I do, and am therefore surprised to see this video. I have not been paying off my mortgage, not because of the higher returns but because of diversification. If they put all that money in that one home, they are undiversifying their portfolio. can you explain why this isnt the case?
@@samreinstein2872 Didn't you already make that diversification decision when you bought your home? I mean you could just rent and not buy a home in the first place (or buy a smaller condo). Putting money to pay off your mortgage is not putting more money into real estate, its just putting money into a negative yielding bond.
Thanks for the high quality content of this channel! I definitely agree that keeping a mortgage is equivalent to holding a negative yielding bond. Thus, I view paying down a mortgage versus buying bonds to be roughly equivalent investments with fairly similar yields, though paying down a mortgage has zero volatility (and therefore zero correlation with all other asset classes). Currently in my early 30s, I allocate 20% of my annual investment contributions to paying down a mortgage and 80% to a 100% stock portfolio. My only hesitation with this strategy compared to buying bonds is the lack of liquidity for rebalancing in market downturns. Right now, that's not a problem as I can simply rebalance with new contributions. In time, my stock portfolio will outgrow my income (I hope!) and I will not be able to rebalance entirely with new contributions as I might with bonds. How do you think about this tradeoff and the use of mortgage prepayment and bonds throughout an investment lifetime?
I hope people realize that this is arguably the top 1% of all informative financial videos on this platform. Great content - i expect this page to explode in 2019. Well done
For younger people (ie under 40) I'd both keep the mortgage and go with a 100% equity portfolio. Just make sure you also have a 6 month emergency fund ready.
I sold my expensive home back in late 2006 and bought a smaller home cash. All I can say is not having a mortgage allowed me to take on more with my life because I had no fear of being homeless. I started my own business. Then I used that money to start buying rental homes during the crash. Now I use the rent money to buy stocks. I basically went from being worth 150K in 2006 to 1.8M in 2019 and semi retired now at age 52
I usually explain it a bit simpler: imagine you live in a paid off home, would you mortgage it to invest in stocks (or bonds as you suggest)? For many people that explanation breaks them out of the mental accounting problem.
With interest rates currently below 3%, yes. If mortgage rates were anywhere near "normal", then no. We live in a really squirrelly economy right now. Normally, I would never justify leverage for passive investing.
@paula I'm curious, how old are you? I've lived long enough to know how leverage can break you in multiple ways. Of course, you might get lucky. Some gamblers do.
@@iandrake4683 The current interest rate is 3-6%, using Smith maneuver by borrowing against the home equity using a HELOC and investing the money from HELOC to invest in a non-registered account makes a lot of sense at this time.
@@kyrie4451 I understand the basic math. It's the more complex math where the problem lies. All rates of return are not equal. For instance, would you rather a guaranteed 3% return with a standard deviation of 0, or an average 4% return with a standard deviation of 9%. Things get a lot more complicated then. Let's say you borrowed heavily against your house at 3% in February of 2020 and put it all in the market. Then you experienced a negative return 3 standard deviations below the average because of an unexpected event. This unexpected event also negatively effects the economy to the point you lose your job. Now you have no income, mortgage payments, and a portfolio worth 23% less than it was when you started. Now you have to start selling low, for cashflow, to pay your bills. I've seen this movie before in 2008. When people start doing this (often called dumb money) the smart money leaves the room.
I've been watching Ben's content backwards these last couple months. Factor tilts and this video are the two things that have truly shocked me. Thank you for your work making this channel and the RR podcast!
Great way to think about mortgage debt! I was able to payoff my mortgage last year after owning for 10 years. Now I use that extra cashflow to invest in 100% equity portfolio long term.
This is great content, thanks Ben! I’ve been in both positions at times, the forced-savings effect of making mortgage payments was far easier on us than committing to save the equivalent. I know that’s an ‘us’ problem, just throwing out human nature as a factor. Thanks again, super video!
The problem in including mortgage in our portfolio asset is also that a bond is liquid asset while a house is pretty illiquid. The only way you could use your home would be through getting HELOC or reverse mortgage and I don't know how much better off that would be vs renting and having bond allocation. I would love to see more video regarding incorporating other assets such as house into the portfolio calculations.
Exactly. My neighbors like having a house because they can take out a HELOC, which to me makes no sense. A HELOC is just exchaning one form of debt to another. It's much better to just have liquid assets like stocks and bonds for money when you need it.
As you know there are financial advisers out there that highly recommend leveraging your home to increase your portfolio, even to the point of suggesting you're crazy not to. It would seem that more often than not this probably serves their interests more than their clients. Every time I watch one of your videos it gives me a new perspective, a more informed one! It's just about time for a serious conversation, I'll reach out soon.
I have experienced this "advice" myself (advised to re-mortgage home to invest more into markets). I already had investments (stocks and bonds) worth four times the value of the property. Seemed like crazy advice at the time - now I can understand/explain why. Thanks and please keep making videos. The quality of your analyses appears to be unmatched on TH-cam. I can not understand why your videos don't get more views - so much useless garbage gets so many views and these gems get so little love.
I'd just explain this as, "Would you borrow money at, say, 4% interest, to invest it for possibly a 6% return?" It comes down to the amount of risk you're willing to take, on your time-horizon, et cetera - the same factors as in really any investing decision.
I was fortunate to have a small mortgage so paid it off very early and started investing in a low-cost Vanguard index fund. I'm now looking to invest in small cap stocks and value stocks to capture some of the benefits this would give me. As for investing in bonds, well, I currently pay into my NHS pension and since this is financed through a mix of general taxation and the issuing of UK treasury bonds, I'd say the monthly contribution to my pension is all the stability i need should all my equity investments not pan out as I like. Besides, considering I don't have a mortgage or any other debt investing in the markets helps me to achieve one of my most-cherished dream which is to set up my own scholarship fund to promote the values and principles of community education. It's something I might not be able to achieve without taking on the risks and benefits of investing in equity.
Interesting.. You could also change the question around. “If you did not have a mortgage, would you take one in order to increase your portfolio?” If the answer is no, then paying off mortgage is sensible. Another aspect is that paying off mortgage frees-up more cash flow. Not having these monthly payment is nice.
This is an awesome video, thanks. Just three things: (i) I think the liquidity premium should be taken into account too. Property is illiquid while bonds are liquid. You may sacrifice certain return in exchange for liquidity, which can even make investing in bonds safer, and (ii) the low/negative correlation of bonds and equity returns. If there is a market crash, bonds would go up in value, my mortgage would go (theoretically) down in value but that value can’t be realised.
Thanks for the vid and valuable information! The reason that someone would not pay off its mortgage is that the money stuck in your house is not fluid. In other words if towards the end of someones life you still want to stay in your home and at the same time have money available to live you better keep your mortgage.
Really glad you enjoyed the video! That is false. Home equity is always accessible through a home equity line of credit, a traditional mortgage (at refinancing hopefully), or over age 55 through a reverse mortgage. If you pay off your mortgage as part of your overall asset allocation as I described in the video, you could still access the capital if needed.
@@BenFelixCSI Thanks a lot for your response. However I do not really follow your logic, nor are the terms/financial products "home equity line of credit" and "reverse mortgage" known to me. Maybe these financial products do not exist in Europe. Once my money is in the bricks and I want to stay between these bricks, I am not able to get the money out again. There is one exception which is called "silver montage". Maybe this is somewhat comparable to what you call "reverse mortgage". With the "silver mortgage" you can sell a part of your house to a financial institution and then lease/rent it back. However the interest rate you pay is outrages high and does not make it really sensible.
Interesting. Apologies, I did not realize that you are in Europe. The examples of accessing home equity that I gave were for Canadian residents. Unfortunately I do not know enough to draw comparisons to financial products that may be available in Europe. It is possible that where you are, paying off the mortgage would not be sensible for the reasons that you initially gave.
I sincerely appreciate these videos, being a professional in investing and wealth management myself. The analysis in this video is similar to an ALM perspective on an individual's total balance sheet. This touch upon the specific ALM perspectives of interest rate risk and equity risk and the conclusions are correct. However, another perspective would be the liquidity risk for the total portfolio. And there, the funding may very well have a longer commitment than the bond assets. This means that it may be wise to loan money with a loan committment, and placing it as liquidity. You never know when you may need liquidity. Also, getting older, new financing may be harder to achieve without a salary to back the mortgage and interest payments. Then you end up with a real estate asset, amortized, that has a low liquidity.
Thanks - this has been my philosophy but I have not seen many folks talk about it this way. When looking at my asset allocation, i include the mortgage as a negative against my bond portfolio and adjust my asset allocation accordingly. There are two reasons I haven't paid it off - i was aggressively paying it off out of my income but not out of savings until TBills started paying more after taxes than my mortgage. While this holds, it doesn't make fiscal sense to pay it off from savings as long as my asset allocation strategy accounts for it. Plus, we'll probably sell within 5-10 years.
Interesting analysis - well illustrated! Personally, I generally prefer to rent and invest in an 80-90% equity portfolio. I just don't like the idea of tying up so much wealth in an illiquid asset. I know you've covered renting vs. owning a home in previous videos, though. Cheers, Doug
I would think there are a few reasons why it is better for some to rent than own, such as not enough down payment, chance of relocation for job or family. But I think the idea of having your largest monthly expense eventually gone, with something to show for it in an asset that increases in value tax free is too compelling for me. You could also throw in pride of ownership, the ability to garden, do improvements & renos,have gatherings & BBQ are much easier in your home as opposed to someone else's.
Great video! I think the situation needs to be looked at carefully. Bonds are liquid, the home is illiquid. If you can repay the mortgage in full by selling the bonds, the argument makes total sense. If you can only repay part of the mortgage, you still have liquidity (repayment) risk, for example if you lose your job, and having at least some bonds can come handy. While one should have some spare cash for emergencies, having bonds can provide an additional return without sacrificing liquidity.
What about mortgage rates being under 2% for five year fixed? Still better to pay down debt rather than invest? Would a government pension also be reason to max risk with few bonds and 95% equity indexing? Thanks
Amazing content. Never thought of it this way. It’s funny that Dave Ramsey gives this same advise of all equity investing and pay o ff your ‘dang’ mortgage but he doesn’t really know the why like you explain. It’s just something he has come to from experience. Kinda like how Buffet was doing factor investing before we knew what factor investing really was. He just had the experience that value investing would get better returns. Again really appreciate these amazing videos. I feel like I’m getting a graduate level education in finance and economics for free. Do you ever plan on teaching at the university level?
Ben has a great vid discussing Ramsey's investing advice. While Ramsey's investing advice is dubious, much of his general financial advice is sound. Paying off a mortgage sooner than later is an example.
Another great episode. Currently I have about 90/10 equity/bond investments. Considering this it makes sense for me to make an additional mortgage principal payment since this has the same practical effect as increasing bond diversification while reducing debt.
Ben, The only exception to your recommendation would be if you are comfortable being a leveraged investor. If you believe in leverage and want to use leverage to invest in stocks then HELOC is the cheapest way to access capital with the lowest cost of capital. Without a mortgage, I am unsure if you could get access to cheap HELOC capital. But I agree it changes the risk profile. Also its hard to think of a 50% stock 50% bond portfolio in today's climate of interest environment (given any investment horizon) and what we know of the possible trajectory of the interest rate regime going forward. But it does help to illustrate your point.
Hi Ben, thanks for the wonderful and informative videos. I have been keenly watching your content and even though they provide really good value for the time, the only small problem for me is the absence of more visuals. I feel like adding more animation or visuals will certainly makes the videos more interesting and easy to understand for audience like me who are not so used to hear so many numbers in one sentence. lol. Just a suggestion! Cheers mate!
I've had this thought too. The information is great, but it's sometimes difficult to absorb it all in real time. Having the core information on the screen most of the time (almost like a powerpoint) would help more than animations that are just visually pleasing.
So if understand, paying down the mortgage and not having to pay the interest is like a risk free investment that earns interest of the mortgage rate (money you didn’t have to pay out) hence because of that “safe” investment you just made, you can increase your risk exposure with your stock portfolio to balance out your overall risk exposure... is that right?
exactly, elephant in the room. i dont see any point to ever carry bonds, basically. so he sets up kind of strawman portfolio, then knocks it down. i have a 5% mortage (signed in 2k10 before rates went so low). i had a portfolio (all stocks) roughly equivalent to the remainder on my mortgage 1 yr ago pre covid. When covid hit, obviously it plummeted, to well below mortgage principal. At that time, buffeted by the psychology of seeing massive daily stock losses, I seriously considering pulling everything out of my portfolio and applying it to the house. Which would have still left the house well short of paid off, but I desired certainty. Now just one year post covid, my portfolio has skyrocketed again well past the principal remaining on the home. I could pay the house off completely today and still have a fair bit left over. One year ago, I could have applied the entire portfolio to the home loan principle, and still come out a fair bit short of paying off the house. Had I made a bad decision in the midst of covid, I would have massively screwed myself. Another way I look at it is with DRIP and expected SP500 returns, I feel it's quite likely that my stock portfolio will double in the next 5-7 yrs. Whereas if I currently pay off my home I will not have too much portfolio remaining, in just 5-7 years it's likely I will be able to both pay off the house AND have a substantial portfolio remaining. Both these examples show the power of math in the stock market.
After wraping my head around the notion it would make sense not to hold any fixed income position in my portfolio for as long as I have a mortgage, I had reached the conclusion that the only thing that would justify not to go ahead with a reallocation to 100% equity was behavioral considerations: do I have the stomach to endure a huge drop in the markets? With that in mind, I finally pulled the trigger march 2020. With insight, it might not have been the best idea to reallocate while the markets where in free fall because of the high volatility and larger spread (let alone I switched from mutual funds to ETFs, increasing the randomness of the operation) - although I've been lucky and only loss a few bps from timing in the adventure and it was really important for me to stick with the rules and protocol I decided before hand, proving to myself I could keep a a cool head while the markets acted crazy. I now see my mortgage as a short position and if interests raise by a lot in a few years I'll accelerate payments - but no bonds in the portfolio for me for as long as I have any mortgage debt. Seeing this video again after a few years, I know that's thanks to this and the related newspaper article that I'm more rational now managing my finances and do so in a more comprehensive way, so thank you!
Actually, a substantial better strategy in your example is to sell the portfolio, pay off the mortgage and then re-borrow money against the house and invest in 50/50 portfolio, a classic "Smith Maneuver". This way your mortgage costs are fully tax deductible which will further push the net interest cost down as long as investments are held in taxable account.
@@BenFelixCSI No, I would not go with HELOC debt, but a regular mortgage refinance for a standard 80% equity take out. You do not need to be in the highest income tax bracket and chances are that to do such a thing you would be in a higher income tax bracket. The idea is simple: you have the same morrgage, except now the interest is tax deductible. Whether it is "no mortgage and 90/10 equity" or "50/50 with a mortgage" is a technicality. One of the reason to do it this way is because the bank is not going to do a margin call every time the stock market drops.
Nevermind, I get it, and agree this eliminates my comment about needing to be in a high bracket. I had never thought about refinancing for the Smith. Interesting.
@@BenFelixCSI it will be tax deductible because it is not whether it is a mortgage or HELOC determines the deductibility but a use of funds. If you refinance your current mortgage to 80% of the house to pay the existing morrgage and use the take out for investment then the interest expense on the portion of the new mortgage related to the investment is tax deductible. Tou still need to keep a track of your source and use of funds. With HELOC it is just a bit easier but it does not need to be a HELOC.
I didn't consider owning debt (bonds) vs owing debt (mortgage etc.) until I read your article a few weeks ago. I was putting into the Canadian bond e series fund from td as part of my portfolio. Since that article I've stopped putting into that and consider the extra on my mortgage as my fixed income portion. I'm waiting to cash it out but it's down due to the rising rates. Your videos always seem to take a financial view from a bit outside the box which I'm sure lots of people like myself appreciate.
Great points, really unintuitive but valid. However, liquidity is an issue. I would also expect most people who have a mortgage to have a much more aggressive portfolio with little or no bonds. In that case, they are explicitly taking on more risk, with the expectation that their arbitrage will be positive. But if you’re talking about retirees with a conservative portfolio (60/40, 50/50, etc.) this is great information.
Thanks, Ben for the analysis. Think Morgage as short Bond makes the treat off clear. But on the same line of argument you should also not invest in a 60/40 portfolio on margin, right? And you should not do risk parity, which also include ,using leverage…
Thank you for covering this question. I'm planning to buy a house soon and its a dilemma that I've been contemplating : how much to set aside for a downpayment and how aggressively to pay down the mortgage. The advice here makes sense to me but seemed a bit contradictory from the advice in an earlier video about Investing With Leverage. The earlier video suggested that investing with leverage can be a good idea for a young investor who can afford to take the risk of more asset allocation in stocks. Isn't a mortgage effectively investing with leverage?
@@mikep4869 I'm in GTA and one could say that this is not a bad idea given the real estate market here. But I acknowledge the fact that rationality is only one part of the equation. I'll sleep better at night if my principal residence is not leveraged. :)
2 things. In the 95% exposed portfolio, the loss is greater and to recover that loss you need to make a larger gain? And with a house, you get to leverage your positions with very little capital. In the example, you only go over the negative scenario but the positive scenario is just better when you keep the house and the mortgage. Not saying you are wrong but seeking clarification.
I have an interesting question and example Lets say you are set to receive an inheritance of $50,000 from your parents, to help you huy a house. Lets also say you already have 40k invested in equities in a TFSA and 8k in your bank account for emergency savings. In the event that you buy a house, would you sell your equity funds and add to your gift money? Or would you sit on it?
I'm a small business owner and was only given the option of a 5.75 % mortgage rate 30 yr fixed because my income is shown from tax returns and bank statements and not w-2. I think it is better for me to pay off the mortgage with extra money than to invest, but I can always swap back and forth depending on if there are good growing stocks.
@@elmateo77 I got it switched to a 20 yr 3% last month thanks to Covid. I also already made extra payments on the first one to decrease the principal by 15k, so only had to pay the 5.75% for 1.75 yrs
I have a 175k euro mortgage on a 300k house. I decided to put some saved up money in low cost ETFs, 100% equity, instead of paying off mortgage. I want to retire a few years early and don't need the money for another 30 years. I hope to get a higher expected return this way. The risk might be high, but the interest rate is now below 2% and I can pay off the monthly mortgage payments without a job, for a year with current savings. Is this a good scenario to be in, or should I play it more safe and pay off my mortgage?
"Another way to think about this is that when you have a mortgage you are short fixed income" - Ben Felix He says it quickly but it's quite profound what this means. However I've seen cases where having a mortgage is short the fiat currency. Especially in low interest rate environments and high inflation. Kind of how what the western world is in now. Can you comment on this Ben? Thank you.
This is always true. Unexpected high inflation benefits borrowers at the expense of lenders. Unless people want to make directional bets on inflation, I don't think this changes the asset allocation implications.
Totally agree with everything in this presentation. Excellent. Whether to keep bonds in the fixed income portion of your portfolio vs paying off your mortgage depends on the current yield of bonds vs your mortgage interest rate. Let's assume you have a low interest rate on your mortgage of around 3%. If you don't, you need to refinance. The current yield on a common bond fund Vanguard BND is 1.59%. Would you borrow money at 3% to invest it in a fixed income investment yielding 1.59%? Probably not, but there is another consideration. If you have a fixed rate mortgage the interest rate on it will not change. Moving forward, if interest rates fall, the bond portion of your portfolio will rise in value. If interest rates rise, the bond portion of your portfolio will fall in value. You are exposed to interest rate risk by investing in bonds. By paying off the mortgage you get a guaranteed return of 3%, but it will be fixed at 3%. There is no way to gain or lose more than 3%. The question is, is it worth it to have access to borrowed capital at a pretty good rate of 3%? It depends on what you are going to do with the money. If you plan to buy or keep bonds today with the money, and hold them for the long term, I would say no. You are losing money doing this, and gains or losses due to yields rising or falling in the future, will be cancelled out by rising or falling bond values, for the most part. But what about the possibility of using the money for a more lucrative investment that may come along in the future? I remember when interest rates were 6%-8% for a long long time back in the 80's and 90's. If rates rise like this, and stay that way, the bank is stuck collecting 3% interest on a 30-year instrument. Any new money you try to borrow then will be at that rate as well. If you have a 3% mortgage it can be valuable to have access to that money, IF you have a plan to put it into action. Paying off a low rate mortgage in the 80's would have been a terrible decision, I can assure you. For instance, if interest rates rise, real estate values may fall, and you may be able to pick up a rental house at some point in the future earning well over 3%. While I do not expect rates to rise dramatically like this, you never know. They certainly don't have much room left to fall. I have chosen not to pay off my 3.25% mortgage for this reason, but I am 98% in stocks and real estate, and the amount of the mortgage is relatively small. If I owned any bonds and planned to keep them, I would sell them instead and pay off the mortgage. I chose to pay off a different commercial real estate loan earlier this year, but it was at 5.75%.
@@joesnikeris2407 Interesting timing of your question. I am cash out refinancing on my home next week. I will be paying off the remaining principal on the 3.25% mortgage next week and borrowing at 6.75%. I know right? The new lender wants first position, and I need additional money.
Not sure if this applies here in the US with mortgage interest deduction. With my 22% and 24% marginal tax rate. my mortgage interest deduction would have cover 24% marginal tax rate.Still more than 30 years from retirement, I have been advised by my financial advisor not to put anything towards mortgage. of-course it is case by case.
What about returns from the property? I.e. the mortgage costs 3% but the property also returns 3% but on a LVR of 80%, you’re 3K ahead on a $500k property. By borrowing, you’re holding a larger asset base which is appreciating and there’s not reason to have such a conservative bond / stock mix.
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What if the options are either make extra mortgage payments, or invest the same amount in US savings bonds? Right know, Series I bonds pay better than most mortgages, specially if you consider mortgage interest deductions...
In Canada mortgage interest is not tax deductible on the principal residence, so that would not likely work well here. What you have described may work in the US.
Hi Ben! Really enjoying your videos and a bit in the same conundrum at the moment. I have 20k that I could invest in paying some of the mortgage off and advance in the months left to my 20yrs mortgage. Ran a quick math analysis comparing that with investing the 20k into index funds and even the pessimistic scenario with 4/6% return was a better deal than paying off the mortgage (interest rate is very low 0.94%). Do you agree with this am I missing some factors? I assume paying off the mortgage is lower risk than investing in stocks but hey :)
I'm not Ben, but I'll humbly offer input. Since the interest rate is so low, you're probably fine either way. I think it's important to consider index fund returns are *long term,* meaning returns could be flat or negative for a year or two, maybe even longer, though that's unlikely. Short-term equity returns are unpredictable whereas mortgage interest is a fixed expense until the mortgage is paid.
@ben felix: what if you are going to invest in a 90% stock portfolio anyway regardless of keeping the mortgage or paying it off. In this case, obviously keeping the mortgage and invest in the portfolio will yield higher returns than paying it off
Yes but it would be more efficient from a tax perspective to take the 10% in bonds in the portfolio and use it to pay off the mortgage. Same assert allocation, higher after tax return. Assuming we are talking about a taxable portfolio.
Smartly presented information. As you alluded to (especially via the Big Banks in Canada), the mortgage penalties in Canada are quite substantial (especially given the so-called "discount rate" being added into the equation.
I am considering a similar scenario: interest 3.75 Fixed, Mort 379k, six more years of a $251. per month for MIP, windfall expected soon so no tax implications for selling off, no more interest income deduction (neighbor to the South) so I lose nothing on that point. From a cash flow perspective it looks pretty good as well. I free up $26,300 annually on my 379k for 6 year until my MIP burns off. That is like a 7% return? The $26,00 includes additional principal. Great video btw!
What about liquidity risk? Isn't it better to have 100k in easily liquidable bonds sitting around plus the 100k in mortgage instead of no additional cash cushion?
In the US you get significant tax deductions for interest expenses which alters the comparison. The recourse options are also favorable to the borrower depending on the type of loan you have so risk is somewhat mitigated.
I just removed the whole real estate from the portfolio by renting the apartment😂 Indeed, there are benefits: no mortgage payments, no property tax, no leveraged risk of property depreciation, no transfer tax, freedom of movement whenever needed, etc. P.S. I realize that I still own a bit of real estate through REITs that sit in the global market ETFs, but that doesn't bother much😅
Absolutely love your videos Ben, good job! Quick question though about your comment "There could be some consideration for taxes payable on selling $400,000 of the portfolio, or penalties to pay off the mortgage in a lump sum, but I will ignore them to keep things simple." I don't understand why this assumption is made. Taking out money of portfolio from a RRSP would imply a major difference in the end results doesn't it ? While I understand that the logic also applies to no portfolio transfer (by simply increasing your mortgage payments + increasing portfolio risks on the decreased investment), I wonder if your "pay off mortgage from portfolio" scenario is limited to taxable portfolios ? Thanks again for your videos!
here's a few things I considered, 1 a mortgage interest only applies to the first half of the loan term, remember it's front-loaded also referred to as the rules of 78's so halfway through the term of the loan the money is interest-free. 2 on the other hand if your home is paid off you don't have the risk of being homeless if the market crashes 80 percent and you lose your income. the security of a paid-for house is a huge benefit if your world turns upside down.
Mortgages in Canada are required to be calculated as compounding semi-annually on the outstanding mortgage balance. They cannot use the rule of 78's. Also for the united states rule of 78's is outlawed for loans/mortgages with terms above 5 years. There is no interest free money and mortgages are not generally (at least in the North american market) front loaded with interest. Short Auto loans may be though.
Hey Ben, you should consider that a short fixed income position is also kind of an inflation lottery ticket. Sure it doesn’t happen all the time, but when it does, it has quite an effect. I suspect that this isn’t systematically being priced into credit, due to erratic monetary policies. So I wouldn’t be the one to pay off a mortgage early, just because of this
Hi Ben, I understand you're trying to make a case when you have both bonds in your portfolio as well as a mortgage. In this case, you are better to use the bonds to buy stocks, in which case you can take more risk and increase your asset allocation in your portfolio to more stocks. What if, however, you're not heavily invested in bonds in the first place, as you're still quite young. Does it - from a risk point of view - make sense to go high in stock allocation AND have a mortgage at the same time? This would of course mean your net worth drops considerably during a market drop, but leaves you time to wait the drop out as time goes on AND consequently possible higher overal net worth at the end?
It’s an extension of the same decision. Decision number one is how much risk you want to take. Decision number two is how to structure your asset allocation. If you want to be a leveraged equity investor, then mortgage debt is a cheap way to accomplish that.
Ben, for a young professional that does not have a large portfolio, would it make sense to simple sell off their portfolio to aggressively pay off the mortgage first, then re-invest in their portfolio? Or would not buying real estate and continuing to pay rent while investing in ETFs until, say, one maxes out their TSFA and RRSP, make more sense? Would Smith Maneuver make sense for a first home?
I mostly agree, with the exception that you can’t eat a house. Suppose my girlfriend and I get into financially stormy weather, after depleting our emergency fund we could dip into our investments. If that money is tied up in the house, the only way to dip into that is to sell the house.
You're mixing up the house with the debt. The house was there regardless. If you pay down the mortgage as an asset allocation decision you could always re-borrow to access that capital.
So fast forward to today? This holds true, except remove excess payments to all time low mortgage rates rates and stay fully long equities with continued low monetary rates and QE in spite of inflation concerns?
Thx for an eye opening video Ben. My only concern is that you would be enable to rebalance your portfolio given a major market correction ? Or am i missi g something?
Does this not negate the principle of time in the market though. yes it is more leveraged depending on your emergency fund cash allocation but it is more likely to have higher returns +dividends (yes taxable) can often outrun morgage interest meaning the 10% per year gains can be made. I see this as a less risky version of people buying multiple homes as a realestate portfolio, arguable highly risky IMO but does often lead to wealth. waiting for 0 debt seems unsuccessful in everything i have seen, why business rarely holds no debt.
Thanks for this Ben. Do the considerations around this change when you're dealing with a windfall? In terms of whether you would pay off your mortgage completely or use some or all to invest?
Dept works when it works and when it doesn’t psychologically it becomes crushing. Mentally I understand formulas, emotionally using your home for investment doesn’t add up. I will give up returns for options and certainty.
I agree with you. There are a whole lot of leveraged real estate/smith manoeuvre/HELOC aficionados out there who seem to swear by leveraged investing. I’d be terrified.
Thanks for another great video. There's one thing I can't quite understand: How did you get to the figure of 95% in shares being similar to the example of having a mortgage?
I'm unsure really why a person wouldn't want to pay off their mortgage. Leaving out the peace-of-mind argument, if one can lower, or even better, eliminate their fixed costs each month that would be the way to go. Variable costs like power, water, gas, are easily paid when there isn't a 1900/month mortgage to keep up with.
The reason is that you're tying up money in your house, and the only way to get the money back out is to sell the house. I'm in the process of buying a house, which forces me to think about stuff like this. I could go one of four ways: 1) Put all income I don't need in a savings account. That's kinda the default position. Leads to a nice emergency fund, but the returns are suboptimal. 2) Put all income I don't need towards paying off my money, thereby reducing my emergency fund to a minimum acceptable level. May make sense, but I'm essentially tying up my money for a very long time. Suppose me or my gf loses a job or becomes disabled, and we're struggling to make those payments, there is no way that the bank will repay us the additional money that we already gave them. That is risky. 3) Put all income I don't need first towards an emergency fund of 3-6 months, and invest everything else conservatively (something like 50/50 equity/bonds). Ben explains very nicely why this is suboptimal, as you're basically going both long and short on the same position. That makes a lot of sense. 4) Put all income I don't need first towards an emergency fund of 3-6 months, and invest everything else aggressively (100% equity or similar). This has the benefit of keeping a large part of your money liquid (forgoing the problem identified in 2) and optimizes returns (forgoing the problem identified in 3). It does mean you have a lot of leverage in your portfolio though. So long story short: it really isn't that one sided, and if you think it is you might be missing something. I haven't decided yet and I may still choose to take a middle-of-the-road strategy, but it really isn't black-and-white.
I've bought a house and lost it in forclosure. While I had the mortgage on the home I earned enough in 8 months to pay it off. It was an 88k loan. Like you have just explained, I was told not to tie up all of my money in the home. But then 2008. The macro and micro economy collapsed where I lived. I couldn't find a decent job; got behind on all of my bills, and then boom forclosure proceedings. So my approach is one sided. I should have paid the house off. Taxes were only 2k each year. I could have worked literally anywhere in town and made the variable costs associated with the home.
Joseph Abraham yes I think paying off a mortgage if a person has the ability to do so is the best bet. as you've noted our financial positions can change drastically short time. the security of having a paid for home could save our life and our sanity.
Ben, amazing video but I'm not really sure I understand what to do if my approach to investing is already to be 100% stocks (my plan is just to jam as much money as possible in XEQT). What's my approach for my first house if I decide to buy one within the next year?
Honestly, it's a very personal decision. If you remains 100% in equity and pay your mortgage at normal rate, it's a leveraged strategy that should have a positive outcome down the road, but through taking up more risk. Not staying it's bad, not staying it's good. I guess it could make sense for financially secure people that are very even minded with market movements and are only investing money they won't need for decades, like they normally should with equity (disclosure: I chose that path).
Let say I have a mortgage of $200,000 at 4%, and an investment of $50,000 yielding 8% return and $50,000 in cash. If I use the cash to increase my investment to $100,000 at 8% that would equal my mortgage. But if I use it to down pay my mortgage to $150,000 my investment would be short of $2,000 year in relation to my mortgage. So I would use $30,000 to reduce the mortgage and $20,000 to increase investment. What do you think Ben?
You didn't discuss the possibility of equity loss in your realeaste. The percentage draw down would have most likely been larger in the financial crises.
What should I do if I have a $500k mortgage now with zero investments but I'm willing to take $100k of equity from my home to invest in a low-cost deversified index fund? Is it worth it?
So you may want to make sure there is no prepayment penalty before you drop the cash. Some lenders regulate how much is allowed to be paid off. Also, when you pay this off is a big factor isnt it? Most of the front half yrs basically are interest and you dont take much dent out of principal. I hate that set up. So the earlier you can do this , the less interest cost damage or lower the interest to principal ratio. Good info here and it is true that when I see someone present the case for keeping mortgage, and they give the return you would sacrifice..that rtn is usually a 100% stock type return. Also, stock market rtns are rarely average anyway, they fluctuate. Although over 15 yrs they have always been positive. I think about 94% of the 10 yr spans have been positive. Anyway, thx for the vid.
I completely agree, but.....aren't you ignoring the behavioural issues? By that I mean the mortgage and the house value don't go down in a crash (well, at the least the house is not marked to market daily and you're living in it so much less likely to sell it), but the stock and bond portfolio does. An investor who can tolerate the volatility of a 50/50 portfolio likely cannot tolerate the volatility of a 90/10 portfolio. So a mortgage and 50/50 portfolio is not the most efficient but it likely is the arrangement most investors can stay the course with so leads to the best outcome. Like somebody said, the best strategy is not the most efficient one, it's the one you can stick with.
Completely agree. I have described in the video what is rational. That may not be the best course for everyone! Edit: Unless, of course, they listen to the Rational Reminder podcast :)
Hi Ben. Great video as always. Would you care to talk about the following: a person who has a real estate portfolio, and who takes out a home equity loan (or rather, a “home owner’s line of credit”) of up to 80% of the equity-value in the person’s real estate portfolio, and who then invests the money into a non registered stock market account, and who can then write off the interest on the home owner’s line of credit from his taxes. How much real estate equity would a person need to have to make this a worthwhile financial exercise? I believe some people call this a Smith manœuvre but I don’t think that’s really the right term for it. Something to consider talking about perhaps? I know your thoughts about rental properties and that it may not be an ideal investment in relation to the work that one has to put in etc, but this tax sashay where you can invest 80% of your properties’ value and write the loan off from your taxes seems like it may be worth doing, provided that one has enough equity. I know you’re a busy guy but, any thoughts?
Good question Barwin. The Smith manoeuvre assumes that you have a mortgage that you have not yet paid off, and a portfolio that could be used to pay off some or all of the mortgage. Doing so and then borrowing the money back on a secured line of credit to invest makes the interest tax deductible. Pretty sweet deal. Everything nets out to being the same, but your interest is now deductible. The downside is that HELOC interest is usually higher than mortgage interest, so for the spread between your after-tax interest cost on the HELOC and the interest cost on the mortgage to be interesting, you have to be in a high tax bracket. On Ratehub I can find a 5-year variable mortgage for 2.65% while the lowest HELOC is 4.45%. If you're at the 53.53% bracket, then your after-tax interest cost is 2.07%; better than 2.65%, but not _that_ much better. If you're lower than the highest bracket on marginal income, then this can flip quickly. If you tax rate was instead 37.91% (the marginal rate for an Ontario resident with income over $91,101 up to $95,259, then your after-tax interest cost is 2.76%. HELOC debt is also callable. Sure, that might never happen in Canada, but you can be sure that if it does happen it will be in a terrible economic scenario, and your portfolio is not going to be in any condition to cover the loan. Some of my above comments apply to both the Smith manoeuvre and your question. I have some additional comments on your question which is assuming you have equity in a property, and you are considering borrowing against it to invest. I think that for real estate to be an attractive investment you _have_ to be leveraged. The unlevered expected return is not worth the risk or hassle. If you use that leverage to invest in the market, it becomes a question of your willingness and ability to handle the risk. Could you handle it financially if the loan were called? Could you handle it emotionally if you knew the portfolio was 50% of the loan, and it might be called? If we ran a computer model to maximize wealth it would suggest as much leverage as possible to invest in risky assets. You would end up borrowing against the property to invest in stocks, and then borrowing on margin to buy more stocks! Of course very few people do that because it is terrifying. Does that sufficiently answer the question?
@@BenFelixCSI Hi Ben. Thank you for your answer. My properties are in Alberta and after the oil crash they lost some equity, like everybody else's properties here. I don't think I have enough equity in them right now to make something like this worth my while, but in a few years from now maybe I'll be wanting to do something along these lines. Keep up the great work, these videos that you make really give people value.
Thanks! I think I kind of covered that in this article: www.theglobeandmail.com/investing/personal-finance/gen-y-money/article-should-i-pay-down-my-mortgage-or-invest-in-my-tfsa/
OK I’m 74 and still working and make about $500k per year. I have a 15 yr mortgage for $340k at 4% and about $1 million invested in REITs, preferred shares and individual; stocks. I plan on working for 1 more year so what are your thoughts regarding paying off the mortgage?
The concept of the mortgage as leverage is what convinced me to adopt the Smith Maneuver. If I'm going to have hundreds of thousands in leverage, why not spread it out across the world equity market rather than in one illiquid asset?
Great video, Ben! I really appreciate your thoughtful insights! What are your thoughts on duration? Taking a 30 year mortgage is going short fixed income for a 30 year duration. Buying a bond is going long fixed income, typically for less duration (7.5 years for the Vanguard Total World Bond fund). Does a long term mortgage make sense with duration mismatch in light of today’s ultra-low rates? This is attractive only if rates rise over 30 years to overcome your other considerations I suppose. Alternatively, does the duration mismatch offer any better investment plans for the mortgage proceeds than 100% bonds? Say you match 50% of your mortgage balance with bonds and 50% of your mortgage balance with equities. You would be a leveraged investor, but your home equity and the bonds act to safeguard you against a liquidity crunch or having to sell stock in a downturn. And you should have strong odds of coming out ahead over 30 years, right?
Thank you for this (and all your videos), Ben. Just a kind question: I live in Mexico, where the mortgage interest is about 11%, would it be even more advisable to first pay off the mortgage than in the Canada examples? Thank you.-
furthermore, if you loose your job or income revenue during a crisis, you might end-up having to sell your assets at a loss just to keep up with mortgage. I'd rather pay the mortgage in fast forward mode and go 100% equity. advanced mortgage payment allows me to pay it even if I need to flip burgers for a living.
another excellent video Ben, really appreciate the insight! I have a question sort of related. my mortgage is up for renewal next year, given the bank of Canada has stated it wants to return to "normal" interest rates in the range of 2.5 to 3.5%, and factoring in atleast 2 probably 3 interest rate hikes by then (June for us) putting the bank of Canadas rate at between 2.25 and 2.5, would it be wiser to go for a variable rate mortgage. I am quite comfortable with the risk of it going up another 1% but I believe we will be in a recession again within about 3 years and rates should deflate again. given I can get a variable rate for between .75 and 1% less than a fixed rate I think variable would allow me to takr advange of any rate decreases in the next 5 years while still allowing me to likely just break even or maybe take a slight hit of they dont. thoughts?
I'm no mortgage pro and my crystal ball is, as usual, pretty foggy. I believe that statistically variable is the best option. Of course one could argue that the statistics don't matter because we have had an unprecedented interest rate environment recently. I am currently a renter, but when (if) I do eventually choose to buy I will probably go variable.
@@BenFelixCSI oh for sure you dont need to explain that to me LOL none of us can predict the future. I just try and do as good as i can with the information i have. it seems like a year from now we will be alot closer to the top then the bottom.
@@hellcat320 maybe. Or maybe we will be at the bottom. If I ever know for sure that we're at the bottom I'm borrowing as much as I can to invest. Too bad I'll never know for sure.
This takes the example of 3% mortgage interest rate but most likely that rate will increase to 5% or higher in coming years. Not accelerating mortgage payments is a bet that interest rates will always stay low
Very underrated comment. Plus, at least in the US, the effective interest rate is much lower due to mortgage interest deduction. If you are under 50, Just go 100 equities and keep a massive mortgage. It's leverage, and unless you run into a life emergency, the risk is more than acceptable.
Did you consider your mortgage when deciding on your portfolio asset allocation?
I do, and am therefore surprised to see this video. I have not been paying off my mortgage, not because of the higher returns but because of diversification. If they put all that money in that one home, they are undiversifying their portfolio. can you explain why this isnt the case?
yes I did! I kind of did that intuitively, but this explains it so clearly.
@@samreinstein2872 Didn't you already make that diversification decision when you bought your home? I mean you could just rent and not buy a home in the first place (or buy a smaller condo). Putting money to pay off your mortgage is not putting more money into real estate, its just putting money into a negative yielding bond.
Thanks for the high quality content of this channel! I definitely agree that keeping a mortgage is equivalent to holding a negative yielding bond. Thus, I view paying down a mortgage versus buying bonds to be roughly equivalent investments with fairly similar yields, though paying down a mortgage has zero volatility (and therefore zero correlation with all other asset classes). Currently in my early 30s, I allocate 20% of my annual investment contributions to paying down a mortgage and 80% to a 100% stock portfolio. My only hesitation with this strategy compared to buying bonds is the lack of liquidity for rebalancing in market downturns. Right now, that's not a problem as I can simply rebalance with new contributions. In time, my stock portfolio will outgrow my income (I hope!) and I will not be able to rebalance entirely with new contributions as I might with bonds. How do you think about this tradeoff and the use of mortgage prepayment and bonds throughout an investment lifetime?
Yes I did consider it. I'm young so I'm 100% equities and I do put extra mortgage payment ever year into the principal.
This channel doesn’t have 2 million subscribers because....? Oh wait he brings valuable content... that’s why.
I hope people realize that this is arguably the top 1% of all informative financial videos on this platform. Great content - i expect this page to explode in 2019. Well done
Would love to see you dig down deeper in the weeds on some of these topics!
Thanks Kyle! Any examples of where a deeper dive would be helpful?
@@BenFelixCSI Smith maneuver, leveraged investing?
Easily the 0.1%
For younger people (ie under 40) I'd both keep the mortgage and go with a 100% equity portfolio. Just make sure you also have a 6 month emergency fund ready.
I sold my expensive home back in late 2006 and bought a smaller home cash. All I can say is not having a mortgage allowed me to take on more with my life because I had no fear of being homeless. I started my own business. Then I used that money to start buying rental homes during the crash. Now I use the rent money to buy stocks. I basically went from being worth 150K in 2006 to 1.8M in 2019 and semi retired now at age 52
I love that story. Nice work.
People forget to pay tax on their houses every year
I usually explain it a bit simpler: imagine you live in a paid off home, would you mortgage it to invest in stocks (or bonds as you suggest)?
For many people that explanation breaks them out of the mental accounting problem.
With interest rates currently below 3%, yes. If mortgage rates were anywhere near "normal", then no. We live in a really squirrelly economy right now. Normally, I would never justify leverage for passive investing.
@@Thurgor_Supreme Agreed until the past month.
@paula I'm curious, how old are you?
I've lived long enough to know how leverage can break you in multiple ways.
Of course, you might get lucky. Some gamblers do.
@@iandrake4683 The current interest rate is 3-6%, using Smith maneuver by borrowing against the home equity using a HELOC and investing the money from HELOC to invest in a non-registered account makes a lot of sense at this time.
@@kyrie4451 I understand the basic math. It's the more complex math where the problem lies.
All rates of return are not equal. For instance, would you rather a guaranteed 3% return with a standard deviation of 0, or an average 4% return with a standard deviation of 9%.
Things get a lot more complicated then. Let's say you borrowed heavily against your house at 3% in February of 2020 and put it all in the market. Then you experienced a negative return 3 standard deviations below the average because of an unexpected event.
This unexpected event also negatively effects the economy to the point you lose your job.
Now you have no income, mortgage payments, and a portfolio worth 23% less than it was when you started.
Now you have to start selling low, for cashflow, to pay your bills.
I've seen this movie before in 2008. When people start doing this (often called dumb money) the smart money leaves the room.
I've been watching Ben's content backwards these last couple months. Factor tilts and this video are the two things that have truly shocked me. Thank you for your work making this channel and the RR podcast!
Great way to think about mortgage debt! I was able to payoff my mortgage last year after owning for 10 years. Now I use that extra cashflow to invest in 100% equity portfolio long term.
Great job!
Wow, this is an ENTIRELY new perspective presented here!
That's great food for thoughts! :)
This is a genuinely incredible video. Thanks for making it.
Thanks!
This is great content, thanks Ben!
I’ve been in both positions at times, the forced-savings effect of making mortgage payments was far easier on us than committing to save the equivalent. I know that’s an ‘us’ problem, just throwing out human nature as a factor.
Thanks again, super video!
The problem in including mortgage in our portfolio asset is also that a bond is liquid asset while a house is pretty illiquid. The only way you could use your home would be through getting HELOC or reverse mortgage and I don't know how much better off that would be vs renting and having bond allocation.
I would love to see more video regarding incorporating other assets such as house into the portfolio calculations.
Exactly. My neighbors like having a house because they can take out a HELOC, which to me makes no sense. A HELOC is just exchaning one form of debt to another. It's much better to just have liquid assets like stocks and bonds for money when you need it.
As you know there are financial advisers out there that highly recommend leveraging your home to increase your portfolio, even to the point of suggesting you're crazy not to. It would seem that more often than not this probably serves their interests more than their clients.
Every time I watch one of your videos it gives me a new perspective, a more informed one! It's just about time for a serious conversation, I'll reach out soon.
It's great to know that you find the videos helpful! Thanks Robin.
You can use leverage to you advantage if you know what you are doing.
I have experienced this "advice" myself (advised to re-mortgage home to invest more into markets). I already had investments (stocks and bonds) worth four times the value of the property. Seemed like crazy advice at the time - now I can understand/explain why.
Thanks and please keep making videos. The quality of your analyses appears to be unmatched on TH-cam. I can not understand why your videos don't get more views - so much useless garbage gets so many views and these gems get so little love.
@@markhousman8447 Thanks Mark! It's great to know that you find the videos useful. I will keep them coming.
Being long and short the same asset is not sensible. Solved my problem right there!
I'd just explain this as, "Would you borrow money at, say, 4% interest, to invest it for possibly a 6% return?" It comes down to the amount of risk you're willing to take, on your time-horizon, et cetera - the same factors as in really any investing decision.
Brilliant analysis and the sensible advice. You are most definitely the best kept Canadian secret.
Thank you!
Came back to watch again. Great advice getting people to think outside the box.
I was fortunate to have a small mortgage so paid it off very early and started investing in a low-cost Vanguard index fund. I'm now looking to invest in small cap stocks and value stocks to capture some of the benefits this would give me. As for investing in bonds, well, I currently pay into my NHS pension and since this is financed through a mix of general taxation and the issuing of UK treasury bonds, I'd say the monthly contribution to my pension is all the stability i need should all my equity investments not pan out as I like. Besides, considering I don't have a mortgage or any other debt investing in the markets helps me to achieve one of my most-cherished dream which is to set up my own scholarship fund to promote the values and principles of community education. It's something I might not be able to achieve without taking on the risks and benefits of investing in equity.
Interesting.. You could also change the question around. “If you did not have a mortgage, would you take one in order to increase your portfolio?” If the answer is no, then paying off mortgage is sensible. Another aspect is that paying off mortgage frees-up more cash flow. Not having these monthly payment is nice.
This is an awesome video, thanks. Just three things: (i) I think the liquidity premium should be taken into account too. Property is illiquid while bonds are liquid. You may sacrifice certain return in exchange for liquidity, which can even make investing in bonds safer, and (ii) the low/negative correlation of bonds and equity returns. If there is a market crash, bonds would go up in value, my mortgage would go (theoretically) down in value but that value can’t be realised.
Thanks for the vid and valuable information! The reason that someone would not pay off its mortgage is that the money stuck in your house is not fluid. In other words if towards the end of someones life you still want to stay in your home and at the same time have money available to live you better keep your mortgage.
Really glad you enjoyed the video!
That is false. Home equity is always accessible through a home equity line of credit, a traditional mortgage (at refinancing hopefully), or over age 55 through a reverse mortgage. If you pay off your mortgage as part of your overall asset allocation as I described in the video, you could still access the capital if needed.
@@BenFelixCSI Thanks a lot for your response. However I do not really follow your logic, nor are the terms/financial products "home equity line of credit" and "reverse mortgage" known to me. Maybe these financial products do not exist in Europe. Once my money is in the bricks and I want to stay between these bricks, I am not able to get the money out again. There is one exception which is called "silver montage". Maybe this is somewhat comparable to what you call "reverse mortgage". With the "silver mortgage" you can sell a part of your house to a financial institution and then lease/rent it back. However the interest rate you pay is outrages high and does not make it really sensible.
Interesting. Apologies, I did not realize that you are in Europe. The examples of accessing home equity that I gave were for Canadian residents. Unfortunately I do not know enough to draw comparisons to financial products that may be available in Europe. It is possible that where you are, paying off the mortgage would not be sensible for the reasons that you initially gave.
I sincerely appreciate these videos, being a professional in investing and wealth management myself.
The analysis in this video is similar to an ALM perspective on an individual's total balance sheet. This touch upon the specific ALM perspectives of interest rate risk and equity risk and the conclusions are correct. However, another perspective would be the liquidity risk for the total portfolio. And there, the funding may very well have a longer commitment than the bond assets. This means that it may be wise to loan money with a loan committment, and placing it as liquidity. You never know when you may need liquidity. Also, getting older, new financing may be harder to achieve without a salary to back the mortgage and interest payments. Then you end up with a real estate asset, amortized, that has a low liquidity.
Thanks - this has been my philosophy but I have not seen many folks talk about it this way. When looking at my asset allocation, i include the mortgage as a negative against my bond portfolio and adjust my asset allocation accordingly. There are two reasons I haven't paid it off - i was aggressively paying it off out of my income but not out of savings until TBills started paying more after taxes than my mortgage. While this holds, it doesn't make fiscal sense to pay it off from savings as long as my asset allocation strategy accounts for it. Plus, we'll probably sell within 5-10 years.
Interesting analysis - well illustrated!
Personally, I generally prefer to rent and invest in an 80-90% equity portfolio. I just don't like the idea of tying up so much wealth in an illiquid asset. I know you've covered renting vs. owning a home in previous videos, though.
Cheers,
Doug
I would think there are a few reasons why it is better for some to rent than own, such as not enough down payment, chance of relocation for job or family. But I think the idea of having your largest monthly expense eventually gone, with something to show for it in an asset that increases in value tax free is too compelling for me. You could also throw in pride of ownership, the ability to garden, do improvements & renos,have gatherings & BBQ are much easier in your home as opposed to someone else's.
@@HamiltonRb yeah good points
I would add that having a home that you are able to rent out also reduce your monthly housing expenses, be it rent or mortgage.
Doug...im with you. I do the same thing
@@HamiltonRbyou would be surprised by Ben's other (extensively researched) videos then
Great video! I think the situation needs to be looked at carefully. Bonds are liquid, the home is illiquid. If you can repay the mortgage in full by selling the bonds, the argument makes total sense. If you can only repay part of the mortgage, you still have liquidity (repayment) risk, for example if you lose your job, and having at least some bonds can come handy.
While one should have some spare cash for emergencies, having bonds can provide an additional return without sacrificing liquidity.
So young here 😊 it’s been a long journey. Please keep up the good work!
What about mortgage rates being under 2% for five year fixed? Still better to pay down debt rather than invest? Would a government pension also be reason to max risk with few bonds and 95% equity indexing? Thanks
Amazing content. Never thought of it this way. It’s funny that Dave Ramsey gives this same advise of all equity investing and pay o ff your ‘dang’ mortgage but he doesn’t really know the why like you explain. It’s just something he has come to from experience. Kinda like how Buffet was doing factor investing before we knew what factor investing really was. He just had the experience that value investing would get better returns.
Again really appreciate these amazing videos. I feel like I’m getting a graduate level education in finance and economics for free. Do you ever plan on teaching at the university level?
Ben has a great vid discussing Ramsey's investing advice. While Ramsey's investing advice is dubious, much of his general financial advice is sound. Paying off a mortgage sooner than later is an example.
Another great episode. Currently I have about 90/10 equity/bond investments. Considering this it makes sense for me to make an additional mortgage principal payment since this has the same practical effect as increasing bond diversification while reducing debt.
Ben,
The only exception to your recommendation would be if you are comfortable being a leveraged investor. If you believe in leverage and want to use leverage to invest in stocks then HELOC is the cheapest way to access capital with the lowest cost of capital. Without a mortgage, I am unsure if you could get access to cheap HELOC capital. But I agree it changes the risk profile. Also its hard to think of a 50% stock 50% bond portfolio in today's climate of interest environment (given any investment horizon) and what we know of the possible trajectory of the interest rate regime going forward. But it does help to illustrate your point.
Very interesting thoughts on a mortgage being a bond you’re selling to the bank and how it should be incorporated into your asset allocation.
Hi Ben, thanks for the wonderful and informative videos. I have been keenly watching your content and even though they provide really good value for the time, the only small problem for me is the absence of more visuals. I feel like adding more animation or visuals will certainly makes the videos more interesting and easy to understand for audience like me who are not so used to hear so many numbers in one sentence. lol. Just a suggestion! Cheers mate!
Thanks Smit! I work with an animator to put the videos together. I will mention it to him.
I've had this thought too. The information is great, but it's sometimes difficult to absorb it all in real time. Having the core information on the screen most of the time (almost like a powerpoint) would help more than animations that are just visually pleasing.
So if understand, paying down the mortgage and not having to pay the interest is like a risk free investment that earns interest of the mortgage rate (money you didn’t have to pay out) hence because of that “safe” investment you just made, you can increase your risk exposure with your stock portfolio to balance out your overall risk exposure... is that right?
I’m curious how the 95/5 portfolio plus a mortgage comes out compared to these two.
exactly, elephant in the room. i dont see any point to ever carry bonds, basically. so he sets up kind of strawman portfolio, then knocks it down.
i have a 5% mortage (signed in 2k10 before rates went so low). i had a portfolio (all stocks) roughly equivalent to the remainder on my mortgage 1 yr ago pre covid. When covid hit, obviously it plummeted, to well below mortgage principal. At that time, buffeted by the psychology of seeing massive daily stock losses, I seriously considering pulling everything out of my portfolio and applying it to the house. Which would have still left the house well short of paid off, but I desired certainty.
Now just one year post covid, my portfolio has skyrocketed again well past the principal remaining on the home. I could pay the house off completely today and still have a fair bit left over. One year ago, I could have applied the entire portfolio to the home loan principle, and still come out a fair bit short of paying off the house. Had I made a bad decision in the midst of covid, I would have massively screwed myself.
Another way I look at it is with DRIP and expected SP500 returns, I feel it's quite likely that my stock portfolio will double in the next 5-7 yrs. Whereas if I currently pay off my home I will not have too much portfolio remaining, in just 5-7 years it's likely I will be able to both pay off the house AND have a substantial portfolio remaining. Both these examples show the power of math in the stock market.
Great video. Just one question. How would you account inflation in your calculation. Since the interest rate if fixed.
After wraping my head around the notion it would make sense not to hold any fixed income position in my portfolio for as long as I have a mortgage, I had reached the conclusion that the only thing that would justify not to go ahead with a reallocation to 100% equity was behavioral considerations: do I have the stomach to endure a huge drop in the markets? With that in mind, I finally pulled the trigger march 2020. With insight, it might not have been the best idea to reallocate while the markets where in free fall because of the high volatility and larger spread (let alone I switched from mutual funds to ETFs, increasing the randomness of the operation) - although I've been lucky and only loss a few bps from timing in the adventure and it was really important for me to stick with the rules and protocol I decided before hand, proving to myself I could keep a a cool head while the markets acted crazy. I now see my mortgage as a short position and if interests raise by a lot in a few years I'll accelerate payments - but no bonds in the portfolio for me for as long as I have any mortgage debt. Seeing this video again after a few years, I know that's thanks to this and the related newspaper article that I'm more rational now managing my finances and do so in a more comprehensive way, so thank you!
Actually, a substantial better strategy in your example is to sell the portfolio, pay off the mortgage and then re-borrow money against the house and invest in 50/50 portfolio, a classic "Smith Maneuver". This way your mortgage costs are fully tax deductible which will further push the net interest cost down as long as investments are held in taxable account.
Maybe. You have to be in a high tax bracket. What are your thoughts on the callability of HELOC debt?
@@BenFelixCSI No, I would not go with HELOC debt, but a regular mortgage refinance for a standard 80% equity take out. You do not need to be in the highest income tax bracket and chances are that to do such a thing you would be in a higher income tax bracket. The idea is simple: you have the same morrgage, except now the interest is tax deductible. Whether it is "no mortgage and 90/10 equity" or "50/50 with a mortgage" is a technicality. One of the reason to do it this way is because the bank is not going to do a margin call every time the stock market drops.
But it can’t be deductible if it’s a standard mortgage. How would that work?
Nevermind, I get it, and agree this eliminates my comment about needing to be in a high bracket. I had never thought about refinancing for the Smith. Interesting.
@@BenFelixCSI it will be tax deductible because it is not whether it is a mortgage or HELOC determines the deductibility but a use of funds. If you refinance your current mortgage to 80% of the house to pay the existing morrgage and use the take out for investment then the interest expense on the portion of the new mortgage related to the investment is tax deductible. Tou still need to keep a track of your source and use of funds. With HELOC it is just a bit easier but it does not need to be a HELOC.
I didn't consider owning debt (bonds) vs owing debt (mortgage etc.) until I read your article a few weeks ago. I was putting into the Canadian bond e series fund from td as part of my portfolio. Since that article I've stopped putting into that and consider the extra on my mortgage as my fixed income portion. I'm waiting to cash it out but it's down due to the rising rates. Your videos always seem to take a financial view from a bit outside the box which I'm sure lots of people like myself appreciate.
Awesome - thanks Dave!
Great points, really unintuitive but valid. However, liquidity is an issue. I would also expect most people who have a mortgage to have a much more aggressive portfolio with little or no bonds. In that case, they are explicitly taking on more risk, with the expectation that their arbitrage will be positive. But if you’re talking about retirees with a conservative portfolio (60/40, 50/50, etc.) this is great information.
Thanks, Ben for the analysis. Think Morgage as short Bond makes the treat off clear. But on the same line of argument you should also not invest in a 60/40 portfolio on margin, right? And you should not do risk parity, which also include ,using leverage…
Thank you for covering this question. I'm planning to buy a house soon and its a dilemma that I've been contemplating : how much to set aside for a downpayment and how aggressively to pay down the mortgage.
The advice here makes sense to me but seemed a bit contradictory from the advice in an earlier video about Investing With Leverage. The earlier video suggested that investing with leverage can be a good idea for a young investor who can afford to take the risk of more asset allocation in stocks. Isn't a mortgage effectively investing with leverage?
A very good observation. What if you leveraged your home to buy a rental property? Them you have more asset allocation towards debt.
@@mikep4869 I'm in GTA and one could say that this is not a bad idea given the real estate market here. But I acknowledge the fact that rationality is only one part of the equation. I'll sleep better at night if my principal residence is not leveraged. :)
@@KhushalSagar Personally, I would not do it either for your same reasons.
2 things. In the 95% exposed portfolio, the loss is greater and to recover that loss you need to make a larger gain? And with a house, you get to leverage your positions with very little capital. In the example, you only go over the negative scenario but the positive scenario is just better when you keep the house and the mortgage. Not saying you are wrong but seeking clarification.
I have an interesting question and example
Lets say you are set to receive an inheritance of $50,000 from your parents, to help you huy a house. Lets also say you already have 40k invested in equities in a TFSA and 8k in your bank account for emergency savings. In the event that you buy a house, would you sell your equity funds and add to your gift money? Or would you sit on it?
I'm a small business owner and was only given the option of a 5.75 % mortgage rate 30 yr fixed because my income is shown from tax returns and bank statements and not w-2. I think it is better for me to pay off the mortgage with extra money than to invest, but I can always swap back and forth depending on if there are good growing stocks.
Sounds reasonable.
Yep 5.75% interest rate is really high for a 30 year mortgage. Get that paid off asap.
@@elmateo77 I got it switched to a 20 yr 3% last month thanks to Covid. I also already made extra payments on the first one to decrease the principal by 15k, so only had to pay the 5.75% for 1.75 yrs
I have a 175k euro mortgage on a 300k house. I decided to put some saved up money in low cost ETFs, 100% equity, instead of paying off mortgage. I want to retire a few years early and don't need the money for another 30 years. I hope to get a higher expected return this way. The risk might be high, but the interest rate is now below 2% and I can pay off the monthly mortgage payments without a job, for a year with current savings. Is this a good scenario to be in, or should I play it more safe and pay off my mortgage?
"Another way to think about this is that when you have a mortgage you are short fixed income" - Ben Felix
He says it quickly but it's quite profound what this means. However I've seen cases where having a mortgage is short the fiat currency. Especially in low interest rate environments and high inflation. Kind of how what the western world is in now. Can you comment on this Ben? Thank you.
This is always true. Unexpected high inflation benefits borrowers at the expense of lenders. Unless people want to make directional bets on inflation, I don't think this changes the asset allocation implications.
Totally agree with everything in this presentation. Excellent.
Whether to keep bonds in the fixed income portion of your portfolio vs paying off your mortgage depends on the current yield of bonds vs your mortgage interest rate.
Let's assume you have a low interest rate on your mortgage of around 3%. If you don't, you need to refinance. The current yield on a common bond fund Vanguard BND is 1.59%. Would you borrow money at 3% to invest it in a fixed income investment yielding 1.59%? Probably not, but there is another consideration.
If you have a fixed rate mortgage the interest rate on it will not change. Moving forward, if interest rates fall, the bond portion of your portfolio will rise in value. If interest rates rise, the bond portion of your portfolio will fall in value. You are exposed to interest rate risk by investing in bonds.
By paying off the mortgage you get a guaranteed return of 3%, but it will be fixed at 3%. There is no way to gain or lose more than 3%.
The question is, is it worth it to have access to borrowed capital at a pretty good rate of 3%? It depends on what you are going to do with the money. If you plan to buy or keep bonds today with the money, and hold them for the long term, I would say no. You are losing money doing this, and gains or losses due to yields rising or falling in the future, will be cancelled out by rising or falling bond values, for the most part.
But what about the possibility of using the money for a more lucrative investment that may come along in the future? I remember when interest rates were 6%-8% for a long long time back in the 80's and 90's. If rates rise like this, and stay that way, the bank is stuck collecting 3% interest on a 30-year instrument. Any new money you try to borrow then will be at that rate as well. If you have a 3% mortgage it can be valuable to have access to that money, IF you have a plan to put it into action. Paying off a low rate mortgage in the 80's would have been a terrible decision, I can assure you.
For instance, if interest rates rise, real estate values may fall, and you may be able to pick up a rental house at some point in the future earning well over 3%.
While I do not expect rates to rise dramatically like this, you never know. They certainly don't have much room left to fall. I have chosen not to pay off my 3.25% mortgage for this reason, but I am 98% in stocks and real estate, and the amount of the mortgage is relatively small. If I owned any bonds and planned to keep them, I would sell them instead and pay off the mortgage. I chose to pay off a different commercial real estate loan earlier this year, but it was at 5.75%.
Bond yields have come up a bit. Still have that mortgage? Seems like being long/short bonds with a 3% mortgage is a pretty solid trade now?
@@joesnikeris2407 Interesting timing of your question. I am cash out refinancing on my home next week. I will be paying off the remaining principal on the 3.25% mortgage next week and borrowing at 6.75%. I know right? The new lender wants first position, and I need additional money.
Very thorough analysis! Great video!
Not sure if this applies here in the US with mortgage interest deduction. With my 22% and 24% marginal tax rate. my mortgage interest deduction would have cover 24% marginal tax rate.Still more than 30 years from retirement, I have been advised by my financial advisor not to put anything towards mortgage. of-course it is case by case.
This was one of your best videos, tnx.
What about returns from the property? I.e. the mortgage costs 3% but the property also returns 3% but on a LVR of 80%, you’re 3K ahead on a $500k property. By borrowing, you’re holding a larger asset base which is appreciating and there’s not reason to have such a conservative bond / stock mix.
What if the options are either make extra mortgage payments, or invest the same amount in US savings bonds? Right know, Series I bonds pay better than most mortgages, specially if you consider mortgage interest deductions...
In Canada mortgage interest is not tax deductible on the principal residence, so that would not likely work well here. What you have described may work in the US.
Hi Ben! Really enjoying your videos and a bit in the same conundrum at the moment. I have 20k that I could invest in paying some of the mortgage off and advance in the months left to my 20yrs mortgage. Ran a quick math analysis comparing that with investing the 20k into index funds and even the pessimistic scenario with 4/6% return was a better deal than paying off the mortgage (interest rate is very low 0.94%). Do you agree with this am I missing some factors? I assume paying off the mortgage is lower risk than investing in stocks but hey :)
I'm not Ben, but I'll humbly offer input. Since the interest rate is so low, you're probably fine either way. I think it's important to consider index fund returns are *long term,* meaning returns could be flat or negative for a year or two, maybe even longer, though that's unlikely.
Short-term equity returns are unpredictable whereas mortgage interest is a fixed expense until the mortgage is paid.
@ben felix: what if you are going to invest in a 90% stock portfolio anyway regardless of keeping the mortgage or paying it off. In this case, obviously keeping the mortgage and invest in the portfolio will yield higher returns than paying it off
Yes but it would be more efficient from a tax perspective to take the 10% in bonds in the portfolio and use it to pay off the mortgage. Same assert allocation, higher after tax return. Assuming we are talking about a taxable portfolio.
Smartly presented information. As you alluded to (especially via the Big Banks in Canada), the mortgage penalties in Canada are quite substantial (especially given the so-called "discount rate" being added into the equation.
I am considering a similar scenario: interest 3.75 Fixed, Mort 379k, six more years of a $251. per month for MIP, windfall expected soon so no tax implications for selling off, no more interest income deduction (neighbor to the South) so I lose nothing on that point. From a cash flow perspective it looks pretty good as well. I free up $26,300 annually on my 379k for 6 year until my MIP burns off. That is like a 7% return? The $26,00 includes additional principal. Great video btw!
What about liquidity risk? Isn't it better to have 100k in easily liquidable bonds sitting around plus the 100k in mortgage instead of no additional cash cushion?
In the US you get significant tax deductions for interest expenses which alters the comparison. The recourse options are also favorable to the borrower depending on the type of loan you have so risk is somewhat mitigated.
Very different up here in Canada.
I just removed the whole real estate from the portfolio by renting the apartment😂
Indeed, there are benefits: no mortgage payments, no property tax, no leveraged risk of property depreciation, no transfer tax, freedom of movement whenever needed, etc.
P.S. I realize that I still own a bit of real estate through REITs that sit in the global market ETFs, but that doesn't bother much😅
Absolutely love your videos Ben, good job!
Quick question though about your comment "There could be some consideration for taxes payable on selling $400,000 of the portfolio, or penalties to pay off the mortgage in a lump sum, but I will ignore them to keep things simple."
I don't understand why this assumption is made.
Taking out money of portfolio from a RRSP would imply a major difference in the end results doesn't it ?
While I understand that the logic also applies to no portfolio transfer (by simply increasing your mortgage payments + increasing portfolio risks on the decreased investment), I wonder if your "pay off mortgage from portfolio" scenario is limited to taxable portfolios ?
Thanks again for your videos!
Great, sensible and well-documented information as always, Ben! Thank you for sharing your knowledge and thoughts.
Thanks!
here's a few things I considered, 1 a mortgage interest only applies to the first half of the loan term, remember it's front-loaded also referred to as the rules of 78's so halfway through the term of the loan the money is interest-free.
2 on the other hand if your home is paid off you don't have the risk of being homeless if the market crashes 80 percent and you lose your income. the security of a paid-for house is a huge benefit if your world turns upside down.
Mortgages in Canada are required to be calculated as compounding semi-annually on the outstanding mortgage balance. They cannot use the rule of 78's.
Also for the united states rule of 78's is outlawed for loans/mortgages with terms above 5 years.
There is no interest free money and mortgages are not generally (at least in the North american market) front loaded with interest. Short Auto loans may be though.
You should make more videos Ben, they are great
Hey Ben, you should consider that a short fixed income position is also kind of an inflation lottery ticket. Sure it doesn’t happen all the time, but when it does, it has quite an effect. I suspect that this isn’t systematically being priced into credit, due to erratic monetary policies. So I wouldn’t be the one to pay off a mortgage early, just because of this
Hi Ben, I understand you're trying to make a case when you have both bonds in your portfolio as well as a mortgage. In this case, you are better to use the bonds to buy stocks, in which case you can take more risk and increase your asset allocation in your portfolio to more stocks. What if, however, you're not heavily invested in bonds in the first place, as you're still quite young. Does it - from a risk point of view - make sense to go high in stock allocation AND have a mortgage at the same time? This would of course mean your net worth drops considerably during a market drop, but leaves you time to wait the drop out as time goes on AND consequently possible higher overal net worth at the end?
It’s an extension of the same decision. Decision number one is how much risk you want to take. Decision number two is how to structure your asset allocation. If you want to be a leveraged equity investor, then mortgage debt is a cheap way to accomplish that.
What about 100% equity via a HELOC w/ a mortgage
Then you're leveragimg even more then either scenario he explained.
HELOC loans tend to have higher interest rates than normal mortgages, so I'm not sure I'd go that far.
Ben, for a young professional that does not have a large portfolio, would it make sense to simple sell off their portfolio to aggressively pay off the mortgage first, then re-invest in their portfolio? Or would not buying real estate and continuing to pay rent while investing in ETFs until, say, one maxes out their TSFA and RRSP, make more sense?
Would Smith Maneuver make sense for a first home?
I mostly agree, with the exception that you can’t eat a house. Suppose my girlfriend and I get into financially stormy weather, after depleting our emergency fund we could dip into our investments. If that money is tied up in the house, the only way to dip into that is to sell the house.
You're mixing up the house with the debt. The house was there regardless. If you pay down the mortgage as an asset allocation decision you could always re-borrow to access that capital.
So fast forward to today? This holds true, except remove excess payments to all time low mortgage rates rates and stay fully long equities with continued low monetary rates and QE in spite of inflation concerns?
Hi Ben, thanks for your information channel. I learned a lot. Just wondering if you have a document version of this video? Thanks a lot!
Here you go! www.pwlcapital.com/mortgage-debt-and-asset-allocation/
Thx for an eye opening video Ben. My only concern is that you would be enable to rebalance your portfolio given a major market correction ? Or am i missi g something?
Does this not negate the principle of time in the market though. yes it is more leveraged depending on your emergency fund cash allocation but it is more likely to have higher returns +dividends (yes taxable) can often outrun morgage interest meaning the 10% per year gains can be made. I see this as a less risky version of people buying multiple homes as a realestate portfolio, arguable highly risky IMO but does often lead to wealth. waiting for 0 debt seems unsuccessful in everything i have seen, why business rarely holds no debt.
Great point of view!
Thanks for this Ben. Do the considerations around this change when you're dealing with a windfall? In terms of whether you would pay off your mortgage completely or use some or all to invest?
Nope, just remember to save enough to pay taxes if applicable.
Next level thinking!
Dept works when it works and when it doesn’t psychologically it becomes crushing. Mentally I understand formulas, emotionally using your home for investment doesn’t add up. I will give up returns for options and certainty.
I agree with you.
There are a whole lot of leveraged real estate/smith manoeuvre/HELOC aficionados out there who seem to swear by leveraged investing. I’d be terrified.
Thanks for another great video. There's one thing I can't quite understand: How did you get to the figure of 95% in shares being similar to the example of having a mortgage?
I'm unsure really why a person wouldn't want to pay off their mortgage. Leaving out the peace-of-mind argument, if one can lower, or even better, eliminate their fixed costs each month that would be the way to go. Variable costs like power, water, gas, are easily paid when there isn't a 1900/month mortgage to keep up with.
The reason is that you're tying up money in your house, and the only way to get the money back out is to sell the house. I'm in the process of buying a house, which forces me to think about stuff like this. I could go one of four ways:
1) Put all income I don't need in a savings account. That's kinda the default position. Leads to a nice emergency fund, but the returns are suboptimal.
2) Put all income I don't need towards paying off my money, thereby reducing my emergency fund to a minimum acceptable level. May make sense, but I'm essentially tying up my money for a very long time. Suppose me or my gf loses a job or becomes disabled, and we're struggling to make those payments, there is no way that the bank will repay us the additional money that we already gave them. That is risky.
3) Put all income I don't need first towards an emergency fund of 3-6 months, and invest everything else conservatively (something like 50/50 equity/bonds). Ben explains very nicely why this is suboptimal, as you're basically going both long and short on the same position. That makes a lot of sense.
4) Put all income I don't need first towards an emergency fund of 3-6 months, and invest everything else aggressively (100% equity or similar). This has the benefit of keeping a large part of your money liquid (forgoing the problem identified in 2) and optimizes returns (forgoing the problem identified in 3). It does mean you have a lot of leverage in your portfolio though.
So long story short: it really isn't that one sided, and if you think it is you might be missing something. I haven't decided yet and I may still choose to take a middle-of-the-road strategy, but it really isn't black-and-white.
I've bought a house and lost it in forclosure. While I had the mortgage on the home I earned enough in 8 months to pay it off. It was an 88k loan. Like you have just explained, I was told not to tie up all of my money in the home.
But then 2008. The macro and micro economy collapsed where I lived. I couldn't find a decent job; got behind on all of my bills, and then boom forclosure proceedings.
So my approach is one sided. I should have paid the house off. Taxes were only 2k each year. I could have worked literally anywhere in town and made the variable costs associated with the home.
Joseph Abraham
yes I think paying off a mortgage if a person has the ability to do so is the best bet. as you've noted our financial positions can change drastically short time. the security of having a paid for home could save our life and our sanity.
@@duanejackson6718 A bullet to the ol brain pan was certainly an viable option in 2008-09 when everything I knew was undergoing full demolition.
Ben, amazing video but I'm not really sure I understand what to do if my approach to investing is already to be 100% stocks (my plan is just to jam as much money as possible in XEQT). What's my approach for my first house if I decide to buy one within the next year?
Honestly, it's a very personal decision. If you remains 100% in equity and pay your mortgage at normal rate, it's a leveraged strategy that should have a positive outcome down the road, but through taking up more risk. Not staying it's bad, not staying it's good. I guess it could make sense for financially secure people that are very even minded with market movements and are only investing money they won't need for decades, like they normally should with equity (disclosure: I chose that path).
Let say I have a mortgage of $200,000 at 4%, and an investment of $50,000 yielding 8% return and $50,000 in cash.
If I use the cash to increase my investment to $100,000 at 8% that would equal my mortgage.
But if I use it to down pay my mortgage to $150,000 my investment would be short of $2,000 year in relation to my mortgage.
So I would use $30,000 to reduce the mortgage and $20,000 to increase investment.
What do you think Ben?
Make sure you keep at least a 6 month emergency fund, never know when something may go wrong...
You didn't discuss the possibility of equity loss in your realeaste. The percentage draw down would have most likely been larger in the financial crises.
That makes no difference either way. In both scenarios you own a house, you are taking on real estate risk regardless
What should I do if I have a $500k mortgage now with zero investments but I'm willing to take $100k of equity from my home to invest in a low-cost deversified index fund? Is it worth it?
So you may want to make sure there is no prepayment penalty before you drop the cash. Some lenders regulate how much is allowed to be paid off. Also, when you pay this off is a big factor isnt it? Most of the front half yrs basically are interest and you dont take much dent out of principal. I hate that set up. So the earlier you can do this , the less interest cost damage or lower the interest to principal ratio. Good info here and it is true that when I see someone present the case for keeping mortgage, and they give the return you would sacrifice..that rtn is usually a 100% stock type return. Also, stock market rtns are rarely average anyway, they fluctuate. Although over 15 yrs they have always been positive. I think about 94% of the 10 yr spans have been positive. Anyway, thx for the vid.
I like your method, slow and exhaustive.
I completely agree, but.....aren't you ignoring the behavioural issues? By that I mean the mortgage and the house value don't go down in a crash (well, at the least the house is not marked to market daily and you're living in it so much less likely to sell it), but the stock and bond portfolio does. An investor who can tolerate the volatility of a 50/50 portfolio likely cannot tolerate the volatility of a 90/10 portfolio. So a mortgage and 50/50 portfolio is not the most efficient but it likely is the arrangement most investors can stay the course with so leads to the best outcome. Like somebody said, the best strategy is not the most efficient one, it's the one you can stick with.
Completely agree. I have described in the video what is rational. That may not be the best course for everyone! Edit: Unless, of course, they listen to the Rational Reminder podcast :)
Hi Ben. Great video as always. Would you care to talk about the following: a person who has a real estate portfolio, and who takes out a home equity loan (or rather, a “home owner’s line of credit”) of up to 80% of the equity-value in the person’s real estate portfolio, and who then invests the money into a non registered stock market account, and who can then write off the interest on the home owner’s line of credit from his taxes. How much real estate equity would a person need to have to make this a worthwhile financial exercise? I believe some people call this a Smith manœuvre but I don’t think that’s really the right term for it. Something to consider talking about perhaps? I know your thoughts about rental properties and that it may not be an ideal investment in relation to the work that one has to put in etc, but this tax sashay where you can invest 80% of your properties’ value and write the loan off from your taxes seems like it may be worth doing, provided that one has enough equity. I know you’re a busy guy but, any thoughts?
Good question Barwin. The Smith manoeuvre assumes that you have a mortgage that you have not yet paid off, and a portfolio that could be used to pay off some or all of the mortgage. Doing so and then borrowing the money back on a secured line of credit to invest makes the interest tax deductible. Pretty sweet deal. Everything nets out to being the same, but your interest is now deductible. The downside is that HELOC interest is usually higher than mortgage interest, so for the spread between your after-tax interest cost on the HELOC and the interest cost on the mortgage to be interesting, you have to be in a high tax bracket.
On Ratehub I can find a 5-year variable mortgage for 2.65% while the lowest HELOC is 4.45%. If you're at the 53.53% bracket, then your after-tax interest cost is 2.07%; better than 2.65%, but not _that_ much better. If you're lower than the highest bracket on marginal income, then this can flip quickly. If you tax rate was instead 37.91% (the marginal rate for an Ontario resident with income over $91,101 up to $95,259, then your after-tax interest cost is 2.76%.
HELOC debt is also callable. Sure, that might never happen in Canada, but you can be sure that if it does happen it will be in a terrible economic scenario, and your portfolio is not going to be in any condition to cover the loan.
Some of my above comments apply to both the Smith manoeuvre and your question. I have some additional comments on your question which is assuming you have equity in a property, and you are considering borrowing against it to invest.
I think that for real estate to be an attractive investment you _have_ to be leveraged. The unlevered expected return is not worth the risk or hassle. If you use that leverage to invest in the market, it becomes a question of your willingness and ability to handle the risk. Could you handle it financially if the loan were called? Could you handle it emotionally if you knew the portfolio was 50% of the loan, and it might be called?
If we ran a computer model to maximize wealth it would suggest as much leverage as possible to invest in risky assets. You would end up borrowing against the property to invest in stocks, and then borrowing on margin to buy more stocks! Of course very few people do that because it is terrifying.
Does that sufficiently answer the question?
@@BenFelixCSI Hi Ben. Thank you for your answer. My properties are in Alberta and after the oil crash they lost some equity, like everybody else's properties here. I don't think I have enough equity in them right now to make something like this worth my while, but in a few years from now maybe I'll be wanting to do something along these lines. Keep up the great work, these videos that you make really give people value.
I have a mortgage and no portfolio, what should be my move? Great video's btw.
Thanks! I think I kind of covered that in this article: www.theglobeandmail.com/investing/personal-finance/gen-y-money/article-should-i-pay-down-my-mortgage-or-invest-in-my-tfsa/
OK I’m 74 and still working and make about $500k per year. I have a 15 yr mortgage for $340k at 4% and about $1 million invested in REITs, preferred shares and individual; stocks. I plan on working for 1 more year so what are your thoughts regarding paying off the mortgage?
thanks for another great video Ben!
Glad you enjoyed it, Ryan!
The concept of the mortgage as leverage is what convinced me to adopt the Smith Maneuver. If I'm going to have hundreds of thousands in leverage, why not spread it out across the world equity market rather than in one illiquid asset?
Great video, Ben! I really appreciate your thoughtful insights! What are your thoughts on duration? Taking a 30 year mortgage is going short fixed income for a 30 year duration. Buying a bond is going long fixed income, typically for less duration (7.5 years for the Vanguard Total World Bond fund). Does a long term mortgage make sense with duration mismatch in light of today’s ultra-low rates? This is attractive only if rates rise over 30 years to overcome your other considerations I suppose.
Alternatively, does the duration mismatch offer any better investment plans for the mortgage proceeds than 100% bonds? Say you match 50% of your mortgage balance with bonds and 50% of your mortgage balance with equities. You would be a leveraged investor, but your home equity and the bonds act to safeguard you against a liquidity crunch or having to sell stock in a downturn. And you should have strong odds of coming out ahead over 30 years, right?
Thank you for this (and all your videos), Ben.
Just a kind question: I live in Mexico, where the mortgage interest is about 11%, would it be even more advisable to first pay off the mortgage than in the Canada examples?
Thank you.-
Absolutely. 11% is crazy.
Goddamn pay off that mortgage before everything except credit card debt
pay that mortgage off hombre
Whew 11% interest on a mortgage, that's highway robbery...
Current age is a factor that should be considered. The older we are, less time we have to rebuild our investment account.
furthermore, if you loose your job or income revenue during a crisis, you might end-up having to sell your assets at a loss just to keep up with mortgage.
I'd rather pay the mortgage in fast forward mode and go 100% equity. advanced mortgage payment allows me to pay it even if I need to flip burgers for a living.
another excellent video Ben, really appreciate the insight! I have a question sort of related. my mortgage is up for renewal next year, given the bank of Canada has stated it wants to return to "normal" interest rates in the range of 2.5 to 3.5%, and factoring in atleast 2 probably 3 interest rate hikes by then (June for us) putting the bank of Canadas rate at between 2.25 and 2.5, would it be wiser to go for a variable rate mortgage. I am quite comfortable with the risk of it going up another 1% but I believe we will be in a recession again within about 3 years and rates should deflate again. given I can get a variable rate for between .75 and 1% less than a fixed rate I think variable would allow me to takr advange of any rate decreases in the next 5 years while still allowing me to likely just break even or maybe take a slight hit of they dont. thoughts?
I'm no mortgage pro and my crystal ball is, as usual, pretty foggy. I believe that statistically variable is the best option. Of course one could argue that the statistics don't matter because we have had an unprecedented interest rate environment recently. I am currently a renter, but when (if) I do eventually choose to buy I will probably go variable.
@@BenFelixCSI oh for sure you dont need to explain that to me LOL none of us can predict the future. I just try and do as good as i can with the information i have. it seems like a year from now we will be alot closer to the top then the bottom.
@@hellcat320 maybe. Or maybe we will be at the bottom. If I ever know for sure that we're at the bottom I'm borrowing as much as I can to invest. Too bad I'll never know for sure.
Home loan is a loan..which is debt
Just the info i needed!
This takes the example of 3% mortgage interest rate but most likely that rate will increase to 5% or higher in coming years. Not accelerating mortgage payments is a bet that interest rates will always stay low
Anyone every tell you that you sound like Obama? Lol great videos btw
Yes many people observed that, as me :-)
As long as you make mortgage payments you won’t get margin called though.
Very underrated comment. Plus, at least in the US, the effective interest rate is much lower due to mortgage interest deduction.
If you are under 50, Just go 100 equities and keep a massive mortgage. It's leverage, and unless you run into a life emergency, the risk is more than acceptable.