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Hi! I'm LRS
Old 03-18-2004, 10:33 AM   #1
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Hi! I'm LRS

Husband and I in a nutshell:

Ages 45 (me) & 48 (he). Early retirement possible, not through dint of hard work, savings, and frugality; no, we earned our money the old fashioned way--we inherited it (about .5 mill).

Challenges: learning to save, spend less, live more frugally in order to retire in 6 or 7 years. We still have 2 kids at home (ages 10 & 15).

Resources: we are both public employees in a state where the public employee retirement system is threatening to go bust, but if it doesn't, we are both eligible for pensions which we can draw at age 55. We have paid off all credit cards and car loans.

Interests: I have been monitoring the topic on the pros and cons of paying off mortgages early--I'm still a bit boggled by the ins and outs of that. I think we will choose to pay off our mortgage and invest the money we save from that. (Our mortgage interest is 6.9% and it's either pay off or refinance).

I am also interested in the sections on living more simply before and after retirement. That has a huge appeal for me, even though we are used to spending money freely. My personal goal is to remain debt free for the next 6 years, if not for life.

That's about it! No opinion about dryer sheets, by the way. I 'll have to look around for a swell avatar to use.
Ta.
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Re: Hi! I'm LRS
Old 03-18-2004, 12:08 PM   #2
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Re: Hi! I'm LRS

Greetings!

I've been in the 'pay off the mortgage' clan for a while, considering it as a feature that helps me reduce necessary withdrawals (a good thing during runs of bad years), and as somewhat of a replacement for a portion of the fixed income piece/real estate piece of a well allocated portfolio.

I started to waver in that opinion when my credit union started offering rates close to 4% apr on a 5/1 fixed/adjustable mort.

They just dropped to 3.98% apr with no upfront costs. I'm sorely tempted. If rates dropped to 3.5% with no costs I might have to dip a little, because even in a crappy year I've been able to do better than that on a short term quarterly basis.

Debt free is a good thing though. My withdrawal is an annualized 30k per year, and I could get by on less than half of that without feeling much of a pinch. I could cut my withdrawal rate down to about 1.5% during a stretch of 3-5 "bad" years if needed.

The most important thing though is developing a position on the dryer sheet issue. Make that your first priority.

By the way, sorry to hear about that thing about you and the husband in a nutshell. No need to get THAT cheap, spring for a second nutshell. Splurge.
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Re: Hi! I'm LRS
Old 03-18-2004, 01:40 PM   #3
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Re: Hi! I'm LRS

I'm sorry to say that a nutshell is right where we belong. I don't think we could afford the mortgage on a second nutshell.
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Old 03-18-2004, 02:33 PM   #4
 
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I think we will choose to pay off our mortgage and invest the money we save from that. (Our mortgage interest is 6.9% and it's either pay off or refinance).
It is a good idea to payoff a 6.9% loan since it is very hard to find an investment that will provide a better yield on a gurantee basis.

Paul
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Old 03-18-2004, 04:56 PM   #5
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Re: Hi! I'm LRS

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I started to waver in that opinion when my credit union started offering rates close to 4% apr on a 5/1 fixed/adjustable mort.
Th, could you explain to me what these terms mean? ( The 5/1 fixed/adjustable part.) I have no current loans, except $15,000 credit card at 3.99% fixed for life of the loans. This wasn't spending for goods and services, it was margin debt that I refinanced to get a fixed rate. If I could get a larger, cheap loan for 15 or 20 years I would do it in a flash. I don't mind periods of bounded negative cash flow.

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Old 03-18-2004, 05:52 PM   #6
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Re: Hi! I'm LRS

Adjustable rate mortgages carry a lower rate than the typical 15/20/30 year mortgages and are a good idea if you think rates will remain stable in the near to medium term.

Since statistically most people sell their homes and move within a 7 year period, this may be a good bet.

Conventional wisdom says that we're about to see a big shoot up in interest rates. However to be fair they said that 2 years ago, last year, and for the last six months. I'm on the fence.

Besides a 1 year Adjustable Rate Mortgage (arm) where the rate may be adjusted once or twice per year, with a limit per year and a maximum rate, there are hybrid fixed/ adjustable mortgages.

Typically these are called 3/1. 5/1 or 7/1 mortgages (i'm sure there are others). In this case you get a sweeter low fixed rate for a number of years (the 3, 5, and 7 in this case), then the rate becomes adjustable.

The bank essentially bets (and hopes) that you'll outlast the fixed portion and that rates will rise by then (not a bad bet in a 3 or 5 year version) and they can start ratcheting up the rates by 2% per year.

You're betting that you'll pay off the mortgage by payoff or by moving to a new home between now and then.

For the purposes of this mortgage I'm looking at, the rate is 3.98 per year for the first 5 years, then it becomes variable for 10, 15 or 25 years, depending on the total term of the mortgage (15, 20 or 30 years).

A great deal if you think you can substantially thump the mortgage rate for that 3, 5 or 7 year period. Pretty speculative for 3 years, fairly good bet for the 7 year. Questionable for the 5 year.

Since you can get CD's in the 4.5-5.25 rate for 5 year jumbo's its on the borderline. Of course the banks front load the interest on mortgages (you pay a larger percentage up front and less as you go) the numbers might not work out. I'll fiddle with a mortgage calculator tomorrow and figure out at what point I can be sure of a 1% margin; once I'm beyond that point I'd probably strongly consider it. A virtually risk free 1% annual gain on money thats never mine wouldnt suck. If you get slightly riskier on the investment side, the returns could be nice.

Not an exercise for someone with a tender stomach.

But a 3/5/7 year fixed/adjustable mortgage is a mighty fine idea if you plan to stay less than that in a home. Saves you a half point to a full point or more during that short haul.
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Re: Hi! I'm LRS
Old 03-18-2004, 07:39 PM   #7
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Re: Hi! I'm LRS

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. . . I think we will choose to pay off our mortgage and invest the money we save from that. (Our mortgage interest is 6.9% and it's either pay off or refinance).

Once again, I will offer my view on this subject, although my opinion makes other posters call me names and spit on me. Most FIRE types become almost obsessive about the importance of paying off their mortgage before they retire. And if you feel that way, you should do it.

But before you do, you should look at the numbers and see if that move is really consistent with your risk/reward character. If you have a 30 year loan in the 5% to 5.5% range, the odds are good (on the order of 70% - 85%) that you will be better off financially by paying the regular loan payments to the end, and investing the payoff amount for the remainder of the loan period. This would require that you refinance your current loan. Choosing to do this also 1) increases your odds of beating a period of high inflation and 2) increases your expected terminal portfolio value. This latter advantage means that you will have greater odds of being able to increase your safe withdrawal rate at some point during your retirement.

There is some risk (~ of 15% to 25%) that this strategy will not result in finanacial advantage and that you will pay more over the life of the loan than you will make from your investments. You can analyze the magnitude of the risks and rewards using FIRECALC. Use the Loan amount as the nest egg value, the length of the loan as the time in retirement, the annual payments as the withdrawal rate and check the box for no inflation. The resulting probability of success is the probability that investing the money will put you ahead of paying off the mortgage. To evaluate the magnitude of the risk, decrement the withdrawal amount till you achieve 100% probability of success. The difference between your actual payments and this number represents the amount of money you are risking under worst case assumptions.

In reality, if you choose to keep making payments, the upside is slightly better than what FIRECALC will tell you since that analysis will ignore the tax advantage that goes with making mortgage interest payments. (That is probably a small amount). You also have the opportunity to reduce your worst case risk at any time during the loan by paying off the balance and thus reducing your investment loss impact.

If you have any intention of using some of your money to invest (as hobby money) during retirement, this is an investment that has a higher probability of paying off than most stock trading.
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. . . . No opinion about dryer sheets, by the way. I 'll have to look around for a swell avatar to use.
Ta.
No opinion about dryer sheets That's blaspheme
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Old 03-19-2004, 03:31 AM   #8
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Re: Hi! I'm LRS

salaryguru

If other posters call you names and spit on you - isn't that like earning credits toward Curmudgeon certification - something like engineer in training status or possibly 'letters of recomendation'.

Dryer sheets are the key to viewing whether to pay off the home. IMHO - the 'true ER' will learn to change his/her wardrobe to match effective dryer sheet recyling. I lean toward Dickies coveralls and cutoffs/aloha shirts as weather permits.

Likewise if you put ER first and run your numbers, then home equity/payoffs vs rent becomes clearer - Terhorst's and Greaney provide the guideposts.

And that's my two cup of coffee theory for today.
guideposts.
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Old 03-19-2004, 07:25 AM   #9
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Re: Hi! I'm LRS

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salaryguru

If other posters call you names and spit on you - isn't that like earning credits toward Curmudgeon certification - something like engineer in training status or possibly 'letters of recomendation'.
Yes, I think you're right again unclemick. That's why I posted that qualifier about the response of others . . . I'm bragging .

Quote:
Likewise if you put ER first and run your numbers, then home equity/payoffs vs rent becomes clearer - Terhorst's and Greaney provide the guideposts.

And that's my two cup of coffee theory for today.
guideposts.
But, I think the answer is different for different people and different lifestyles. Rent vs buy analysis gives different answers for different people/lifestyles as does mortgage vs payoff analysis. And the numbers are only part of the story.
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Old 03-19-2004, 07:56 AM   #10
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Re: Hi! I'm LRS

There are two things I see lacking in the strict numbers analyses of mortgage vs payoff. Bear in mind that my coffee is still brewing and thus I throw my intellectual self at the mercy of the court.

First is the analyses dont consider variable expenses. I cannot decide to not pay the mortgage or to pay less of it during "tough times" in the market. Without that bill every month, I can however decide to eat a lot of pasta, not replace the car this year, and wear the same pants for the forseeable future. In other words, I can electively defer a substantial portion of my expenses and cut my withdrawal rate.

Second is the value quality of the investment. If I have a $200k mortgage, and $200k in investments in stocks and bonds, and the stocks and bonds drop by 30-50%, I have virtual ownership of pieces of paper that have lost considerable value...no more, no less. If those investments fail to produce satisfactory output for me to make my mortgage payment, I have physically lost the house. However, with a paid off home, the only value that can drop is that of the home, and even if it loses 90% of its saleable value, it retains the value of providing a comfortable place to live. I dont think any other investment vehicle (a true one, not a speculative one like art) provides this sort of value.

So I dont think its simply a matter of "running the numbers" to say that $x invested will make >x%, y% of the time, using constant rates of expense for both scenarios. You need to incorporate the stable value of the home as a place to live, and you need to consider that a debt free life creates significant opportunity for voluntary expense reduction that cannot reasonably exist in a debtors world.

Coffees done...
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Old 03-19-2004, 12:06 PM   #11
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. . . First is the analyses dont consider variable expenses. *I cannot decide to not pay the mortgage or to pay less of it during "tough times" in the market. . . In other words, I can electively defer a substantial portion of my expenses and cut my withdrawal rate.
If you think about it, this argument actually works the other way. Yes, you have to pay your mortgage whereas you don't have to buy the premium dryersheets or premium wine if your investments are doing poorly. But now look at real numbers. Let's say you have $1.2M in investments and a $200K mortgage. The approximate $900 per month payment represents much less than one tenth of one percent of your nest egg. It represents less than a third of your monthly spending (assuming a 4% SWR) and if inflation runs up, it represents even less. If your investments return more than the mortgage rate, it represents even less (and remember the probability of that happening is high).

Realistically, how much do your investments have to fall before you can't pay mortgage and keep eating? And if it really comes to that, how much would your payoff depleted nest egg have fallen to? Wouldn't you rather have the option of selling and moving to a smaller dwelling to preserve resources? I would think, the less equity you have the better off you are if times get that hard. A McMansion roof over your head without food seems like a bad place to be.

On the other hand, if you pay off the mortgage, you are left with only $1M in investments. Your personal inflation rate will be higher in this case because all of your expenses are subject to inflation. If your investments go sour, you deplete them more quickly because you start with less. If times get really tough, you have a roof but not enough money to eat. Selling the house is the only option, but what kind of market do you think you will have to sell into if investments do that poorly?

Quote:
Second is the value quality of the investment. *If I have a $200k mortgage, and $200k in investments in stocks and bonds, and the stocks and bonds drop by 30-50%, I have virtual ownership of pieces of paper that have lost considerable value...no more, no less. *If those investments fail to produce satisfactory output for me to make my mortgage payment, I have physically lost the house. *However, with a paid off home, the only value that can drop is that of the home, and even if it loses 90% of its saleable value, it retains the value of providing a comfortable place to live. *. .
I don't really get this argument (although it's not the first time I've heard it) it seems like an emotional argument to me. (Is this really a concern for the ER's on this board? Does anyone with the means to retire early really lie around and loose sleep worrying that they might be homeless some day?) A loss is a loss and assets are assets. You can trade assets for a roof over your head. You can buy the roof and lose the future use of the assets. You can rent the roof and pay what the market will charge you for the foreseeable future. You can get a mortgage and fix the time and rate of the payments. Each of these options provide tradeoffs/advantages/disadvantages different from the others.

I guess I would like to see someone turn this fear into numbers for me. What circumstances would you have to see to make you lose your house because of mortgage payments? What would you forsee the nest egg having to fall to for you to default? What conditions would have to occur for that to happen? . . . And remember, unless it happened overnight, you would always have the option of paying off the mortgage before things came to that. Now apply those conditions to your pay-off case and tell me how you are really better off. Maybe I'm missing something, but if I am, someone quantify it for me.

I do believe that you shouldn't plan on making money by keeping a low rate mortgage if you feel like your nest egg is very marginal (eg. you are planning a 4.0% initial withdrawal rate and hoping it will last 40 years with no pension and minimal ss). On the other hand, if you are working comfortably with a 3.5% initial withdrawal rate and reasonable ss/pension benefits coming and you were going to use 10% -20% of your portfolio to invest in hobby stock trading, the mortgage would be a better, safer bet.

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Old 03-19-2004, 12:07 PM   #12
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So I dont think its simply a matter of "running the numbers" to say that $x invested will make >x%, y% of the time, using constant rates of expense for both scenarios. . .
It's certainly not. But if you really want to make arguments about variable expenses or quality of the investment, you should be able to quantify what you mean by that. I really think the variable expense argument works the wrong way for payoff with a high degree of probability. That analysis is easy to perform using FIRECALC. As far as the quality of the investment goes, saying you could lose your house seems like a pretty remote possibility. You could also point out that if you paid off the mortgage, "you could starve to death." Remember, with all else being equal, the portfolio of the person who chose to pay off the mortgage goes to zero before the portfolio of the mortgage holder. When that happens, one person has a house and one person has cash. I can't imagine what economic times would produce this catastrophe, so I also don't know which would be more valuable. And the other important point to make is that the decision to hold the mortgage can be reversed at any time by choosing to pay it off. You can easily set your own stop-loss level if you want.
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Old 03-19-2004, 12:39 PM   #13
 
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SG,

First of all, I agree with you even though I paid off my mortgage.

A real simple scenerio.

Let's say a guy has got $1 Million portfoilo and it's 100% invested in the market. He also has a 250K mortgage at 6% interest on a 750K home. He comes to this forum and starts believing he should only be invested about 60% in the market with his $1 Million Portfolio.


He looks around at the low interest rates and is frustrated that he can only seem to get 2% interest. So he starts thinking about paying off his mortage.

You need to advise him.

A.) Don't pay off the Mortgage, refinance, invest the 40% of your portfolio - SG you tell us where.

B.) Don't pay off the Mortagage and refinance and borrow more and invest - SG tell us where.

C.) Pay off the Mortgage and save the refinance costs an instant $4K!! and 6% return!! - and put the remaining $150K in short term bond funds.

D.) Stay 100% in stocks!!

E.) Other - Your choice here SG

SG,

Recognize that choice B is the same as A if you feel very strongly about not paying off the Mortgage.

BTW - SG, I was that guy and chose option C.
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Old 03-19-2004, 01:06 PM   #14
 
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Hello Cut-Throat.............Good stuff re. mortgages vs.
no mortgages. I currently have none although I own
quite a bit of real estate (as a % of total net worth).
In my case, keeping cash locked up in real estate
has a psychological component. It is slightly more difficult to access the cash (although lenders make it
easier all the time). I find I get more frugal if my
wallet is not fat with cash. Obviously I know I am
"tricking" myself with this rather transparent ploy,
but it works,

John Galt
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Old 03-19-2004, 01:42 PM   #15
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Re: Hi! I'm LRS

Without going tit for tat, I'll try to keep it simple.

Most folks here seem to feel that the Bernstein book (which I'm halfway through) is the bible. He says he expects returns from stocks and bonds to be 6% over the long haul. Hence the big bonanza benefit to investing the mortgage amount isnt that big of a bonanza. Unless you dont believe that part.

Second, I would agree with everything said about investing the mortgage sum if we're talking in terms of decades and/or the full 30 year term. Completely. When we're talking about 3-5 year stretches, what catastrophe? Maybe the 3 year whallop we just had...or the 65-75 stretch, or the much longer run during the depression. Bernstein again says you'll see one, maybe two bad times in your investing career. A lot of folks here are talking about runaway inflation, lousy returns on stocks, and TIPS as a safe haven for half of your investments. TIPS at 2.5% return (which we're nowhere near now) and a 4.5% inflation rate (ditto) arent going to get you very far ahead of that 30 year mortgage.

What I'm talking about is two fold. In one case, if you get 3-5+ years of crappy returns, I can electively simplify my life and reduce my withdrawals without suffering, in order to compensate. In the long haul, if we have one of these truly horrific 10-20 year periods of awful inflation and terrible stock returns, no matter how badly my portfolio gets spanked I still have a house to live in, that should be value carried along with that inflationary run. If not, I can still live in it.

One last distinction...if you're sitting on a mil and a half plus portfolio, keeping the mortgage and investing the money makes sense, no bad time in recorded history is likely to get you to the land of default on the mortgage. A 750k portfolio on the other hand makes one want to be able to control the monthly expenses a little more tightly, and a 50% investment drop on a port that size sends you back to work. On the other hand, if you have two mil, paying of the mortgage is lunch money.

Bonds taste bad, and stocks, no matter how thickly you have them laid by ex-survivor escapees...still leak when it rains.
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Old 03-19-2004, 03:53 PM   #16
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. . . You need to advise him.

A.) Don't pay off the Mortgage, refinance, invest the 40% of your portfolio - SG you tell us where.

B.) Don't pay off the Mortagage and refinance and borrow more and invest - SG tell us where.

C.) Pay off the Mortgage and save the refinance costs an instant $4K!! and 6% return!! - and put the remaining $150K in short term bond funds.

D.) Stay 100% in stocks!!

E.) Other - Your choice here SG

SG,

Recognize that choice B is the same as A if you feel very strongly about not paying off the Mortgage.

BTW - SG, I was that guy and chose option C.
The problem is that you are trying to find a short term solution to a 30 year problem. Here's my answer: How do you allocate the rest of your funds? Now keep allocating them the same way for the next 30 years.

Why do you separate out money that could be used to pay off the house as separate from the rest of your portfolio? You don't have to come out ahead tomorrow to come out ahead over the next 30 years. And there has never been a time in history when the stock market did not return more than 5% over 30 years.

I don't want to sound defensive on this issue (again). But I keep providing hard data in the form of 30 year rates of return, current mortgage rates, and FIRECALC simulation results that all point out how to evaluate the dollars and cents expectations as well as the worst case downside potential. I hear people say things about fear of losing their home, etc. but I don't see any quantitative backing for how the payoff vs mortgage approach really provides greater safety under catastrophic economic times.

Now you want to know how to allocate the funds that could have been used to pay off the house. Fine. You should have put 60% into a total stock index fund and 40% into I-bonds. You would be way ahead. And today you could choose to pay off the house and lock in that investment gain, or you could choose to keep the money on the high probability bet and let it ride.
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Old 03-19-2004, 03:58 PM   #17
 
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SG,

I'm not sure I understood your answer. But isn't there a 30K limit per SS no on I-Bonds. If so, that would not work.

Also,

Do you own a house? If so do you have any equity in it? If so, why don't you borrow as much as you can against the equity at record low interest rates and Invest in I-Bonds?
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Old 03-19-2004, 04:26 PM   #18
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Re: Hi! I'm LRS

The view from the bleachers is great - fish camp, uninsurable,unmortgageable and like the dryer sheet hopefully recylicable every year(if Mother Nature is nice).

You guys are doing a good job of pointing out the defense and offense strategy's to be considered in ER. My backup is to check equivalent rents every few years. If the worst happened(hurricane wipeout) then the rent/buy strategy's would come into play. The easy part for us - zero equity consideration, so playing the numbers is easier.
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Old 03-19-2004, 04:26 PM   #19
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Most folks here seem to feel that the Bernstein book (which I'm halfway through) is the bible. *He says he expects real returns from stocks and bonds to be 6% over the long haul. *Hence the big bonanza benefit to investing the mortgage amount isnt that big of a bonanza. *Unless you dont believe that part.
Well . . . I haven't read the Bernstein book, but if he projects returns over the next 30 years, I question the validity. Bogle has suggested we should see returns in th 6% to 9% range over the next decade. Buffet has suggested similar numbers. As far as I know, niether of them would presume to have a clue about the next 3 decades. Projecting beyond a decade is pure nonsense. This would be equivalent to the late 1960's investor anticipating the bull market of the 90's. But even 6% over 30 years vs a 5% mortgage gives you about a 30% increase in earning on the payoff amount. So a $100K loan could put an extra $130K in your pocket over the life of the loan.

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Second, I would agree with everything said about investing the mortgage sum if we're talking in terms of decades and/or the full 30 year term. *Completely. *When we're talking about 3-5 year stretches, what catastrophe? *Maybe the 3 year whallop we just had...or the 65-75 stretch, or the much longer run during the depression. *Bernstein again says you'll see one, maybe two bad times in your investing career. *A lot of folks here are talking about runaway inflation, lousy returns on stocks, and TIPS as a safe haven for half of your investments. *TIPS at 2.5% return (which we're nowhere near now) and a 4.5% inflation rate (ditto) arent going to get you very far ahead of that 30 year mortgage..
This is absolutely correct. This approach works best if you are able to refinance your home with a 30 year fixed rate (5% to 5.5%) mortgage just before you retire. Very few times in history would provide you with that opportunity. Now just happens to be one of them. Shorter periods result in increased risk of not coming out ahead and in larger downside potential. If you remember, I mentioned that when you posted your idea of trying to take out the low interest 5 year loan several weeks ago. I don't like your odds there. There have been 10 year periods when the stock market provided negative returns and several where it provided sub 5% returns. Five year periods look worse.

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One last distinction...if you're sitting on a mil and a half plus portfolio, keeping the mortgage and investing the money makes sense, no bad time in recorded history is likely to get you to the land of default on the mortgage. *A 750k portfolio on the other hand makes one want to be able to control the monthly expenses a little more tightly, and a 50% investment drop on a port that size sends you back to work. *On the other hand, if you have two mil, paying of the mortgage is lunch money.
Agreed. As I've always said, run the numbers. And I have also indicated that the advantage of keeping a long term, low interest mortgage is that you get to trade excess probability of success for increased insurance against inflation and the possibility to increase your withdrawal rate significantly in the future. If you are significantly concerned about your portfolio providing adequately for your retirement, you might want to pay off the mortgage.
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Re: Hi! I'm LRS
Old 03-19-2004, 04:40 PM   #20
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Re: Hi! I'm LRS

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SG,

I'm not sure I understood your answer. But isn't there a 30K limit per SS no on I-Bonds. If so, that would not work.
That's 30K per person per year. Since your question assumed you had the mortgage all along, I assumed you had investments all along too. If you find your I-bond amount limiting, then invest in any reasonable bonds or bond funds beyond the limits you hit. Basically, my answer is keep doing what you're doing.


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Do you own a house? If so do you have any equity in it? If so, why don't you borrow as much as you can against the equity at record low interest rates and Invest in I-Bonds?
That's exactly what I did. I chose to move from Iowa to Arizona for retirement. I took the equity out of my house in Iowa and put down a minimal 20% (to avoid PMI) on my new house to take full advantage of the historically low mortgage rates. Only I didn't invest in only I-bonds. I just used the money to keep my regular allocation.

But for someone else, it really depends on how much their total portfolio and total mortgage would be.
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