sure I buy that the same level of economic growth will be sustainable in perpetuity.


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[Tyson]

That's the whole point... the world has changed remarkably in 150 years, yet if you plot a stock market index on a semilogy plot, it looks amazingly straight over that period.  It goes to show that over long periods of time across periods of remarkable change, the stock market keeps ticking away.

Haha no that is actually MY point. 150 years in the arc of human existence is still a pretty short period. In that time span humans' impact on the planet has grown exponentially. I'm not sure I buy that the same level of economic growth will be sustainable in perpetuity.


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OK, then what's a better option to put investments into?

[Scortius]

That's the whole point... the world has changed remarkably in 150 years, yet if you plot a stock market index on a semilogy plot, it looks amazingly straight over that period.  It goes to show that over long periods of time across periods of remarkable change, the stock market keeps ticking away.

Haha no that is actually MY point. 150 years in the arc of human existence is still a pretty short period. In that time span humans' impact on the planet has grown exponentially. I'm not sure I buy that the same level of economic growth will be sustainable in perpetuity.

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Exponential economic growth goes back much further than 150 years.  There were commodity and equity markets long before the DJIA.  You can go back to the early 1700s and still piece together a stable exponential curve.  You can go back even farther, although you run into trouble normalizing economies around the 1300s and the 'dark ages'.  Agrarian human civilization is relatively recent (even modern human existence), so yes, a trend over hundreds of years can be seen as a significant indication of sustained stable growth.

If you don't believe in continued world economic growth to the point where you're anticipating sub-4 returns over the next few decades, then I guess paying off your mortgage would be a good idea.  The problem with this line of thinking is that you're trying to looking at the shape of the world economy 30 years from now through the lens of today.  Go to any point in industrialized human history and compare the world economy across a 30 year gap.  The point is that we have no way to even guess at what new innovations, technologies, and entire industries will be around 30 years from now, but we can likely predict that some of the main market drivers 30 years from now will be ones that won't even come into being for another ten or twenty years.  When you invest across the market in its entirety, you aren't just betting that today's companies will be running strong 30 years from now, you will be buying a share of every company to the point where you will pretty much be guaranteed to own a small slice of 'the next big thing'.

This goes back to some of the discussions in the Investor Alley subforum talking about the skewness of the distribution of company market returns.  It turns out that every year, a very small percentage of companies provide a very large portion of your portfolio return.  The catch is that it's almost impossible to guess which ones they will be for a given year, so you simply buy all of them.  I mention this because many people view the market by looking through their own lens of the types of companies available and see a cross section of industry sectors such as 'energy', 'health', 'tech', 'manufacturing', 'communications', 'agriculture', etc.  You look at those sectors and you look to the future and you see a relatively bleak outlook for all the sectors you can think about.  The problem is that you are implicitly ignoring the set of companies that are going to provide the lion's share of market growth over the next decade, because they simply aren't visible yet.  Further, you have absolutely no way of even comprehending the set of companies that will be moving the market 30 years from now.  So, you make the mistake of looking at the market as it is today and projecting that the companies you see will not be able to sustain their growth over the next 30 years, which is true, but you ignore the fact that the next phase of the world economy is already out there getting ready to change the world.  If you invest in index funds, you will own a share of that market as it becomes the next great investment class.

[Car Jack]

Counterpoints:

I paid my mortgage off early and it was the correct thing to do.  Why?  I bought stocks in 87 as the market was crashing, thinking "what could possibly go wrong, it'll come back up".  None of my stocks did.  I turned it into a 90% loss.  Shell shocked, I then went into "guarranteed mode only" and paid debt and mortgage.  For me....if I did not pay towards the mortgage, the money would have sat in a CD.  For me, it was the absolute right thing to do.

The biggest thing is to live below your means and my wife and I, having both paid our own ways through college lived like college students at least 10 years after college ended.  This gave us the means to pay off the mortgage, buy whatever cars we felt like buying, having the money to put the kids through fancypants private college with zero aid and yes.....buy lunch every single day at work.

I know we focus on the little stuff here and yah....the mortgage decision is little stuff compared to spending all the money because it ain't gonna spend itself.  Heck, on my lunchtime walk (after going to Subway and using my points to get a free sub, chips and a soda), I found and picked up 3 pennies.  That's the kind of guy I am.  We spend only 1/3 of our gross income and haven't had a payment for a decade.

[boarder42]

Counterpoints:

I paid my mortgage off early and it was the correct thing to do.  Why?  I bought stocks in 87 as the market was crashing, thinking "what could possibly go wrong, it'll come back up".  None of my stocks did.  I turned it into a 90% loss.  Shell shocked, I then went into "guarranteed mode only" and paid debt and mortgage.  For me....if I did not pay towards the mortgage, the money would have sat in a CD.  For me, it was the absolute right thing to do.

The biggest thing is to live below your means and my wife and I, having both paid our own ways through college lived like college students at least 10 years after college ended.  This gave us the means to pay off the mortgage, buy whatever cars we felt like buying, having the money to put the kids through fancypants private college with zero aid and yes.....buy lunch every single day at work.

I know we focus on the little stuff here and yah....the mortgage decision is little stuff compared to spending all the money because it ain't gonna spend itself.  Heck, on my lunchtime walk (after going to Subway and using my points to get a free sub, chips and a soda), I found and picked up 3 pennies.  That's the kind of guy I am.  We spend only 1/3 of our gross income and haven't had a payment for a decade.

so you bought individual stocks obviously b/c the markets have more than recovered since then.  And the lesson you learned from that was to look for guaranteed returns vs learning the lesson that buying a total stock market index fund would have been better.

and you're picking up pennies .... while quite clearly the math indicates that a mortgage isnt little stuff compared to anything else we advocate doing around here.

To me this is clearly learning the wrong lesson from the mistake you made in 87.

[Tyson]

Just wanted to chime in here and say thanks to boarder22.  Because of this thread (and a few others), I've stopped paying $280 extra to my mortgage every month and re-directed that $$ to a Vanguard Roth IRA VTSAX account.  I'm actually much happier now because my monthly expenses are lower and my savings in the form of cash/investments is up.  That's important for me because I have job instability and being more liquid is a better path.  The math being better is gravy.

[BlueHouse]

Counterpoints:

I paid my mortgage off early and it was the correct thing to do.  Why?  I bought stocks in 87 as the market was crashing, thinking "what could possibly go wrong, it'll come back up".  None of my stocks did.  I turned it into a 90% loss.  Shell shocked, I then went into "guarranteed mode only" and paid debt and mortgage.  For me....if I did not pay towards the mortgage, the money would have sat in a CD.  For me, it was the absolute right thing to do.

The biggest thing is to live below your means and my wife and I, having both paid our own ways through college lived like college students at least 10 years after college ended.  This gave us the means to pay off the mortgage, buy whatever cars we felt like buying, having the money to put the kids through fancypants private college with zero aid and yes.....buy lunch every single day at work.

I know we focus on the little stuff here and yah....the mortgage decision is little stuff compared to spending all the money because it ain't gonna spend itself.  Heck, on my lunchtime walk (after going to Subway and using my points to get a free sub, chips and a soda), I found and picked up 3 pennies.  That's the kind of guy I am.  We spend only 1/3 of our gross income and haven't had a payment for a decade.

so you bought individual stocks obviously b/c the markets have more than recovered since then.  And the lesson you learned from that was to look for guaranteed returns vs learning the lesson that buying a total stock market index fund would have been better.

and you're picking up pennies .... while quite clearly the math indicates that a mortgage isnt little stuff compared to anything else we advocate doing around here.

To me this is clearly learning the wrong lesson from the mistake you made in 87.

GAH!  Boarder42, you have acknowledged in the past that you sometimes come off a bit abrasive.  This is one of those times.  Car Jack identified reasons that his choice was the right one for him at the time.  His choice was between holding on to cash vs. eliminating debt, and within those bounds, he did make a good financial choice, and he made a decision that he was and still is comfortable with. 

WHY don't you just change the title of the thread to:  "Tell me why you made a financial decision, and let me punch you in the gonads while I make myself feel like I'm the smartest guy in the room". 

I'm done listening to your wisdom on why anyone else might have made a sub-optimal choice until you sell your boat and your McMansion and stop accepting no-interest loans from your rich parents.  You come from a place where you do not seem to have any empathy for anyone who is less willing or able to take short term risks.  You only seem to understand risk in a 30-year time period.  It's infuriating.

[FIreDrill]

Counterpoints:

I paid my mortgage off early and it was the correct thing to do.  Why?  I bought stocks in 87 as the market was crashing, thinking "what could possibly go wrong, it'll come back up".  None of my stocks did.  I turned it into a 90% loss.  Shell shocked, I then went into "guarranteed mode only" and paid debt and mortgage.  For me....if I did not pay towards the mortgage, the money would have sat in a CD.  For me, it was the absolute right thing to do.

The biggest thing is to live below your means and my wife and I, having both paid our own ways through college lived like college students at least 10 years after college ended.  This gave us the means to pay off the mortgage, buy whatever cars we felt like buying, having the money to put the kids through fancypants private college with zero aid and yes.....buy lunch every single day at work.

I know we focus on the little stuff here and yah....the mortgage decision is little stuff compared to spending all the money because it ain't gonna spend itself.  Heck, on my lunchtime walk (after going to Subway and using my points to get a free sub, chips and a soda), I found and picked up 3 pennies.  That's the kind of guy I am.  We spend only 1/3 of our gross income and haven't had a payment for a decade.

so you bought individual stocks obviously b/c the markets have more than recovered since then.  And the lesson you learned from that was to look for guaranteed returns vs learning the lesson that buying a total stock market index fund would have been better.

and you're picking up pennies .... while quite clearly the math indicates that a mortgage isnt little stuff compared to anything else we advocate doing around here.

To me this is clearly learning the wrong lesson from the mistake you made in 87.

GAH!  Boarder42, you have acknowledged in the past that you sometimes come off a bit abrasive.  This is one of those times.  Car Jack identified reasons that his choice was the right one for him at the time.  His choice was between holding on to cash vs. eliminating debt, and within those bounds, he did make a good financial choice, and he made a decision that he was and still is comfortable with. 

WHY don't you just change the title of the thread to:  "Tell me why you made a financial decision, and let me punch you in the gonads while I make myself feel like I'm the smartest guy in the room". 

I'm done listening to your wisdom on why anyone else might have made a sub-optimal choice until you sell your boat and your McMansion and stop accepting no-interest loans from your rich parents.  You come from a place where you do not seem to have any empathy for anyone who is less willing or able to take short term risks.  You only seem to understand risk in a 30-year time period.  It's infuriating.

Abrasive? Yeah.... But he has a valid point.  No one on this forum would advocate for picking individual stocks with the majority of their portfolio.  If carjack was invested in the S&P500 during this time, he would have seen about a 33% drop which would have recovered in less than 2 years.  I can only assume carjack did not realize the risk he was taking when he made the decision to bet on single stocks. 

Most members here have very similar investment strategies that rely on highly diversified index funds.  I am personally invested in total US stock market funds, so I compare my mortgage rate to the average return and volatility of that fund.  Most of us in the invest club compare mortgage rates to 30 year average index returns because that is the duration of the debt we are leveraging.  Which makes perfect sense IMO.  Paying off your 30 year 4% mortgage is perfectly fine as long as you realize that, on average, it will return much less than a broad index fund such as VTSMX over that same 30 year period.

I just wish people derived as much emotional satisfaction from investing as they do mortgage pay down.  Emotionally, I use to be on the fence about invest vs. mortgage pay down.  Now I can't get enough of investing.  I love throwing extra money into my brokerage account and I'm actually hoping we get a nice downfall so I can take advantage of cheaper stocks.  I think in a way we are really talking about training our emotions to have the same reaction to investing as they do to debt pay down.  For some people that may be impossible because of the debt they had to dig themselves out of.  They may be so stuck in the emotional satisfaction of debt pay down that they are unable to make the transition to emotional satisfaction through investing.  But, they are going to have to get there eventually.  Might as well start now.

[boarder42]

yeah thats the advice i want in a FIRE Forum. 

invest in bonds b/c in 1987 i invested in individual stocks and they sucked and i lost a lot.  I'm still working today as a matter of fact b/c of my incorrect lesson learning from the time i made a bad investment decision.  annectodotal and poor advice for the general person on these forums. 

[lamil]

correct vs incorrect != optimal vs sub-optimal.

the correct approach for one person will not always match the correct approach for another person.

the most optimal approach will not always be the correct approach for someone.

edit- optimal can also mean most favorable, but using it for the math argument alone above.

[rpr]

Actually people do advocate individual stocks on this forum. The diversity benefit of holding VTSAX instead of 40 stocks, all equally weighted, is practically 0*. The diversity benefit of holding VTSAX instead of 20 stocks, all equally weighted, is hardly noticeable*. As a portfolio grows in size it is more efficient to hold individual stocks instead of index funds due to fees and taxes.

*See A Random Walk Down Wall Street by Burton G. Malkiel

The 15-stock diversification myth

http://www.efficientfrontier.com/ef/900/15st.htm

[boarder42]

Counterpoints:

I paid my mortgage off early and it was the correct thing to do.  Why?  I bought stocks in 87 as the market was crashing, thinking "what could possibly go wrong, it'll come back up".  None of my stocks did.  I turned it into a 90% loss.  Shell shocked, I then went into "guarranteed mode only" and paid debt and mortgage.  For me....if I did not pay towards the mortgage, the money would have sat in a CD.  For me, it was the absolute right thing to do.

The biggest thing is to live below your means and my wife and I, having both paid our own ways through college lived like college students at least 10 years after college ended.  This gave us the means to pay off the mortgage, buy whatever cars we felt like buying, having the money to put the kids through fancypants private college with zero aid and yes.....buy lunch every single day at work.

I know we focus on the little stuff here and yah....the mortgage decision is little stuff compared to spending all the money because it ain't gonna spend itself.  Heck, on my lunchtime walk (after going to Subway and using my points to get a free sub, chips and a soda), I found and picked up 3 pennies.  That's the kind of guy I am.  We spend only 1/3 of our gross income and haven't had a payment for a decade.

so you bought individual stocks obviously b/c the markets have more than recovered since then.  And the lesson you learned from that was to look for guaranteed returns vs learning the lesson that buying a total stock market index fund would have been better.

and you're picking up pennies .... while quite clearly the math indicates that a mortgage isnt little stuff compared to anything else we advocate doing around here.

To me this is clearly learning the wrong lesson from the mistake you made in 87.

GAH!  Boarder42, you have acknowledged in the past that you sometimes come off a bit abrasive.  This is one of those times.  Car Jack identified reasons that his choice was the right one for him at the time.  His choice was between holding on to cash vs. eliminating debt, and within those bounds, he did make a good financial choice, and he made a decision that he was and still is comfortable with. 

WHY don't you just change the title of the thread to:  "Tell me why you made a financial decision, and let me punch you in the gonads while I make myself feel like I'm the smartest guy in the room". 

I'm done listening to your wisdom on why anyone else might have made a sub-optimal choice until you sell your boat and your McMansion and stop accepting no-interest loans from your rich parents.  You come from a place where you do not seem to have any empathy for anyone who is less willing or able to take short term risks.  You only seem to understand risk in a 30-year time period.  It's infuriating.

Abrasive? Yeah.... But he has a valid point.  No one on this forum would advocate for picking individual stocks with the majority of their portfolio.  If carjack was invested in the S&P500 during this time, he would have seen about a 33% drop which would have recovered in less than 2 years.  I can only assume carjack did not realize the risk he was taking when he made the decision to bet on single stocks. 

Actually people do advocate individual stocks on this forum. The diversity benefit of holding VTSAX instead of 40 stocks, all equally weighted, is practically 0*. The diversity benefit of holding VTSAX instead of 20 stocks, all equally weighted, is hardly noticeable*. As a portfolio grows in size it is more efficient to hold individual stocks instead of index funds due to fees and taxes.

A $10,000,000 portfolio in VTSAX will generate $5,000 per year in fees every year forever. Their is no fee or cost to hold individual stocks, only a fee per transaction. If you make one stock transaction per month at Vanguard with a large portfolio it is free. Even with a small portfolio it is only $7 per trade, $84 per year assuming one transaction per month. Additionally, mutual funds can generate realized gains due to turnover. Individual stocks allow you to defer realized gains completely until you sell. 

However, most people use and recommend index funds because they are easy, simple, and relatively cheap. They also don't under-perform the market, for that matter they don't out-perform the market either.

*See A Random Walk Down Wall Street by Burton G. Malkiel

quite obviously that book was not what carjack was following to select assets if their conclusion was to never hold equities and continue working for over 30 years (i assume they're still working based on the spending 1/3rd of income statement) 

[rpr]

Actually people do advocate individual stocks on this forum. The diversity benefit of holding VTSAX instead of 40 stocks, all equally weighted, is practically 0*. The diversity benefit of holding VTSAX instead of 20 stocks, all equally weighted, is hardly noticeable*. As a portfolio grows in size it is more efficient to hold individual stocks instead of index funds due to fees and taxes.

*See A Random Walk Down Wall Street by Burton G. Malkiel

The 15-stock diversification myth

http://www.efficientfrontier.com/ef/900/15st.htm

Interesting article that basically confirms Mr. Malkiel's claim that you can obtain most of the benefits of diversification with 15 stocks.

From the article:

So, yes, Virginia, you can eliminate nonsytematic portfolio risk, as defined by Modern Portfolio Theory, with a relatively few stocks. It’s just that nonsystematic risk is only a small part of the puzzle. Fifteen stocks is not enough. Thirty is not enough. Even 200 is not enough. The only way to truly minimize the risks of stock ownership is by owning the whole market.

[Scortius]

Actually people do advocate individual stocks on this forum. The diversity benefit of holding VTSAX instead of 40 stocks, all equally weighted, is practically 0*. The diversity benefit of holding VTSAX instead of 20 stocks, all equally weighted, is hardly noticeable*. As a portfolio grows in size it is more efficient to hold individual stocks instead of index funds due to fees and taxes.

*See A Random Walk Down Wall Street by Burton G. Malkiel

Picking 15 across a broad range of
The 15-stock diversification myth

http://www.efficientfrontier.com/ef/900/15st.htm

Interesting article that basically confirms Mr. Malkiel's claim that you can obtain most of the benefits of diversification with 15 stocks.

This also goes back to the nature of the skewness of the distribution of stock market returns.  Annual portfolio gains will be dominated by a small number of highly performant stocks, but you will have a very hard time picking out the lucky few.  Look at the final chart in that link.  Given that the mean was stated to be 24.15%, the median of those picks is appears to be significantly below that value.  Now, it may seem like being a few points below a 24% return isn't a big deal, but those extra points count for a hell of a lot once you go through a market correction.  You simply can't afford to miss out on the maximum gains of a bull market if you want your portfolio to have a reasonable return.

Finally, you can't claim that paying off a mortgage was correct because the only other option was to invest in individual stocks.  The ability to invest in index funds was available in 1987 as well, even if it wasn't known to a specific person.  Ignorance of a better option doesn't make the realization of a worse option correct, especially when we're discussing how to be aware of the trade-offs between the options today.

[FIreDrill]

Counterpoints:

I paid my mortgage off early and it was the correct thing to do.  Why?  I bought stocks in 87 as the market was crashing, thinking "what could possibly go wrong, it'll come back up".  None of my stocks did.  I turned it into a 90% loss.  Shell shocked, I then went into "guarranteed mode only" and paid debt and mortgage.  For me....if I did not pay towards the mortgage, the money would have sat in a CD.  For me, it was the absolute right thing to do.

The biggest thing is to live below your means and my wife and I, having both paid our own ways through college lived like college students at least 10 years after college ended.  This gave us the means to pay off the mortgage, buy whatever cars we felt like buying, having the money to put the kids through fancypants private college with zero aid and yes.....buy lunch every single day at work.

I know we focus on the little stuff here and yah....the mortgage decision is little stuff compared to spending all the money because it ain't gonna spend itself.  Heck, on my lunchtime walk (after going to Subway and using my points to get a free sub, chips and a soda), I found and picked up 3 pennies.  That's the kind of guy I am.  We spend only 1/3 of our gross income and haven't had a payment for a decade.

so you bought individual stocks obviously b/c the markets have more than recovered since then.  And the lesson you learned from that was to look for guaranteed returns vs learning the lesson that buying a total stock market index fund would have been better.

and you're picking up pennies .... while quite clearly the math indicates that a mortgage isnt little stuff compared to anything else we advocate doing around here.

To me this is clearly learning the wrong lesson from the mistake you made in 87.

GAH!  Boarder42, you have acknowledged in the past that you sometimes come off a bit abrasive.  This is one of those times.  Car Jack identified reasons that his choice was the right one for him at the time.  His choice was between holding on to cash vs. eliminating debt, and within those bounds, he did make a good financial choice, and he made a decision that he was and still is comfortable with. 

WHY don't you just change the title of the thread to:  "Tell me why you made a financial decision, and let me punch you in the gonads while I make myself feel like I'm the smartest guy in the room". 

I'm done listening to your wisdom on why anyone else might have made a sub-optimal choice until you sell your boat and your McMansion and stop accepting no-interest loans from your rich parents.  You come from a place where you do not seem to have any empathy for anyone who is less willing or able to take short term risks.  You only seem to understand risk in a 30-year time period.  It's infuriating.

Abrasive? Yeah.... But he has a valid point.  No one on this forum would advocate for picking individual stocks with the majority of their portfolio.  If carjack was invested in the S&P500 during this time, he would have seen about a 33% drop which would have recovered in less than 2 years.  I can only assume carjack did not realize the risk he was taking when he made the decision to bet on single stocks. 

Actually people do advocate individual stocks on this forum. The diversity benefit of holding VTSAX instead of 40 stocks, all equally weighted, is practically 0*. The diversity benefit of holding VTSAX instead of 20 stocks, all equally weighted, is hardly noticeable*. As a portfolio grows in size it is more efficient to hold individual stocks instead of index funds due to fees and taxes.

A $10,000,000 portfolio in VTSAX will generate $5,000 per year in fees every year forever. Their is no fee or cost to hold individual stocks, only a fee per transaction. If you make one stock transaction per month at Vanguard with a large portfolio it is free. Even with a small portfolio it is only $7 per trade, $84 per year assuming one transaction per month. Additionally, mutual funds can generate realized gains due to turnover. Individual stocks allow you to defer realized gains completely until you sell. 

However, most people use and recommend index funds because they are easy, simple, and relatively cheap. They also don't under-perform the market, for that matter they don't out-perform the market either.

*See A Random Walk Down Wall Street by Burton G. Malkiel

Under your example the amount of money most people would be giving up in trade fees for a 20 fund portfolio would be absolutely ridiculous, especially in the accumulation phase.

You would pay $140 in just trade fees to establish your 20 fund portfolio.  Then you would be hit with additional trading fees every time you acquire more stock.  I currently purchase additional shares an average of 6 times a month, which would result in $42 a month just in trade fees.  That would be $500 a year I would be giving up in trade fees alone when starting from a balance of 0.....

You could go to a discount broker with much lower fees like IB though...

Either way, 20 stocks is in no way what I would consider a well diversified portfolio.  If one of those stocks tanks then you will see a significant decrees.  Likewise, if one goes an a bull you will also be set for a nice gain.  VTSAX on the other hand is right where I want to be because it offers some exposure to mid and small cap stocks.  I think there are strong arguments for keeping small/mid cap stocks in your portfolio but you have to do this on a very diversified basis.

That being said, I will happily pay 5k a year in fees when my portfolio reaches 10,000,000 ;)

Plus, It will be much easier to manage :)

[daschtick]

So, what I am hearing is that I should go out, and take a $200k mortgage on my paid off house, and stick it in the stock market in hopes of making an additional 3%, or else be face punched?

Sorry, but this not a one size fits all proposition.  In my 20's, 30's, and early 40's I did have 30 year mortgages, and simultaneously invested 16% into my 401k during this time.  This made a lot of sense, as I had 30 years of potential market gains to take advantage of.   However, now that I am turning 50, and considering retirement in a few years,and I still have my entire 401k invested in index funds, I consider my paid off house and pension as my stable investments.

I fully realize that there is potential to make more money throwing everything I have into the market, however, my risk tolerance is becoming somewhat reduced, as I prefer the security of these lower performing investments over maximizing retruns.

One of the greatest tenants of MMM is 'ENOUGH'.  The idea of increasing your buffer far beyond what you truly need does not make sense, as you already have enough.  Since I already have enough, I'll take a nice size helping of stability, thank you.

[FIreDrill]

Counterpoints:

I paid my mortgage off early and it was the correct thing to do.  Why?  I bought stocks in 87 as the market was crashing, thinking "what could possibly go wrong, it'll come back up".  None of my stocks did.  I turned it into a 90% loss.  Shell shocked, I then went into "guarranteed mode only" and paid debt and mortgage.  For me....if I did not pay towards the mortgage, the money would have sat in a CD.  For me, it was the absolute right thing to do.

The biggest thing is to live below your means and my wife and I, having both paid our own ways through college lived like college students at least 10 years after college ended.  This gave us the means to pay off the mortgage, buy whatever cars we felt like buying, having the money to put the kids through fancypants private college with zero aid and yes.....buy lunch every single day at work.

I know we focus on the little stuff here and yah....the mortgage decision is little stuff compared to spending all the money because it ain't gonna spend itself.  Heck, on my lunchtime walk (after going to Subway and using my points to get a free sub, chips and a soda), I found and picked up 3 pennies.  That's the kind of guy I am.  We spend only 1/3 of our gross income and haven't had a payment for a decade.

so you bought individual stocks obviously b/c the markets have more than recovered since then.  And the lesson you learned from that was to look for guaranteed returns vs learning the lesson that buying a total stock market index fund would have been better.

and you're picking up pennies .... while quite clearly the math indicates that a mortgage isnt little stuff compared to anything else we advocate doing around here.

To me this is clearly learning the wrong lesson from the mistake you made in 87.

GAH!  Boarder42, you have acknowledged in the past that you sometimes come off a bit abrasive.  This is one of those times.  Car Jack identified reasons that his choice was the right one for him at the time.  His choice was between holding on to cash vs. eliminating debt, and within those bounds, he did make a good financial choice, and he made a decision that he was and still is comfortable with. 

WHY don't you just change the title of the thread to:  "Tell me why you made a financial decision, and let me punch you in the gonads while I make myself feel like I'm the smartest guy in the room". 

I'm done listening to your wisdom on why anyone else might have made a sub-optimal choice until you sell your boat and your McMansion and stop accepting no-interest loans from your rich parents.  You come from a place where you do not seem to have any empathy for anyone who is less willing or able to take short term risks.  You only seem to understand risk in a 30-year time period.  It's infuriating.

Abrasive? Yeah.... But he has a valid point.  No one on this forum would advocate for picking individual stocks with the majority of their portfolio.  If carjack was invested in the S&P500 during this time, he would have seen about a 33% drop which would have recovered in less than 2 years.  I can only assume carjack did not realize the risk he was taking when he made the decision to bet on single stocks. 

Actually people do advocate individual stocks on this forum. The diversity benefit of holding VTSAX instead of 40 stocks, all equally weighted, is practically 0*. The diversity benefit of holding VTSAX instead of 20 stocks, all equally weighted, is hardly noticeable*. As a portfolio grows in size it is more efficient to hold individual stocks instead of index funds due to fees and taxes.

A $10,000,000 portfolio in VTSAX will generate $5,000 per year in fees every year forever. Their is no fee or cost to hold individual stocks, only a fee per transaction. If you make one stock transaction per month at Vanguard with a large portfolio it is free. Even with a small portfolio it is only $7 per trade, $84 per year assuming one transaction per month. Additionally, mutual funds can generate realized gains due to turnover. Individual stocks allow you to defer realized gains completely until you sell. 

However, most people use and recommend index funds because they are easy, simple, and relatively cheap. They also don't under-perform the market, for that matter they don't out-perform the market either.

*See A Random Walk Down Wall Street by Burton G. Malkiel

Under your example the amount of money most people would be giving up in trade fees for a 20 fund portfolio would be absolutely ridiculous, especially in the accumulation phase.

You would pay $140 in just trade fees to establish your 20 fund portfolio.  Then you would be hit with additional trading fees every time you acquire more stock.  I currently purchase additional shares an average of 6 times a month, which would result in $42 a month just in trade fees.  That would be $500 a year I would be giving up in trade fees alone when starting from a balance of 0.....

You could go to a discount broker with much lower fees like IB though...

Either way, 20 stocks is in no way what I would consider a well diversified portfolio.  If one of those stocks tanks then you will see a significant decrees.  Likewise, if one goes an a bull you will also be set for a nice gain.  VTSAX on the other hand is right where I want to be because it offers some exposure to mid and small cap stocks.  I think there are strong arguments for keeping small/mid cap stocks in your portfolio but you have to do this on a very diversified basis.

That being said, I will happily pay 5k a year in fees when my portfolio reaches 10,000,000 ;)

Plus, It will be much easier to manage :)

I am not advocating and do not use a portfolio of individual stocks. My point is their is a legitimate argument to using that strategy and some people do use this strategy.

Good to know.

I personally have not seen this strategy advocated on this forum, at least not from a decent amount of mustachians.

Usually the 20 stock portfolio strategies that I've seen come up revolve around chasing dividend stocks which is a whole other topic.

It seems the majority here are index investors.  Would make for a good poll though!

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