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Bond Allocation Alternatives... had a thought
Old 05-10-2016, 05:40 AM   #1
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Bond Allocation Alternatives... had a thought

I was tooling around on the site looking at some previous DCA vs lump sum investing for my my personal predicament when it struck me... Should I (or anyone) consider paying off my mortgage(s) as an alternative to my bond allocation? By way of a simple example, use the following assumptions...

- $2m investeted portfolio
- AA 70/30, $1.4m/$600k
- assume bonds are paying after tax returns of 2%
- mortgage balance of $300k with an effective after tax interest rate of 2.5%
- still working, 4+ yrs from ER, no concerns about having to tap the bond funds or allocation anytime soon

Can you make an argument to take $300k of your bond allocation and pay off your mortgage as part of your overall AA? I suppose you have effectively bought a cd for the remaining period of your mortgage and that becomes the pickle?? So I suppose that is the real question relative to opportunity cost... in this example if your mortgage has 15 yrs left, you are locking in your return effectively for 15 yrs at 2.5% and if you think you will average more than that over 15 yrs in your bond funds, than don't pay it off? On the other hand, if you have 3 yrs left on your mortgage than I suppose you could make the argument to pay it off as part of your AA?

My previous logic always had me comparing my after tax mortgage rate to my projected whole portfolio returns as opposed to looking at it the way described. I know there are probably allot of "depends", but I wanted to get everyone's thoughts here, particularly while we are in a such a low yield environment.
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Old 05-10-2016, 05:50 AM   #2
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I did the same thing on a slightly smaller scale a few years back. I ran into two issues I did not like.

one was that when the market dropped, I did not have as much bond allocation as I would have liked, to use to reset my allocation.

the other was that when I decided to put some money into a pretty big house project, I was strapped for cash and had to go through the process of borrowing more money. Kind of a pain, but it did come at a reduced interest rate. So now I'm in that same boat, I have approximately a 100K mortgage, fixed at 2.75% for 12 years. I could pay it off, but then I'd be strapped for cash again, and, I see the mortgage as a hedge against rising interest rates. If they ever do start to crawl up, 2.75% is going to seem like a good deal for me.
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Old 05-10-2016, 06:04 AM   #3
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I suppose that is where one of the "depends" lies. Ideally, any replacement of a paid off mortgage for a bond allocation would be some % that doesn't hopefully affect your ability to rebalance or hopefully force you to take out a home equity loan at higher terms.
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Old 05-10-2016, 07:42 AM   #4
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It makes sense to considering the relative return of the bonds you would sell against the expense of maintaining the mortgage. I did that calculation and made a lump sum payoff when I retired. But I did not then treat the home equity as a bond portion of my portfolio. I couldn't (easily) tap the equity for withdrawals and the equity did not reduce the volatility of the portfolio (one one the reasons for bonds). I did look at the SWR the portfolio could be assumed to return before and after the payoff and the expenses before and after removing the mortgage payment. In the near time the SWR position was improved by the payoff, in the long term it appeared to be a wash or advantageous to keep the mortgage. I valued the near term advantages which seemed fairly certain more than the long term possibilities which were more speculative.
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Old 05-10-2016, 09:03 AM   #5
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In adverse to debt, having once been deep in the hole years ago thanks to a divorce. I paid off my mortgage as soon as I could without hurting my emergency fund or retirement savings. Now we're in a position of paying cash for things, including our new winter condo on the beach in Florida. Getting rid of debt and investing heavily is what made us FI and able to sleep at night.


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Old 05-10-2016, 03:14 PM   #6
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Liquidity of bonds is better than real estate. Both face some level of interest rate risk.

I do not like bonds - in general real estate seems to be a reasonable diversification and likely better than just cash.
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Old 05-12-2016, 03:52 PM   #7
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I suppose you have effectively bought a cd for the remaining period of your mortgage and that becomes the pickle??
Not really. You can take out a HELOC or remortgage.
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Old 05-12-2016, 04:17 PM   #8
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An interesting proposal.

Quote:
Many institutional investors have been favoring private real estate over bonds, drawn by its steady income stream and higher yields. While the short-term income may be bond-like, the long-run behavior of the asset class is much more cyclical and growth-sensitive.
[https://www.msci.com/www/blog-posts/...e-/0182641408]

Your paid-off home won't produce income like comm'l real estate or rental. It could decline in value.

But it is what we did, only not to replace bonds.

Over 20 years, the value has grown from $190 to $350 or so. That works out to 9% annual average growth. Not sure we'll get that going forward, though.
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Old 05-12-2016, 04:20 PM   #9
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I do it with my rental mortgages, at 5.375%+...

It depends on why you own bonds. If it's for income and cash flow, then it's OK.

If it's to reduce volatility on your portfolio, it will not help.

It's it's to have liquid cash, it will not help.

So, it depends.
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Old 05-12-2016, 04:22 PM   #10
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Quote:
Originally Posted by DawgMan View Post
I was tooling around on the site looking at some previous DCA vs lump sum investing for my my personal predicament when it struck me... Should I (or anyone) consider paying off my mortgage(s) as an alternative to my bond allocation? By way of a simple example, use the following assumptions...

- $2m investeted portfolio
- AA 70/30, $1.4m/$600k
- assume bonds are paying after tax returns of 2%
- mortgage balance of $300k with an effective after tax interest rate of 2.5%
- still working, 4+ yrs from ER, no concerns about having to tap the bond funds or allocation anytime soon

Can you make an argument to take $300k of your bond allocation and pay off your mortgage as part of your overall AA? I suppose you have effectively bought a cd for the remaining period of your mortgage and that becomes the pickle?? So I suppose that is the real question relative to opportunity cost... in this example if your mortgage has 15 yrs left, you are locking in your return effectively for 15 yrs at 2.5% and if you think you will average more than that over 15 yrs in your bond funds, than don't pay it off? On the other hand, if you have 3 yrs left on your mortgage than I suppose you could make the argument to pay it off as part of your AA?

My previous logic always had me comparing my after tax mortgage rate to my projected whole portfolio returns as opposed to looking at it the way described. I know there are probably allot of "depends", but I wanted to get everyone's thoughts here, particularly while we are in a such a low yield environment.
If you paid off the mortgage and then had 82/18 AA ($1.4m/$0.3m) then I could see it... conceptually the risk would be the same as 70/30 with a $300k mortgage... I think.
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Old 05-12-2016, 09:15 PM   #11
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Over 20 years, the value has grown from $190 to $350 or so. That works out to 9% annual average growth. Not sure we'll get that going forward, though.
Something is wrong with those numbers.

Maybe 3.1% annual growth? That might not beat inflation. Plus the maintenance costs which a bond mutual fund in a tax-deferred account does not have.
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Old 05-13-2016, 02:39 AM   #12
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Something is wrong with those numbers.

Maybe 3.1% annual growth? That might not beat inflation. Plus the maintenance costs which a bond mutual fund in a tax-deferred account does not have.
Yup.

$190K in 1996 equals $288 in 2016 dollars. So yeah, you're talking about a real return of about 1% annually less carrying costs (maintenance, taxes, etc).

Meanwhile, 20 year treasuries yielded 6% in 1996.

For the most part residential real estate isn't an investment. It's an expense. Not much different than paying rent once you include the opportunity costs of having a large chunk of equity tied up in housing.
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Old 05-13-2016, 05:23 AM   #13
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189 to 350 over 20 years is about 3%. I stand corrected.

Some consider it an investment, others don't. It does require maintenance, and there is such a thing as inflation. Come to think of it, about half was mortgaged, but paid off after 10 years. Also, USG gets involved with mortgage interest deduction. Too complex for me.

Some may even call me a renter. LOL.
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