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Can FireCalc Produce these Results?
Old 03-16-2015, 03:13 PM   #1
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Can FireCalc Produce these Results?

Hi. I ran two versions of my early retirement. Version one had me paying my fixed mortgage over the course of 30 years. I am 44 now. This produced a 100% success rate. Version two had me paying off the mortgage, reducing my yearly expenses for the mortgage payment and reducing my investment portfolio by the amount of the mortgage (140,000) to account for the mortgage payoff. Version two only provided a 85.1% likelihood of early retirement success.

I would have thought paying the mortgage off early would, if anything, increase the likelihood of my early retirement success. But the numbers suggest otherwise. Can you explain why this may be the case?

Thank you for your insight.
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Old 03-16-2015, 03:51 PM   #2
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The return from the 140,000 exceeds the mortgage payment.
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Old 03-16-2015, 04:16 PM   #3
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You repay a mortgage with inflated, devalued dollars. A mortgage with a rate near the long-term inflation rate of 3.something % is basically free money that you can invest more productively elsewhere.
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Old 03-16-2015, 04:39 PM   #4
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Much depends on how you have things set up (the inflation rate you assumed in Firecalc, the investment allocations you have, etc). If your inflation rate exceeded your mortgage interest rate, then it's easy to see why keeping the mortgage was a "winner".

I don't think, overall and in theory, there's a big impact on total average ending net worth from either keeping or paying off the mortgage, but the FIRECalc results you got do point to a difference between averages ("overall return is about the same whether we pay off our mortgage or not") and real life. In FIRECalc, if the portfolio ever reaches zero, it "fails", and a large number of these failures tend to occur early/mid retirement if investment returns are poor during the first years of retirement--the portfolio gets so depleted by spending and by loss of share value that it can't generate enough returns to support the withdrawal rate --and it crashes. By keeping the money in your portfolio instead of paying off your mortgage, it provides more "cushion" if you have a series of poor returns right off the bat, so your portfolio has a chance to recover. Even though you reduced your withdrawals to account for not making the mortgage payment and this would have slowed your "descent to zero" a tiny bit, having the mortgage money in your account was probably still a more powerful (positive) impact on portfolio survival.
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Old 03-16-2015, 06:08 PM   #5
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Just for clarification, I used the CPI choice for inflation. FireCalc doesn't ask for the interest rate on my mortgage, but I believe it is around 3.5%.

When I use a "safe" withdrawal rate of 4 percent on the value of the outstanding mortgage (140,000) this amount is still less than the annual amount of the required mortgage payment. Here, I was figuring an average return on the portfolio of 7 percent with a 3 percent inflation rate.

I guess I am just confused as to the dramatic difference in success rates, when I read that some financial advisors really advocate getting rid of the mortgage debt. I think I understand what samclem means by an extra "cushion", that the 140,000 in my investment portfolio provides.
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Old 03-16-2015, 06:37 PM   #6
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Originally Posted by nico08 View Post
....

I would have thought paying the mortgage off early would, if anything, increase the likelihood of my early retirement success. ....

I had to re-read that line, as my brain read it as 'decrease the likilhood', since in general, market returns have exceeded mortgage rates, so the expectation would be in favor of holding the mortgage.

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...
I guess I am just confused as to the dramatic difference in success rates, when I read that some financial advisors really advocate getting rid of the mortgage debt. ...
Who?

samclem makes some great points. I'll add that it was pointed out to me that historical reports like FIRECalc may not be giving a super-clear picture of the mortgage pay off decision. For example, 1966 is one of the 'killer' start years. But could you get this low of a mortgage in 1966? So it may not be reflective.

While there's no guarantee of course, it seem pretty reasonable that a portfolio will outperform a current low rate mortgage. And there is the liquidity issue. But if you don't feel comfortable with that market guess, and you have sufficient liquidity, you could pay it off. Probably won't make a lot of difference either way.


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When I use a "safe" withdrawal rate of 4 percent on the value of the outstanding mortgage (140,000) this amount is still less than the annual amount of the required mortgage payment. ...
Remember, some of that mortgage payment is against principal - you are essentially 'paying yourself' - it is adding to your net worth. Only the interest is an 'expense'.

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Old 03-16-2015, 07:42 PM   #7
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Tom Anderson makes the case for keeping the mortgage in a new book, "The Value of Debt in Retirement."

Wiley: The Value of Debt in Retirement: Why Everything You Have Been Told Is Wrong - Thomas J. Anderson

I reviewed a draft and think it is worth reading.
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Old 03-17-2015, 10:41 AM   #8
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... Remember, some of that mortgage payment is against principal - you are essentially 'paying yourself' - it is adding to your net worth. Only the interest is an 'expense'.
Paying back principal does not add to one's net worth. It is "neutral" to net worth. Answer is the same whether you pay it back monthly with interest, or all at once. More importantly, the principal portion of your monthly payment is still a cashflow obligation which must be satisfied via one's withdrawal rate.

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... By keeping the money in your portfolio instead of paying off your mortgage, it provides more "cushion" if you have a series of poor returns right off the bat, so your portfolio has a chance to recover. Even though you reduced your withdrawals to account for not making the mortgage payment and this would have slowed your "descent to zero" a tiny bit, having the mortgage money in your account was probably still a more powerful (positive) impact on portfolio survival.
That depends. At the time I paid off our mortgage, there were 9 years left on, what was originally, a very large 30-year mortgage. The unpaid balance was now quite small relative to our investable portfolio, less than 10%. Yet the mortgage payment (P&I only) was still quite high at about 25% of expenses. In fact, the annual mortgage payment was 15% of the unpaid principal balance at that time, and rising fast.

Without the mortgage, we could cover all our expenses with pensions, rentals, dividends, and extremely small withdrawals (less than 1%, pre-SS). With the mortgage, the incremental withdrawal rate was uncomfortably large, with significantly more early risk to portfolio survival.

I do think the historically low interest rates available over the last few years have created a unique opportunity that might warrant some degree of voluntary leverage in retirement, especially if you plan to stay in the house forever. However, one still needs to contemplate the applicability of FIRECalc's rich history to a future period starting with historically low interest rates and historically high equity valuations. Then consider the leverage decision in the context of your overall financial situation and risk profile. In my case, I had considered refinancing the remaining small mortgage balance at 3.375% for 30 years, but I ultimately concluded that was simply adding an unnecessary risk and uncertainty to a game I had already won.
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Old 03-17-2015, 11:16 AM   #9
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I guess I am just confused as to the dramatic difference in success rates, when I read that some financial advisors really advocate getting rid of the mortgage debt. I think I understand what samclem means by an extra "cushion", that the 140,000 in my investment portfolio provides.
Financial advisors don't give super accurate advice.

Look at your amortization schedule. You can always pay ahead just enough to make it all yours on some future date.

How you look at this in 10 years may very well change. Your view of the world as interest rates rise will be very different than our view of holding 8% mortgage as rates were declining. At that time we had been paying ahead, and paid off with cash that was earning less and less each year.
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Old 03-17-2015, 11:27 AM   #10
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Paying back principal does not add to one's net worth. It is "neutral" to net worth.
Yes, I misspoke, and too late to edit, so I confused things, darn it! Thanks for the correction - it doesn't add to net worth, the principal is a transfer from one account to another, not an 'expense'.

Quote:
More importantly, the principal portion of your monthly payment is still a cashflow obligation which must be satisfied via one's withdrawal rate.
True, it is a cash-flow issue, but often I find people make a big deal about this monthly cash flow, and then ignore the much larger lump-sum cash flow of the pay-off (I'm not implying you are doing that, but it has been down in the past by others). I guess the devil is in the details, maybe some withdraws and pay-offs in low tax years (like before RMDs) could work for some people.



Quote:
Without the mortgage, we could cover all our expenses with pensions, rentals, dividends, and extremely small withdrawals (less than 1%, pre-SS). With the mortgage, the incremental withdrawal rate was uncomfortably large, with significantly more early risk to portfolio survival.
But what about the risk of having a lower invested portfolio due to the lump sum withdrawal (samclem laid this out in an earlier post)?


Quote:
I do think the historically low interest rates available over the last few years have created a unique opportunity that might warrant some degree of voluntary leverage in retirement, especially if you plan to stay in the house forever. However, one still needs to contemplate the applicability of FIRECalc's rich history to a future period starting with historically low interest rates and historically high equity valuations. Then consider the leverage decision in the context of your overall financial situation and risk profile. In my case, I had considered refinancing the remaining small mortgage balance at 3.375% for 30 years, but I ultimately concluded that was simply adding an unnecessary risk and uncertainty to a game I had already won.
And that sounds like the right decision for you then. As I state, I don't think it is likely to make a big difference either way (assuming good rates, and not wiping out liquidity). I just gristle at the comments where people make it sound like it will have some amazing financial advantage. If it feels good, do it. Just don't over-sell it please. Or infer (intended or not) that those with a mortgage must be dummies for not taking advantage of all this 'safety'.

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Old 03-17-2015, 11:33 AM   #11
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I suspect that you have something wrong somewhere. I set up a run with a $1m 60/40 portfolio, $35k of expenses and 50 years and got a 96.8% success rate. Then I reduced the portfolio to $860,000 (-$140k mortgage) and reduced the expenses by $7,560 (annual mortgage payments on a $140k 30 year mortgage at 3.5%) to $27,440 and the success rate was 100%.

A better way of including the mortgage is to exclude the mortgage payments from expenses and then include the mortgage payments as a non-inflation adjusted off-chart spending starting immediately and then offset by a non-inflation adjusted pension for the same amount beginning when the mortgage ends because if you include mortgage payments in expenses it inflates them and they never end.
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Old 03-17-2015, 11:36 AM   #12
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I suspect that you have something wrong somewhere. I set up a run with a $1m 60/40 portfolio, $35k of expenses and 50 years and got a 96.8% success rate. Then I reduced the portfolio to $860,000 (-$140k mortgage) and reduced the expenses by $7,560 (annual mortgage payments on a $140k 30 year mortgage at 3.5%) to $27,440 and the success rate was 100%.

A better way of including the mortgage is to exclude the mortgage payments from expenses and then include the mortgage payments as a non-inflation adjusted off-chart spending starting immediately and then offset by a non-inflation adjusted pension for the same amount beginning when the mortgage ends because if you include mortgage payments in expenses it inflates them and they never end.
^ What he said.
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Old 03-17-2015, 11:44 AM   #13
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I think it depends on your AA and inflation settings. Maybe 3-4% inflation will be the norm again, but it hasn't been recently. The Fed has tried their best to get inflation up to 2% and have yet to do so.
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Old 03-17-2015, 11:48 AM   #14
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Try adding your old P&I amount into the "Retired yet?" tab in the "How much will you add to your portfolio until then, per year?" input. When we retired our mortgage we applied the P&I amount to our monthly investment amount. I think this wil change your success rate.
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