Wednesday, July 25, 2012

At the Margin Mortgage vs Retirement


First, I am not a financial planner (or panther) and I have no formal training in this so the below is for informational purposes only and does not constitute financial advice, seek a professional (preferably not someone named Ponzi or Madoff).

So my thinking through to pay above the minimum payments on my 30 year mortgage versus retirement savings. In short paying money to my mortgage provides roughly a 3% return (after accounting for the mortgage tax deduction).

These two articles provide the pros and the cons of making extra payments.

In short I agree if you have other debt at a higher interest rate, pay that before your mortgage. If you get a matching contribution from your employer for retirement savings then put more in retirement.

Assuming you have no other debts or matching to take advantage of it seems to me the question comes down to a bet on future returns in your retirement account.

If you are investing conservatively (like in say bonds and money market funds in your retirement) then it would seem paying off the mortgage makes sense.

Most people early in their mortgage instead invest in stocks. So in short putting more in retirement funds is a bet that stock market will beat 3% a year.   I could look up the average return to various funds but I’m not sure how informative past performance is.

One thought I have been having though if the stock market substantially outperforms 3% then putting money in your mortgage was the worse move. However, if the market substantially outperforms 3% adjusting for inflation than you will not have needed as much contribution in retirement. If on the other hand the market under performs than the mortgage contribution was a better deal.

What complicates this is if stock prices go up due to inflation say inflation for the years 2020-2030 was 8% and stock market returned 9% (or real inflation adjusted stock returns are 9 - 8 = 1% after inflation). The stock investment was better, but the real or post inflation return is really low so now under investment in retirement might sting more.

To me inflation seems as big a source of potential variation in this calculation then predicting returns. With treasury yields at 1.4% it seems that inflation expectations are really low.  I’m not worried about inflation now, but who knows in 10 or 20 years.

Unfortunately as someone once said economists are bad at predictions particularly about the future. So I’m not sure on the optimal choice.

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5 comments:

Bob Gitter said...

I am reminded of the story of someone asking the original J.P. Morgan for advice. He told Morgan he worried about his stocks and could not sleep at night. He asked Morgan what he should do.

Morgan replied "Sell down to the sleeping point."

I thought we could earn a better return than the four percent or so we were paying on our mortgage. Your mother, however, wanted the peace of mind of a paid off mortgage. We sold down to the sleeping point and paid off the mortgage.

Dad

Kate Morgan said...

Thanks for sharing
Does anyone knows any good mortgage calculator? i found this one http://mlcalculator.org and don't know it works good or not
Thanks

Unknown said...

Your Aunt also liked the idea of a paid-off mortgage. However, once paid off, we refinanced at 3.75 and took out a loan to buy rental property. We rent it to Ian (son) and his girlfriend Katie at a somewhat below-market rate. They get a fun place to live. I get an investment and someone else pays for the mortgage and taxes. Ian contributes to family wealth that he might hope to inherit one day. It's a win-win until it turns into a disaster:-).

Your grandfather used to say "Real estate is the only investment that pays for itself." Of course, he also always discouraged me from becoming a landlord.

Tom is getting very good at brewing beer. Come to Portlandia!

Aunt Jenny

Mortgage News said...

Great post Mortgage calculators can calculate the total payment with primary, interest, taxes and insurance, called as the PITI payment. Payments can be calculated irrespective of the time period how it is paid - quarterly, monthly or biweekly.
mortgage calculator

Martin Thompson said...

yes you are right that market under performs than the mortgage contribution was a better deal. but it not happens mostly.

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