These days when I see a fixed 3% mortgage, I want to tell people never to pay it off, but that's the black and white in me. Finance people tend to see things more as probabilities and miss the emotional parts. However, there certainly is something to be said for not having a mortgage.
After brainstorming sessions with clients, I've often recommended what I call a “hybrid bond” which isn't really a bond at all. (Disclaimer: I don’t know if I read about this at some point, or made up the concept.)
If your financial situation is in good shape, you will usually have an emergency fund, and some money in safe investments to carry you through the inevitable down periods. Sometimes, taking a portion of those funds to pay off the mortgage might make sense, and give you a sense of relief, as well.
For example, these days I see our very safe bond investments yield maybe 2% or 3%. If we instead put some of the funds toward paying off your mortgage, the interest payment not due will be a guaranteed savings you will never have to pay again. So, if your mortgage is 4% or 5%, it’s even more compelling.
Now bond yields are going up, and we're assuming there's going to be many more rate hikes in the future. But if you do want to take a portion of your safe money and put it towards guaranteed debt retirement, that might be something to think about and discuss.
This can present the "hybrid bond" opportunity where we may allow the overall risk of the portfolio to drift higher as we have removed a future obligation and eliminated a guaranteed interest payment from your budget. So, in theory, you may be able to take a small amount of risk and use it to rebuild your safety allocation.
Ultimately, as you close in on retirement, you'll probably want to start thinking about how many years worth of safety you want in the portfolio. This means how many years worth of investments you want in things that won't be going down in a bad stock market. This could include bonds, alternatives, cash CDs, money markets, etc.
Generally, clients seem to like a minimum of five years, which I think is quite aggressive, to up to maybe 20 years of safety. The last stock market crash in 2008 was back to even in about five years, so if you were able to live on your safe money for five years, and not sell stock, you were good to go. It was still unpleasant or terrible frankly, but highly “normal” and survivable. If you have to sell when the stocks are down, they don't have a chance to recover, and you lock in those losses forever.
Previous to the crash of ’08, the last one was around the year 2000, and that was back to even in about seven years. Now, with this bull market being around nine years old, we're probably overdue for a correction of 20% or more, but that's okay. The assumption is that the market will eventually come back to even, which will take some time. So, if you have a buffer of safe money, that can help you ride that out.
The important discipline comes in not selling when things look ugly, which we can talk about another day. If you look back at the statistics, when the stock market has been down 15% , it's made sense to hold on.
Market timing does not work consistently. You might have a brother-in-law that claims to get lucky now and then, but if you look at the actual profit and loss, the true situation is likely much more dire.
If you or a loved one have a mortgage and would like to discuss this “hybrid bond” concept let us know.
We can also help you understand what your hypothetical net worth might be if you had to replace your guaranteed income from social security and pension funds. That's also an interesting asset allocation exercise. When we have guaranteed income coming in, we can sometimes factor it into your risk budget to make it as appropriate for you as possible.
Thanks for taking a look!
Tom Gartner, MSAPM, CFP®
This article represents opinions of the authors and not those of their firm and are subject to change from time to time, and do not constitute a recommendation to purchase and sale any security nor to engage in any particular investment or legal strategy. The information contained here has been obtained from sources believed to be reliable but cannot be guaranteed for accuracy.