Hi! I'm LRS

[cute fuzzy bunny]

Quote:

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. 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.

Bernstein actually feels the opposite...thats its entirely possible to predict returns over long periods like 30+ years, but impossible to do so in shorter periods. And bogle liked his book, so perhaps a read and a critique would be good, because I'm still reading it. I had to 'request' it at the library, but I did get it.

Its also worth noting that there have been three periods of 20 years with zero or worse returns.

As far as running the numbers, I'm not disputing the good sense that says over a 30 year period 6% beats 5%. What I'm disputing is the "total picture" during short term runs of bad market behavior.

The reason why firecalc simply isnt an effective tool for doing this calculation is because firecalc doesnt give you the option of changing your withdrawal to a lower number during "bad times" to compensate. Sure it gives a higher chance of succeeding with a mortgage and the amount invested, but I can get a higher result by not having the mortgage or the extra money invested and cutting my withdrawal in half during the bad times. I cant do that in the mortgage scenario, because the mortgage is a fixed amount every month.

Here are the simple numbers: I can cut my annual withdrawal from $30k to $12,000 if I have to, and that is by simply deferring discretionary spending. I can make that deferral in total for at least 5 years. If I have a 1500 a month mortgage, I can only cut back to 30,000 a year. Thats 18k a year getting sucked from that 200k extra money we're investing by keeping a mortgage. If stocks fall by 30-50%, and naysay all you will, its happened several times, that 200k could become 100k and if the market takes 5+ years to recover, at 18k a year, its gone...and you still owe the mortgage for 25 more years.

Could we see a 50% drop? By historical valuations, the Dow should be between 5000 and 6000...roughly a halving. Are historical valuations hooey? If so, then so are all the firecalc calculations and everything else based on anything historical. Dont believe in RTM or think its a statistical anomaly? Its an awful consistent anomaly.

The only thing you lose by not having the mortgage is the prospect of future earnings growth of that money...an uncertain and undeterminable amount, and the prospect of the home devaluing. If you've done your homework on buying the house and know the local market conditions, the latter is somewhat defensible and certainly moreso than market returns. Not to mention a home which has had its value drop to zero can still be lived in for 100 years.

This discussion has a simple analog:
You can take the $10,000 or you can trade it for whats behind curtain number 1 or the box that Carol is holding. Knowing that the curtain and/or the box often contains a car or the keys to one, and the car is worth more than 10k, you might roll those dice. Or you can take the sure thing. 5% and a place to live for free guaranteed.

[wabmester]

Quote:

This discussion has a simple analog: You can take the $10,000 or you can trade it for whats behind curtain number 1 or the box that Carol is holding. *Knowing that the curtain and/or the box often contains a car or the keys to one, and the car is worth more than 10k, you might roll those dice. *Or you can take the sure thing. *5% and a place to live for free guaranteed.

Or, do what I did:

1) Keep your mortgage.

2) Put the money that could have paid off your mortgage in a mid-term fixed rate instrument that pays about the same rate as your mortgage.

3) Wait a few years. *If interest rates go up, roll over the cash into a higher yielding instrument and enjoy the spread. *If rates go down, pay off the mortgage.

[sgeeeee]

Quote:

Here are the simple numbers: I can cut my annual withdrawal from $30k to $12,000 if I have to, and that is by simply deferring discretionary spending. *I can make that deferral in total for at least 5 years. *If I have a 1500 a month mortgage, I can only cut back to 30,000 a year. *Thats 18k a year getting sucked from that 200k extra money we're investing by keeping a mortgage. *If stocks fall by 30-50%, and naysay all you will, its happened several times, that 200k could become 100k and if the market takes 5+ years to recover, at 18k a year, its gone...and you still owe the mortgage for 25 more years.

Simple numbers?

In order to come to the point of disaster, you had to assume two things that don't make sense to me: 1) That the 200K you could have used to pay off the loan was a stand alone amount of money. I say mingle it with your other funds. If you do that, you don't run out of money and when the market rebounds after 5 years you have a bigger nest egg to recover with. 2) the mortgage calculator I used said a 200K mortgage only cost me $1074 per year with a 5% loan.

So I put together a spreadsheet to look at what happens in bad times. Case 1: $1M nest egg, $40K/year withdrawal, adjusted with 3% inflation rate Case 2: $1.2M nest egg, $40K/year withdrawal, adjusted with 3% inflation rate plus $12884/year non-inflating mortgage . Here's the results for 30 year simulation:

Annual Return................Portfolio difference
on Investment...............after 30 years
4.04%............................-$71,221
5.00%............................$0
6.00%............................$130,138
7.00%............................$305,448

At 4.04% return, both portfolios run out of money in year 30. At 5% you break even and you make money by keeping the mortgage for returns greater than 5%.

You can cut back on the initial withdrawal rates to extend the portfolio longevity, but you don't change the difference picture much. You still break even at 5%.

[cute fuzzy bunny]

Wab - arent you losing money to inflation and taxes by putting the amount in a fixed income instrument that equals the mortgage? What fixed income instruments produce 5% after tax and inflation with low risk?

SG - We're discussing the same two points without coming to meet.

I have already conceded your point that if we have a steady x% rate of return as calculated by a spreadsheet and x% is higher than the mortgage rate, then it looks good on paper and you'll come out ahead.

You havent addressed the main point I'm making, and in fact you cannot do so with a spreadsheet, historical return data, or any financial model because they have nothing to do with the area of concern.

The point I am making is this: If we have a large drop in investment value, followed by 5 or more years of low or no returns, you will pay out much, most or all of the cash you reserved by keeping a mortgage.

It is a reasonable possibility that such a drop and sideways period will happen. When that happens, you cannot decide not to pay the mortgage or to pay less. It is a fixed amount. When that extra money is depleted, unless you presume an immediate and fairly strong uptick to offset that draining of funds, you are left with the mortgage and not left with the extra money.

If I pay off the mortgage, I have protected that portion of my money from any investment market action, and I may withdraw that money at any time by selling the home or taking out a mortgage later.

In a worst case scenario where my portfolio takes a multi year beating, I can reduce my withdrawal rate because excepting taxes, eating and the utilities, its all discretionary.

So presuming a mortgage is better presumes the following:

- Average return rates on investments will remain at 6% after taxes and inflation for the duration of the mortgage; I dont think they will. In fact, historically few investments have and all of them are on the wrong side of the risk curve. Bernstein says 3% real returns (after tax/inflation) on bonds and 3.5% for stocks going forward. Roughly 6% total return for either. Our other hero, Bogle, likes his book and hasnt publicly contradicted this.

- We wont see a drop of 30-50% followed by a sideways period of 5 years or more; I think its a strong possibility. In fact, based on the hunk of Bernsteins book I've read, we either need a 50% drop to get back to historical stock returns from there forward, or we'll see almost no gains at all for a very, very long time until the companies catch up with their valuations. Or its "different this time" again

So stepping away from mortgage tables...

Do you feel confident that during the next 30 years there wont be a 30-50% drop in the market followed by a short term (5-7 years) of zero to modest returns?

If you feel good about that, do you feel that investment returns, after taxes and inflation, will exceed 5%? And if so, in a manner as risky as a 5 year treasury? And please tell me where, because all my money is headed there first thing monday!!!

I havent even discussed or mentioned the psychological positives of owning the property outright, or the "sleep better at night" factor. I can say with exceptional authority that without a mortgage my necessary withdrawal rate is low enough for me to support it without a portfolio at all - - doing almost any job that pays at least minimum wage. If we as a country do suffer a severe and protracted economical drought, I can live by digging holes, carting trash or the good old quick-e mart.

By the way, sorry LRS for hijacking your thread...we have to have this discussion every six weeks to make sure our brains still work and apparently to scare the daylights out of a lot of pre-ER people.

[sgeeeee]

Quote:

. . . You havent addressed the main point I'm making, and in fact you cannot do so with a spreadsheet, historical return data, or any financial model because they have nothing to do with the area of concern. . .

Yes. You can run a simulation that addresses your concern and I did. Read the original post and run the analysis as I suggested -- not a standard SWR run, but the specific mortgage pay-off evaluation. You have approximately a 75% probability of seeing a combination of stock returns, bond returns and inflation that would make keeping your mortgage a good investment (assuming a reasonable stock/bond allocation). If you don't believe those odds, then you really can't justify what FIRECALC says about SWR either.

Can you dream up a "what if" scenario with a combination of years of negative returns, low bond payoffs and inflation that would make this not work? Sure you can. And you can come up with a "what if" scenario that leaves wyou starving to death in your dark, paid-off house several years from now too.

Quantify your specific concerns and we can run simulations and look at the results for specific cases. Part of the problem, is that the specifics of every nest egg, stock allocation, initial withdrawal rate, reduced withdrawal rate, house value, . . . is unique to each investor. That's why I always say, run your numbers. I've run mine over and over again. I understand the odds and the downside potential of keeping my mortgage and I'm very comfortable with this strategy. I've run a number of general cases and it looks to me like this strategy could be valuable for a lot of others -- not all.

[wabmester]

Quote:

Wab - arent you losing money to inflation and taxes by putting the amount in a fixed income instrument that equals the mortgage? *What fixed income instruments produce 5% after tax and inflation with low risk?

I'm not sure what you mean by losing money to inflation. *My mortgage payment doesn't go up with inflation, why should the returns? *I just try to stay even until it's clear whether or not I can come out ahead (so far, I am).

As far as taxes go, I assume that my mortgage deduction pretty much offsets my investment income taxes (at least that's how things have gone so far; ask me again if the personal exemption keeps rising).

As far as the investments go, I keep an amount about 4x my mortgage in an 8-year bond/CD ladder with rungs yielding from 4.75% to 9.25% *(the weighted average is around 7%). * Basically, in any given year I can make the choice to reinvest a maturing rung or pay down the mortgage.

My mortgage is at 5.25%, and while interest rates are still dropping, I can still find yields > 5.25% without going out more than 5 years (such as a PenFed CD; and my ladder is structured to let me go out 8 years if I need to).

Of course, this mapping of mortgage money with my investments is somewhat imaginary -- I wouldn't necessarily change my allocation based on whether or not I have a mortgage, but as long as my overall portfolio returns are greater than my mortgage interest costs, I consider keeping the mortgage a win.

If I ever decide that my longer-term investment prospects look more dismal than 5.25%, then I just might exercise the free put option that came with my mortgage.

[cute fuzzy bunny]

Wab - I must have misunderstood something in between your posts...I was addressing this element:

" 2) Put the money that could have paid off your mortgage in a mid-term fixed rate instrument that pays about the same rate as your mortgage. "

Presuming the mortgage is 5%, putting the cash into an instrument that pays the same rate wont keep you even, because you have to pay taxes on the returns of that instrument and inflation reduces the "real" return each and every year. Hence you'd need 5%+taxes+inflation (say about 7.5-8%), or something like a fed + state tax free TIPS paying a yield of 5%+. The 5% "return" by not having a mortgage is 100% guaranteed risk free.

See what I mean?

SG - You didnt address either of my points.

Here they are again:

Do you feel confident that during the next 30 years there wont be a 30-50% drop in the market followed by a short term (5-7 years) of zero to modest returns?

If you feel good about that, do you feel that investment returns, after taxes and inflation, will exceed 5%? And if so, in a manner as risky as a 5 year treasury? And please tell me where, because all my money is headed there first thing monday!!!

[wabmester]

Quote:

See what I mean?

Senator, that depends on what you mean by "mean."

If you pay off your 5% mortgage today, your "guaranteed risk-free return" is 5% less whatever additional taxes you'll need to pay without the mortgage deduction. * That 5% is not inflation adjusted. Those future dollars you no longer need to pay are worth less than the present dollars you gave back to your bank.

When I pick an investment to stay even (or better), I include the consideration that my mortgage interest is both nominal and tax deductable (and that the principal gets paid down with future dollars that will be worth less than the present dollars loaned to me).

Hello GDER and all. GDER, I will "pass" as well
(on mortgaging our paid off home to invest). I have a bunch of issues besides the obvious which led me to this
decision (and I've thought about it plenty). For one thing our home is in a flood plain and any lender would
require me to buy flood insurance, which I have never carried. One thing that has worked for me is borrowing
on those promo credit card deals and investing that
money short term. You have to stay on top of the
fees you pay to take the cash and the expiration dates
of the low CC interest, and of course you need to shop
hard to find a home for the cash.

John Galt

[cute fuzzy bunny]

I'm at the threshold of the tax issue; this year I barely made it over the standard deduction, and I think next year I'll end up better off taking that, so the mortgage interest deduction (unless I took out a very big one) wouldnt help my tax situation.

Gder: Senator Blutarski? I'm afraid I'm not full of doody enough to get into politics.

Re. taking the standard deduction, what a relief that is!
My records are lousy and not itemizing is a real treat.
Even so, I find tax law almost unintelligible. I also
notice that the annual tax guides they put out now are about twice the size they used to be. What ever happened to tax simplification?? On the bright side,
it makes work for accountants. I was one in a former life.

John Galt

[sgeeeee]

TH,

Here's a way to use FIRECALC to look at a specific mortgage payoff situation vs continuing to pay your loan including a method to look at how reducing spending temporarily in bad times can effect the results:

BASELINE CASE (payoff and spend normally)

1) Subrtract the mortgage payoff amount from your current nest egg and use this amount in FIRECALC as the starting portfolio value.
2) Enter your initial withdrawal rate
3) Use 30 years (assumed mortgage length) for lifespan of the portfolio.
4) enter remaining data as it applies to you.

PAYOFF IN BAD TIMES(Reduce spending for five years)
1) Enter data as before,
2) But now you assume the first N number of years in retirement are bad enough that you reduce your retirement budget to your bare bones budget. This is accomplished by using withdrawal changes 1 and 2.
2a) Make withdrawal change 1 start in year 0 and reduce your withdrawals by the amount you believe you could reduce your budget by.
2b) Make withdrawal change 2 start in year N and be the negative of withdrawal change 1.

KEEP MORTGAGE (spend normally)
1) Use total nest egg starting portfolio value
2) Use your spending minus mortgage payments as initial withdrawal rate.
3) Use withdrawal change 1 to increase your annual withdrawal by your annual mortgage starting in year 0 and uncheck the box so that you do not use inflation adjusted dollars here.
4) Use 30 years (assumed mortgage length) for lifespan of the portfolio.
5) enter remaining data as it applies to you.

KEEP MORTGAGE (Reduce spending for five years)
1) Enter data as above
2) But now you assume the first N number of years in retirement are bad enough that you reduce your retirement budget to your bare bones budget. This is accomplished by using withdrawal changes 2 and 3.
2a) Make withdrawal change 2 start in year 0 and reduce your withdrawals by the amount you believe you could reduce your budget by.
2b) Make withdrawal change 3 start in year N and be the negative of withdrawal change 1.


Results . . . I'll put some specific results in a post to follow.

[sgeeeee]

Th,
I think these are the numbers we've been throwing around. The $42888 initial withdrawal of the second mortgage case incudes $12888 which is what I calculated to be the payment on a 30 yr. 5% loan on $200,000.


PAYOFF CASES
Nest Egg.....680000..........680000
Init Withd .....30000............30000 -18000 for 1st 5 years
Prob of Suc.....94.7..............99.2
term val.....1,540,607........2,088,218

KEEP MORTGAGE CASES
Nest Egg.....880000..........880000
Init Withd......42888 ...........42888 -18000 for 1st 5 years
Prob of Suc.....97.................99.2
term value..1,989,441......2,550,746

[cute fuzzy bunny]

SG -

Still didnt answer either question, and the problem with continuously going back to the calculator is that you're using historical return factors that some experts, and myself, dont believe we're going to see again.

Bernstein says 3.5% equities return after taxes and inflation, a 'real' return. Bogle says 6-9%, or by my rough calc 3.5-6.5 after taxes and inflation. I see very expensive investments in almost every category. Hence I agree with both of them and dont think returns will be as good as the historical returns generated by firecalc, at least until valuations return to normal. Because of todays valuations, I also think we may be in the vicinity of either a sharp downturn or a long slide. Or a lot of years of little or no return on investments.

Hence I'll take the 5.whatever% sure thing investment that also provides me free shelter as an intended byproduct. But thats me.

I think this is simply a matter of preference and we can craft whatever scenario makes us feel comfortable with our respective decisions.

I also think we beat this to death enough that anyone can pick whichever preference suits them and adopt the line of thinking and/or numbers that makes them comfortable with that decision.

[sgeeeee]

Quote:

SG - Still didnt answer either question, and the problem with continuously going back to the calculator is that you're using historical return factors that some experts, and myself, dont believe we're going to see again.

Yeah, if you believe that we are likely to face times worse than anything we've seen since 1871, then you can't really use a historical simulator for anything.

I'm skeptical that Bernstein or anyone else can develop a reasonable case for why the next 30 years is likely to be worse than anything we've ever seen, so I do place value on the results. I've never seen any quantitative analysis projecting financial results for a 30 year time frame. I don't know what numbers and projections you could possibly use with any confidence. And based on what I've read, I see no reason to believe our economy today is really in worse shape than they were in 1929 or even 1965.

[cute fuzzy bunny]

Well, without a substantial portfolio and a very small withdrawal, most people wouldnt have survived ER in those time periods whether they owned their home or not.

I would suspect that in the nth year of a multi-year drop, not having to make the mortgage might be a comfort though.

I guess you'd have to read the bernstein book to comment on his methodology, but his take isnt far from Bogles. I imagine at least one of them knows what they're talking about, but then again we are talking about the future.

I think to summarize Bernsteins point, and with gross simplification because I am a simpleton, overall market returns over long periods of time tend to follow a fairly straight path of their future income production. When that rate is discounted by a risk adjusted discount rate into todays dollars, you get todays value. Over 20+ year periods, this calculation rings true for every civilizations equity and bond markets going back through recorded time. Deviations from that trend in periods shorter than 20 years are simply speculative gains and losses.

His assertion is that due to high current prices and low current dividend rates (the source of a substantial piece of historical return), that would suggest much lower returns going forward.

A good analogy he uses talks about a guy walking his dog on a straight line from his apartment to central park. The dog is on a 20' leash and as dogs do, it runs all over the place. His take is that by watching the man (the trend of discounted future income of a company or the risk adjusted interest rate of a bond), you get an idea of long term market movement. However most people watch the dog and try to make bets as to which direction the dog will go next. In other words, buying the total market index vs market timing.

His approach observes markets from europe of 500 years ago to today, with the acknowledgement that the US equities market is a shining star in the history of investment for its duration.

He lays out a whole chapter (#2) which outlines the idealogy. Plenty of math and numbers, all possibly arguable, once again because we simply cant guess the future.

He does include an interesting article that really captures the mindset of todays american: the ability to obtain anything, invest anywhere, travel anyplace, with obstruction to these efforts considered a major annoyance to the impeded. Except the article was written by a Londoner just prior to WWI, following which the English investment markets were hammered for about 50 years by unstable world conditions invoked by two world wars and ripple effects from the depression in the US.

In other words, when things look pretty good, look out. When things look pretty bad, might be time to get your checkbook out and buy some beaten out stocks. If you have a 20+ year horizon that is.

A secondary effect is the lifecycle of a market/civilization. Most are characterized early on by higher risks, high interest rates, highly speculative and risky corporate equities markets and the like, with appropriate discounted current values of those risky assets. Eventually they settle down until the risk becomes very low, interest rates bottom out, bonds return below inflation, and equities barely outperform those due to relatively marginal additional risk.

Except for the equities underperforming (so far), doesnt that sound a little familiar? Maybe the US equities/bond markets will perform differently going forward than the dozens of strong civilizations/markets that Bernstein outlined: the romans, the greeks, the portugese, the english.

Maybe its all different now.

So with these things in mind, I'll take my $250k off of that table, put it in an appreciating asset that is relatively decoupled from the finance markets (that I can also live in and that also gives me nearly complete control of my withdrawal rate), and keep the other mil asset allocated to about 50% us stocks and bonds and the rest to foreign and emerging markets, other real estate, and oil and gas pumpers.

You've got half of it though, historical calculators can help people get a handle on what to do and when to do it. The only problem is that if the markets moved in a manner that was calculable, this would be easy. The fact is that the market moves as a socialogical function of expectations and reactions. Faced with the same set of criteria, sometimes people move it up, sometimes down. That factor of unpredictability makes me want to increase the predictability.

But thats because it makes me feel good, I can afford to do it, and because I want to.

[LRS]

I think I deserve a whole box of dryer sheets for providing a forum for the mortgage pay-off debate.

My situation is not exactly like the hypotheticals, so I am still mulling the best option for my mortgage. I'll spring the dilemma on my tax lady when I see her this week and get yet another opinion.

Actually, I think I can achieve a good result by quitting my job now, thereby reducing our marginal tax rate, AND paying off the mortgage with a portion of our investment money. Husband will have to keep on working, poor devil, but it's only for 6 more years.

Nah, that would be mean.

[haha]

TH-

Thanks for explaining the mortgage terms. I think a fixed would be better for me, if I do a re-finance.

Mikey

[cute fuzzy bunny]

Quote:

I think I deserve a whole box of dryer sheets for providing a forum for the mortgage pay-off debate.

Ah newbie, newbie, newbie...you have it backwards...you owe a small fee for out having chosen your welcome thread as a place for discourse. Say about $25 worth of dryer sheets?


Mikey - no problem. Fixed 30 years are pretty good deals right now. Rates have nowhere else to go but ^

[unclemick]

Historically low P/E's and very high interest rates - if it were to occur would be a screaming buy. I.e. up stock allocation and go long on bond durations. Of course some foolish people might get upset over Mr Market's repricing portfolio value.

The two greatest financial guru's of all time offer guidance:

Charles DeGaul: 'God Looks After Drunkards, Fools, and The United States of America'. Bogle's corrallary - buy the appropriate balanced index and press on regardless.

Mrs Stevenson(aka the Norwegian widow): Wait by the mailbox for your dividend checks. Of nowadays you can have your div/interest electronically deposited.

As for the mortgage debate, still in the bleachers enjoying the posts. My interest warms up every hurricane season (june to december). Renting looks better than buying around here - even with the low rates. Only as a back up strategy.