Have you heard this phase – Why keep playing the game if you already won? People are funny. We work hard and take risks to get what we want, but when we actually achieve our dreams, we can’t stop. Americans are raised to keep pushing forward to achieve more. Our culture values hard work and frowns upon idle hands. We find it really difficult to say ‘enough’ and be satisfied with life. On top of that, our consumerism environment is pushing us to accumulate more and more.
On Monday, I wrote about paying for a house in cash and got some really good feedback from many readers. BTW, this cash is from the sale of rental properties, so it won’t impact our retirement saving, emergency fund, or our dividend portfolio. Thank you for reading and commenting. I really appreciate it. If you haven’t seen it, you should check out the comments. It seems to me most people really fall into two camps.
- Security minded – Pay cash for a house and ensure a high level of financial security.
- Opportunity cost minded – Pay cash for a house and lose out on millions in stock market gains.
I want to take a closer look at the opportunity cost and see how much we’d really lose out if we paid for a house in cash.
Here is our fictitious home.
- Cost $500,000
- Mortgage $400,000 at 4% effective rate (after deducting tax)
- Monthly payment for 30 years is about $1,900
- After 30 years, interest paid would be about $300,000
Invest the lump sum in the market
If we get a mortgage and invest $400,000 in the stock market, then we’ll most likely get a better rate of return. Let’s assume 7% because I’d invest the lump sum more conservatively. At the end of 30 years, we’d have over  3 million dollars. That’s 10 times more than $300,000 that we’d save in mortgage interest!
Use the lump sum to buy a house
At first glance, the difference is huge, but don’t forget that we’d free up $1,900/month from not having a mortgage. If we invest that amount every month, we’d have about $2,250,000 after 30 years at 7% ROI. Add the $300,000 interest and we’d have about 2 and a half million dollars.
The difference is almost half a million dollars, but it’s really not as astronomical as I first thought. It’s about 15% and I can live with that.
Why keep playing?
Let’s get back to the why keep playing concept as it applies to retirement investing. When you retire, you won’t have a regular paycheck anymore and you will need to withdraw from your nest egg. Hopefully, you saved up enough to pay for 25 years of expenses. If you invest that money in safe treasury bonds, you will be fine for 25+ years. On the other hand, if you invest in the stock market, then a few bad years in the beginning of your retirement can be devastating to your nest egg.
Many people had enough to retire, but they continue to be overweight in equities. Some of them sold out during the financial crisis and never bought back in. This did a number to their nest egg and they have to keep working to rebuild their accounts. If they had invested in bonds instead, then they’d be able to retire.
The other option is to ride out the bear market and keep adding to your investment. Unfortunately, when you’re retired, you can’t do this because you won’t have enough income. Conventional wisdom says retirees just draw down their portfolio, right? When you’re near retirement, equities should be invested with extra money. The money you really need for day to day living should be invested in safer investments. You need to factor in social security and any pension as well.
Of course, most people haven’t saved up 25x their annual expense and they’ll have to take more risk on the stock market with their asset allocation. Working part time after retirement is another option.
Our Winning Plan
If we pay for a house in cash, our monthly expenses would drop down to around $2,200. The good news is that we already have enough passive income to cover this. The bad news is that most of it is in our retirement accounts. That’s fine though, because we aren’t planning to withdraw anytime soon. We are pretty heavily invested in the stock market with our retirement accounts.
Here is the winning plan.
- Buy a house in cash to reduce monthly expense
- Gradually become more conservative with our retirement account. In 20 years, the retirement account should be mostly invested in safe government bonds and throw off enough to cover our living expense.
- Extra money invested in stock market. We’ll use the money that we don’t have to pay the mortgage to invest in the stock market. This fund will be used for entertainment.
- Social security is gravy.
So that’s my plan. I feel like we are on our way to winning the game and I don’t mind giving up some gains. Sure, half a million dollars extra sounds tempting, but I don’t think we’ll need it. Meanwhile, we’ll have 30 years additional years of being debt free and I won’t lose as much sleep worrying about the stock market.
What do you think? Am I counting my winning too early? Should I stay hungry and keep on taking more risks?
Photo credit: Mike Baehr
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.
Latest posts by retirebyforty (see all)
- Make Your Partner Happier by Being Cheap - March 26, 2023
- 4 Ways to Avoid The 10% Early Withdrawal Penalty - March 22, 2023
- Goodbye SAHD FIRE, Hello Barista FIRE - March 19, 2023
- Don’t Stop Investing When SHTF - March 15, 2023
- Pack Your Bags for A 3-Year-Cruise - March 12, 2023
I have read all the comments and understand both positions . It seems all the people commenting are men, which sort of bothers me for many reasons. I am a newly single woman with a similar situation. I have to decide if I will sell the family home and keep the 500,000 to buy a house for cash or rent and invest the money in the stock market.
My other option is to take half the equity of the house and then have half of my
Ex husbands retirement.
Any advice? Thanks
Hi Gina, You probably should talk to a financial advisor if you don’t know what to do. A good financial advisor would go over your whole finance and figure out what’s the best step for you. Personally, I would get a mortgage, use some money for a down payment, and invest the rest. The interest rate is still very low and it’s a good deal right now. That’s just me, though.
Not being a financial wizard, I’ll generally take these scenarios and plug them what-if style into quicken and/or esplanner. I came to the same conclusion that I could make more money (increased lifetime peak net worth) but it was not enough to suggest I could significantly change my lifestyle. I paid off my mortgages (home + 2 rentals) at the beginning of this century because the market was tanking and I had extra income I wanted to invest somewhere. I chose to eliminate the mortgages (at 4-5%) rather than buy into the market as it went down or to wait/guess for the market bottom.
I agree that we overanalyze on dollars because, you know, more is always better. If it is still fun to figure out how to eek out a few more percent gains then — go for it — I understand, I’ve been there.
But for me now I’d rather spend time on things like being healthy (ran my first marathon last month and I’m in my 50s, adopted a plant based diet, etc.). I figure that provides a greater return on my time investment than does gaining a few more dollars. Besides, who wants to spend all that hard earned net worth on hospital bills and nursing home care?
Thanks for sharing your story. A few percentage gain would be nice, but at this point in our lives, we value security and peace of mind even more. I’d rather spend time with family and being healthy as well.
Financial security vs. opportunity cost is a good way of viewing it.
However, you can’t leave out taxes on the two different investments. You’re not going to find 7% return in the markets with tax deferred or tax free investment. The $400K isn’t sitting in a retirement fund, so annual taxes will cut into the investment portfolio every year and greatly reduce the long-term value.
On the housing side, you’re also not going to have $1,900 additional to invest every month. You’ve owned property before and understand how much goes into taxes, repairs, maintenance, upgrades, etc. None of that changes because the property is owned free and clear. However, the tax benefits are much easier to follow for the house. If it doubles in value to $1M, you’ll have $500K in capital gains that will qualify for the homeowner exclusion. There isn’t any equivalent in the stock market.
A much better question is comparing paying off the mortgage on your primary residence vs. buying an equivalent investment property(ies). At least you’ll be comparing similar investments. Or perhaps buying a handful of good stocks and holding them for 30 years to avoid annual taxes.
If the goal is long-term wealth, paying off the mortgage lump sum will never win financially. The effective interest rates are lower than you can earn investing in different places. The decision is really about having peace of mind with no personal debt. As the saying goes, that’s priceless.
You know, all this debate makes me think of something. Us people who are blessed enough to have excess resources to invest, pay off mortgages, etc… we will AlWAYS be faced with the challenge of optimizing our investments and trying to predict the future. Personally I’ve found this to be quite a source of stress, trying to ensure I’m doing the best with my invested funds. Since we simply can’t predict the future, it seems like rb40’s approach makes the most sense. Do what you “feel” most comfortable with, because it’s likely going to still go very well for you – whether you pay off the house or invest in stocks. So the feeling of security and comfort really matter. We won’t “know” for sure who is right until the 30 year (0r 15 year) mortgage period is over, so why not feel good about your financial position in the meantime?
There are scenarios in which either option – paying off the house or not – would be a winner or a loser. And the truth is we just don’t know which scenario will come to pass. We just don’t know. But I do know this: in EITHER case, we’ll be better off than those who are under water on their mortgages or who can’t pay their basic bills. I’m going to start trying to be more grateful for that fact, instead of being stressed that I can’t know the future.
With all that said, here’s my own personal mortgage strategy. I’m going to put my pile of cash into short term safe assets like iBonds and bonds, with maturity of around 5 years or so. Then, I’ll wake up in 5 years, look around, and see what makes the most sense. If the stock market is even higher, I won’t buy stocks. If stocks are on sale, I’ll buy stocks. If real estate is on sale, I’ll buy more real estate. If interest rates are 7, I’ll likely get 7% somewhere and use that proceeds to pay off the house. In other words I’d like to buy some more time, because I think we’ll get some new clues over the next few years. What I don’t want to do, now, though, is pay off my mortgage when its only 3.75%, because I think there’s a good chance that something will come up in a few years that makes me want to keep that cheap money to invest elsewhere. But the good thing about my plan is I don’t have to commit either way right now, I can take in some small income from safe low yield investments while waiting.
My plan wouldn’t work putting money in short term stock market position, because if the market tanks and takes 15 years to recover, my money isn’t liquid.
I guess what my ultimate conclusion is, is this: I’d like to keep reading smart people like those who post on this blog, and keep watching the market conditions, and keep doing this for more time, so I can wait until I have a real “ah ha” moment generated by a new insight of my own or generated by some new macro conditions. I’m open to thoughts on this approach, of course 🙂
Buying the house with cash and the etc. that goes with that is definitely the way to go, in your situation.
One big thing that you would possibly avoid that you didn’t mention – having a huge pile of capital sitting in stocks when a “black swan” world event happens that knocks the stock market down a sleep preventing amount. It is possible though hopefully unlikely.
IMO — and I am a long-time “active” investor — , people should never have too much at once in the stock market, in spite of how well it’s done the last few years, after the crash. You are much better off dollar cost averaging into it and taking some profits when your allocation to it gets too large.
Good luck
I should add, dollar cost averaging into the markets via INDEXES is usually the safest and easiest way to go.
Point of information… The U.S. S&P500, from Jan 2000 to March 2014 (that is more than 14 years, not to put too fine a point on it!) returned an annual…wait for it…1.8%. From Jan’00 to Jan’13, 12 years, the annualized return was negative. Read that again. I’ll wait.
Continuing, I wish everyone well with their stock picks and am happy they have had a few years of outsized gains. But a paid-off home provides a revenue stream equal to the imputed mortgage payment at the current rate, reduces taxable income, provides an opportunity of up to $500K in tax-free capital gains for a married couple living in the home over two of the last five years, and brings the return risk of an arbitraged mortgage amount invested in equities to zero. I’m just sayin’.
been following the posts on this particular blog for a while. some excellent comments both pro and con vis a vis paying off your house vs investing in the market. The math says putting money into the market vs paying down a piece of real estate will win almost all the time…again, the numbers…just the numbers.
Many considerations are personal, and some go beyond the raw math such as:
1. your primary residence is often protected in a worst case financial scenario – for example, a bankruptcy. And in many cases judgments against you will exclude a primary residence (lawsuits do/can happen when you are a rental property owner)
2. real estate tends to be a good inflation hedge.
3. having at least one piece of real estate in portfolio is good for diversification
4. real estate, however, is less liquid and generally less liquid markets are also less efficient.
5. carrying any form of debt including a mortgage implies, in a worst worst case scenario, that net worth can swing to the negative. having zero debt (a paid off house) limits the downside case to losing everything ….zero net worth…not negative net worth.
6. A lot of this is dependent on the amount of house you have vs your total net worth. A 500K house on 1.5M total NW is a lot more in real estate than a 200K house on 3M total NW……
7. divorce…. can and does happen at least half the time…
I personally was in the “keep the mortgage, use my cash for other investments” til I hit about age 40. From that point on, I realized that the cash pile that I was supposedly using for other investments had either sat in the bank doing nothing, or lost some value (that hot stock or deal of a century was not such a deal) or simple inertia – I sat on the side lines watching a gyrating market trying to time the entry points to the market which i was not good at….
Somehow i had become more conservative and so i went ahead and paid off the house.
Was a good feeling for dear wife – Women – they tend to like to have a nest and one that’s paid off seems to make them real real happy – regardless of the math involved.
All great points. It seems like 40 is such a big turning point for many of us. I am much more conservative now and it’s just been a couple of years. My wife value security much more than I do as well and we need to keep her happy. 🙂 Emotion trumps math when you’re married.
You are human. You have cognitive biases. You are experiencing loss aversion because you are human and especially because you have a family. Rationally, investing is the better decision, but I understand how many people feel that paying off a mortgage early is a good idea. Mortgage rates are still very low in the current environment, and until their rates exceed what you would expect to get from a low cost index fund I do not agree with this argument of paying with cash for a house instead of investing. Also what if you need the money from the house? You can sell shares of a stock and have the money in a week or less but to get money from your house is expensive and could take months. Also the value of your house is independent of the fact you have a mortgage. When you consider mortgages are only a percent or two above inflation, I do not understand why people are so passionate about paying off mortgages early.
I guess some people are more debt averse than others. I used to think like you too, but I must be getting more conservative as I get older.
Just my 2 cents… Stock market fluctuates a lot, you are a dgi investor so you are probably looking for value. While there are some attractive stocks out there, there are not many. Since a straight line 7% is unlikely, and you actually stick with investing the monthly mortgage payment, you would probably do better dollar cost averaging over 30 years.
One other thing that can have an effect on all of this are income taxes.
I don’t know if you manage to claim mortgage interest deduction on your taxes, although paying $1 in interest to get a $0.25 tax deduction isn’t necessarily the wisest fiscal move. But looking at it another way, your wife’s (and your income from the websites) will now almost all be taxable. Does that bump you into the next tax bracket?
You should run that scenario through Turbotax (or some other tax software), so that you see what the changes are to your taxes that will be paid throughout the year.
13 years ago, I bought our house!
And in the last 13 years, I have put every buck into the house to reduce the debt!
Last year in april I was debt free.
And this was really a great feeling!
Since this time, I invest in shares and collect the dividends to reinvest.
I love it to be an investor.
Best regards
D-S
If I was in your position, I’d certainly pay cash for the house. I’ve never heard anyone say they regretted paying off a home, and your living expenses would be so low, you could get by really easily.
That’s another great point. Nobody ever regret paying off their house. A lot of people regret investing in the stock market at the wrong time.
>> A lot of people regret investing in the stock market at the wrong time.
A lot of people do regret buying a house at the wrong time as well… Buy low and sell high (if necessary) apply to both.
I find myself being very conservative when it comes to finances. Owning a home provides a real sense of security that I can’t put a price on. As for the additional half mill, the question I always ask myself is, what would I do with it? Usually the answer is, purchase something that I don’t really need. Balancing “wants” and “needs” is crucial to living a happy life. If you can’t balance the two you will never have enough money to retire.
That’s what I think. We don’t really need the extra half million. I’d rather be conservative and have what we need, than take a risk to get more. I’m satisfied with what we have.
Nice blog, I look forward to reading more. On the subject at hand I feel qualified to offer the following:
Yes on buying a home for cash, if you can, or paying off your loan early. Even at 4% the interest is high and there is usually little tax advantage. The standard deduction will be greater than interest & tax write-offs for most couples (~$12k). It is great freedome to not have a monthly mortgage, even if it is a small one.
Contra to above, borrowing can often be a good thing. I’ll probably raise an argument here, but utilize very low margin interest rates at a discount broker, borrowing against solid stocks, etf’s, mlp’s and reit’s (not mRiets) with a long history of strong, stable, growing dividends & distributions. Interactive Brokers top rate is 1.58%, even E*Trade will drop theirs to 2.75% if you hammer and threaten them. I’d suggest a maximum of 30-40% on margin and have set rules to reduce this if rates go up.
Except one pesky problem, buying stock on margin, by design, forces you to sell low in a declining market. Not sure how you might’ve missed the clues that Joe is risk averse 🙂
Early in the loan, a majority of the payment is interest, so the tax deduction is quite significant. If I were in RB40’s shoes (with his wife still working), I’d put 20% down and get a 15 year loan. When the wife retires, I’d highly consider paying off the balance.
“forces you to sell”? Sounds like you believe a margin call is a given. Even fully margined currently, the typical dividend growth stock, etf, bond fund, etc portfolio would need to decline 70% before you would get a call. This didn’t even come close to happening in 2008. In today’s elevated market, but with borrow rates at 1.6%, I’d still advise only ~30% margined against selected holdings. Anything I would buy on margin, if I were to be called, would have had to declined nearly 90% (basically the end of the world as we know it).
Your house, your portfolio, etc, choose to borrow against the asset class with the best rates & terms. A 4.25% mortgage v. 1.6% margin, the delta is almost 3% and margin interest is deductible from dollar one (and better your stock get’s called than your house if times get that bad).
The real risk is not including some borrowing at low rates in your long term plan. Borrowing on margin gets a bad rap, rightfully so if at the higher rates and against stocks like TSLA, FB, or even SBUX, but applying 35% margin to a stock like O will return a solid ~7% and offer 3-4% appreciation for a 10% total return. I can tell you the rich get richer using a lot of margin in this fashion (and not holding a mortgage).
You remind me distinctly of a poster on the Bogleheads Forum, ‘market timer’ that blew up in 2008 / 09. Although the theory is academically sound, and I got pretty enthralled following his posts, ‘the market can stay irrational much longer than you can stay liquid’. Sounds like you have done your research, but ‘market timer’ also sounded pretty sharp and the market went irrational on him. Reminds me of the Aronofsky movie Pi, didn’t turn out too well for the genius.
Haha, well definitely not a market timer here. I have said to research well, buy, then hold for a year (to secure long term gains), and then DON’T sell. There are a few exceptions and rebalancing, and I think it is ok to “play” some short term strategies, but only with a small amount of money – make your core holdings buy and hold dividend growth, use a little margin that is easily paid off by the solid dividends and distributions.
It’s great to live in a house without a mortgage, or have an investment property without a mortgage. But you could lose some opportunity costs, if another great, all cash deal comes up.
There are quite a few ways to get great deals on properties, and having cash makes it faster to close. It also eliminates a major hurdle to buying a property.
That’s a good point about the cash deal. It’s too expensive in our area to pay cash for investment properties, though. We don’t have that much money.
When you make your own deals, places can be bought for .50 on the dollar, sometimes. You just have to know where to look, and pounce when you find one. They are not every day deals, generally. But there are deals everyday.
I’m not sure if there’s a right answer either. We got a small mortgage compared to most people and have a 15yr fixed rate. I think if we had gone with a 30 yr rate it would have been easier to buy more house.
I would feel more secure with a paid for house and more monthly cash flow.
It’s great that you got the 15 yr fixed rate. You’ll be very thankful you did that in 10 years.
We are 50 now and we paid off our town home about 10 years ago more or less. At that moment we felt we owned the world. At work, at was the only one debt free! It felt soooo good! I felt I could even quit my job if I wanted to. Our mortgage was also small but that is because we also bought a town house. We have a small garden and I am very happy with it, association is only $200 and that includes water bill! While most of our friends complain about their costly bills we are constantly planning our next vacation. My husband is semiretired already and only works two days a week. He is happy that he doesn’t have to worry about yard work, taking trash out, etc. There are only seven units and that has helped us a lot because we don’t have to deal with a lot of people. That is another thing to consider when buying a town home, there are no amenities either (like pools, tennis) and that keeps the area quiet. My advice pay off your home because there are a lot of sharks out there that want your money! It took me three years to figure that out, but seven years later we were done with payments. You don’t really have to refinance to pay it off, just send the extra payment to principal and make sure it goes to principal. In fact it is best to have that option of paying less a month just in case. Once a year call the mortgage for the payoff balance, that will encourage you to do it faster. Some companies/sharks will charge you for that information if they send it to you in paper, ho have them just email it to you. Mine wanted to charge me $10!
Thanks for sharing. If we find the right house, we’ll definitely pay down a big % or just pay it off. It would be great to have no debt at all.
I am totally torn on the right draw down strategy once retired, Joe. I hear very different strategies: everything from the traditional glidepath that becomes more conservative over time, to the exact opposite. I’m not sure there is a right answer.
I think if you have 30+ annual expense saved up, it’s better to go more conservative. If you have less, then you’ll probably have to take on more risk.
I don’t know why, but it pains me to see other people talk themselves into a bad decision. You even state that investing a lump sum for 30 years will put you half a million ahead, how can you argue against that? I have the cash to pay off our mortgage and will ride the 15 year 2.875% tax deductible loan until the final day, because I am getting paid 3.25% in non-taxed municipal bonds, plus I’m far more liquid than a paid off house. At some point in the next 30 years, a fantastic opportunity might present itself (remember March 2009?) – will you then take out a more expensive HELOC to chase it? Other than what Justin said about health care subsidy, I see your plan to have less money in 30 years not being very convincing.
That half million isn’t guarantee. It could be half a million behind. Who knows what’s going to happen in 30 years?
I don’t think either way is bad decision. It’s a first world problem and we’ll be fine either way.
It actually is as guaranteed as anything experienced up to the present. You are actually taking a very high risk gamble that ‘this time the next 30 years is different’. You can afford to take the gamble, which is why so many people are gathering around to see you do it, but you might just barely make it to the finish line with enough money as opposed to being flush just by doing what has worked best. I put this sentiment into my post ‘Splendid Days’, about how someone with $1million ended up almost tied with someone with $500k by being conservative from 2009 to 2014.
Not trying to be a pain, but you and I are still have some of the game to play (in response to the post title), in my opinion, until we are ‘freely’ able to tap our retirement accounts and are eligible for social security, which we hopefully don’t need. Shortfall in the intervening years is the worry, and having so much cash tied up in a non-liquid asset doesn’t allow required flexibility. However, when your wife retires, cash flow may be more important – to lower taxes and increase ACA subsidy.
In fact, all of this is inspiring me to work on my post ‘A Tale of Two Home Buyers’. I had a friend that paid off his house in 2009. It was a great comfort to him during those unsteady times, but in the ensuing years, I refinanced twice, had the tax deduction, AND experienced a 176% gain in the S&P500. I want to run the numbers, all things being equal, between my 250k mortgage vs. his DCA back into the market over those years, just to see the numbers, since I see many younger people rushing to crush mortgage debt as though it is similar to credit card or car loan debt. Alas, I still have a day job, so these things don’t get done on my schedule.
If I get my way, I hope to retire soon and pursue an inexpensive degree in econ and personal finance. I’d like to take issues like this all-the-way and see if there ever was a period where paying off a mortgage was superior to having, say, a 15 year mortgage (since I’m 99.999% positive a 30 year mortgage with the equivalent amount in S&P500 index, especially if refinanced after a 1% drop in interest rate is available, will always historically win handily) . It’s super-complicated, even if you ignore the tax benefit, so I don’t think it’s ever been done.
I get your point. But, as you may someday experience as you age, this decision has little to do about money. It is called Peace of Mind. The money game is just that … a game that does not have to be played forever. Been there, done that. You might want to revisit Maslow’s Hierarchy of Needs.
I am open minded and I get all of the people that like the peace of mind factor. Right or wrong, I do understand not having a mortgage or any ‘real’ debt is pretty awesome and perfect for a retired or soon to be retired couple. Thanks for humoring me also, commenting is a little like driving a car, it’s hard to be personable.
davidmichael,
THANK YOU!!!!!!!!!!!! Wow ! I can not believe how difficult it is to explain to “numbers people” the value of peace of mind by having a paid off mortgage. Maybe you just have to be of a certain age before you actually fully grasp that concept.
Totally, TOTALLY agree with your plan — it’s basically identical to mine. There are a couple other subtleties here as well. One is the difference between one-time bulk stock market investment, which could have much greater negative impacts than the house pay-off plan. If a major correction occurs at the wrong time in your planning, it could take 10 years or more to recover, meaning a computation of a straight 7% could end up being very optimistic.
The other factor is that you’re basically already golden on your retirement funds, so it’s really about icing your freedom in the short-term. Lowering your overhead (and risk) is key to that. You’ll only need enough in your non-retirement funds to cover monthly bills and play money. Then when you retire for real, it’ll be like getting a huge raise.
You’re basically exactly where we would be, except we bought too much house so we have a bigger hole to dig out of. (:
Now I know how you feel. It’s all academic until you face the same situation. 🙂 It will be nice when we finally have access to our retirement fund. It’s all good though, I don’t want to spend that down yet.
Great plan and very similar to what we are doing. I like that you mentioned about already having enough with this plan. So many people chase returns that are no longer necessary if the plan is right.
I think the calculation is simpler if we take the cash purchase as baseline and consider the option of borrowing 400K to earn 7% returns while paying the 4% mortgage. The difference after 30 years is your 400K times (1.07-1.04)^30 – 1 or 571K. If you strip out ~3% annual inflation, this difference drops to 571K*(0.97)^30 or about 230K in today’s dollars. There’s also an adjustment for taxes– that’s your dividend/distribution returns, net of whatever mortgage interest deduction you can get, no idea what this would be, maybe ~10% range? If so, you’re looking at a present value of ~200K if you take the higher risk path and your assumed 7% annual return holds.
Personally I wouldn’t rule out the possibility of negative stock market returns over the next 30 years. Granted it’s never happened in the US, but I believe Japan’s Nikkei 225 has a strong chance of seeing this unfortunate milestone five years from now. If stocks return 1% annually instead of 7%, that ~200K present value would be a loss rather than a gain. In my opinion this scenario is less likely than a double-digit return rate– but is it worth the risk? Only you can decide for your own situation.
With respect to your title, I think this game is like a race without a finish line. It’s never over when the other guys are still running. Only when you get past this notion, that’s when you’ve won.
This analysis is also flawed. RB40 is correct in that the mortgage interest will be around $300K. The total price of paying cash isn’t 400K*(1.04^30), but rather 400K*(1.019^30) due to amortization – you only pay interest on the remaining balance. Hence the actual rate of return for paying cash over the 30 year period is 1.9%. Now assuming the gains reduce the after tax rate of return from 7%*.75 to 5.25%, the net rate of return by investing versus paying cash for the house is $400K*(1.0525-.019)^30=$1.07M after tax. That is a premium of more than 2X the price of the home. It’s like paying $3000 a month in insurance to protect your capital based on the assumptions. If you want to assess the risk you need to bring probability into the equation and evaluate the likelihood that the market will underperform the mortgage rate of return – failure to do so and comparing to an arbitrary end point is nothing more than speculation.
I’m not trying to discourage people from paying off a mortgage. It many instances its the best recommendation given circumstances and spending impulses. I am merely trying to point out that depending on the mortgage rate, choosing to do so may in fact be a huge opportunity cost to protect against fairly unlikely outcomes. Math is an excellent tool for assessing risk, but only if applied correctly. The effect of compounding can drastically change the outputs and lead to incorrect courses of action.
“… incorrect courses of action.”
Correction
“… courses of action other than what would be preferred from an accurate analysis.”
Joe I like this plan and it’s what I would do, because it will minimize risk. The risk behind having a mortgage and the risk behind putting in the 400K in now when the markets are high could be substantial. Also with the extra cash flow savings, if you invest it right, those investments will pay dividends which will increase your final nest egg number.
Best decision of your life, with the greatest opportunities available, you will not suffer sleepless nights as you will always have a roof over your head. Additionally, no guarantee of anything in the stock market as for the rate of return or even the principle of your investment. I have purchased stocks that went from “hero to zero” over time. Best to you as you have the right attitude and your family is working as a team (one of the most important issues, in my opinion).
Having a 30 year fixed rate mortgage is a great hedge against inflation.
I won’t go in depth, but here’s one example: imagine 20 years from now investing in CDs or other safe investments at 7% while only paying 4%. No risk profit. You’re using devalued future dollars to pay down current value debt.
People always seem to forgot about the inflation hedge when I see this question
You’re right about that. In 20 years, $1900 will be pocket change.
I’d pay cash for the house, no question. Avoiding, say, a 15-year mortgage @3.5% is identical to making a significant investment with a guaranteed, risk-free return of 3.5%. In today’s investing environment and in my (and what I understand is your) financial circumstances, I’d happily add a 3.5% guaranteed, risk-free return for 15 years to my investment portfolio anytime. Next time stock values crash 50% (as they have twice in the past 15 years), I’ll be feeling pretty pleased with myself.
I think the older people are more conservative and we lean more toward guaranteed return. 40 seems to be the cut off date. 🙂 The younger folks don’t mind more risk and that’s good.
I’m still in favor of paying the house off. This is about peace of mind and having a shelter overhead regardless of the world scene. Markets are unpredictable. With age, what is predictable is that you and your wife will want more security and safety and less stress.
Surprisingly, at our age (77), our best investment was I-Bonds. Can’t believe it. We happened to buy them when they were 3.0 fixed rate, so we have been receiving at least 5-6 % a year. Why I like them is that there is no worry, no hassle, no grief. Our P2P funds are getting around 10% as an extra boost.
Having said that, you are doing so well with dividend paying stocks, they contribute a great balance to your portfolio. Remember, that Social Security will add at least an equivalent of $650,000 value in your retirement once you reach age 66-67. That’s a nice picture! I’d say you have won the game. Congratulations.
Paying cash would probably prevent us from buying too much house too. I would love to pick up more I Bonds when they have higher interest rate.
Thanks! We just need to keep our expense down and we’ll be set.
Your analysis is flawed. You are incorrectly counting increased cash flow that should not be a factor in the analysis. The increased rate of return on the lump sum investment kicks off more interest than the mortgage so the mortage can be paid in full purely from the investment returns. The increased cash flow is present in both scenarios since that comes from other income (wages or existing passive streams). If you rerun your analysis and pay the mortgage from the monthly returns of the $400K investment approach, at the end of the mortgage you have $1.5M in addition to owning the house ($700K after principal and interest payments).
In the end paying the mortgage off may be your preferred choice but you will be paying a significant premium at today’s mortgage rates for 10-15% of capital preservation downside protection. The most likely scenario over a 30 year time frame is that the market, even if invested in fairly conservative dividend and income producing assets, will outperform today’s 4% mortgage rates. The high premium may be tolerable particularly if you have accumulated ample assets so that longevity risk is minimal, but given the large uncertainty in future expenses and life expectancy, very few people can probably claim longevity risk is negligible in this type of analysis.
For me I would seriously consider cash if mortgage rates exceed 6%, anything less and the tradeoff of taking on longevity risk in an effort to maximize capital preservation is too high. I have a question for you, at what mortgage rate would you not pay cash and prefer the mortgage: 3%, 2%, 1%, 0%?
I think you are making it too complicated. I used compound return in both scenario. If I use the proceed from the $400k investment to make extra mortgage payment, I’d have lower return at the end.
Mrs. RB40 would do 0%. Me? Probably 3%.
How much would you say you need to accumulate? We’d have over 30x annual expense invested if we pay cash for the house. And we are not withdrawing for another 20 years. It will have plenty of time to accumulate.
50x annual expense, 100x annual expense? Why would you need so much money?
I’m not making this too complicated – simply using appropriate analysis methods.
Personally, I would be very comfortable having 30X annual expenses available with a mortgage free house. You are in an excellent position because it sounds like your accumulated assets minimize the longevity risk. A conservative capital preservation approach is very reasonable, but my point is that you are paying a high premium for that capital preservation.
However, most people don’t fall into your longevity risk situation. Paying too high a premium to preserve capital can increase the risk of running out of money in retirement. In most discussions of investment risk, the focus is on not losing money, but not having enough is a competing risk – hedging towards one side exposes you to more of the other. If we consider both types of risk, capital preservation and longevity, blindly assuming paying off the mortgage is the best option may not be true, but as always with financial planning everyone’s situation is different – sometimes the premium is worth the peace of mind of avoiding that 1/10 chance a worse outcome is realized.
Sure, I see your point. I would never cash out our investment account to pay for a house.
With a 20+ years investing horizon, the stock market is the best bet. Although, I’d dollar cost average in over time to make sure we don’t invest before a big correction.
Regardless of who is making it too complicated or oversimplifying… it does seem to me that you double counted in the “no mortgage” scenario. That is you counted both the return on the $1900 per month and then included the $300k in “saved” interest too. One or the other, not both.
I’m very much in favor of having the house paid off. I’ll admit to being an odd combo on the risk/security spectrum. I don’t mind having my retirement savings 100% in stocks (through less risky index funds). I’m only 35, so that doesn’t affect the here and now. But I’d love to be debt free, including the mortgage. That way I feel secure in the here and now, knowing I don’t need much to maintain my current lifestyle. I feel like that creates more long term security, while also allowing you more freedom and flexibility earlier on in life.
I had 100% in stock when I was in my early 30s too. Now I’m at about 80/20 stock/bonds. I’ll increase my bond allocation as I get older.
Our home value and mortgage is tiny enough to not really impact our retirement portfolio to any great extent ($150k house and $45k remaining mortgage balance). The mortgage has 3 years left on the regular amortization at 1.99% interest, so we’ll probably keep making payments and be done with it in 3 years. Although the market’s gains make it appealing to sell $45k in stocks and pay it all off tomorrow (why keep playing, right?).
Long term, I think it makes sense to have no mortgage in retirement. If you’re looking at Obamacare for health insurance, it makes even more sense to keep your expenses low, since your subsidy is tied to AGI. Getting rid of a $1000 or $2000 monthly expense means you can get by on a lower AGI and that means waaay more in Obamacare subsidy.
1.99% interest is incredible. That’s a good point about Obamacare. The lower your income, the better.
We caught the proverbial falling knife with that 1.99% rate. And paid no closing costs with that particular refinance. 🙂
I’m a huge proponent of paying off one’s home despite any potential losses in the market.
Anytime someone can guarantee having a roof over their head with no payments left on that roof and four walls, I think it’s a good idea. Who knows what tomorrow brings so locking in a home brings about incredible security.
The Warrior
NetWorthWarrior.com
Thanks for your input. Mrs. RB40 feels the same way. I’m still undecided.
Joe,
Ultimately, you need to do what gives Mrs. Rb40 peace of mind. Both are sound plans. Let’s not forget that you still have the house that will probably be worth far more than $500,000.
That’s right. If we really need money, we can get a HELOC or a reverse mortgage. Hopefully, it won’t come to that.
Joe, I concur with your analysis. As I mentioned in a previous comment, I paid off our “mortgage” early in our marriage. Never looked back at any opportunity cost. I should also mention that we purchased the house from an older relative with no realtor fees (a win for all parties). About 25 yrs later we purchased a large lot in a rural area and built a custom home with mostly sweat labor. With all the savings over the years, and reasonable risk in the markets, we are now retiring early while all our friends continue to work. Again, your plan sounds good to me…you’ll sleep well.
Congratulation on your win! Enjoy your retirement.
I say do what makes you comfortable!
I invest in stocks for the challenge of trying to pick winners. It’s also good diversification.
Sounds like you want to be conservative and that’s just fine.
I invest in stock to get more money. I don’t like the challenge at all. It’s not fun for me. I’m definitely getting more conservative as I get older.
I feel the same way about being more conservative as I get older.
However, I also feel like I’m playing with ‘house’s money’ now b/c I’ve built my financial nut to the point where it is generating a livable passive income stream.
Hence, I feel it’s more prudent to go ALL OUT and take as much risk as possible. Leave no stone unturned as they say, if you’ve already won as you say.
Just make sure your wife continues to work for as long as possible while monitoring your online income, and all will be good!
I’m terrible playing with the house money. I tend to get too aggressive and then lose it. It’s better for me to walk away once I won. 🙂
I agree. Each person has to do what they feel is best for them. I feel some people are too conservative with their money, but I also believe it is for good reason. I am practically addicted to investing and trading and waste way too much time doing it 🙂 I look forward to the day when I have enough saved to start to ramp down the risk taking.