Mortgage Debt and Asset Allocation

TL;DR

Paying off mortgage debt while increasing the portfolio's equity allocation can result in equivalent risk and return characteristics while eliminating a fixed expense.

Transcript

Do you have a mortgage? Based on  2016 census data, 61.7% of Canadian   families owned a principal residence, and  57.3% of those families had a mortgage. If you have both a mortgage and an investment  portfolio you might have wondered if it makes   sense to use some of your investments  to pay off your mortgage. This is a   very common question, a... Read More

Key Insights

• 🥺 Paying off mortgage debt while increasing the portfolio's equity allocation can lead to equivalent risk and return characteristics while eliminating a fixed expense.
• ✳️ Keeping both a portfolio and a mortgage creates leverage, which increases risk.
• 🌸 Comparing the outcomes during the 2008 financial crisis, a 50/50 portfolio with a mortgage incurred a greater loss than a 95/5 portfolio without a mortgage.

Questions & Answers

Q: What is the common advice regarding using investments to pay off mortgage debt?

The common advice is to keep the investment portfolio intact to benefit from higher expected returns compared to the low cost of mortgage debt.

Q: What is the flaw in the common advice?

The flaw is that if the investment portfolio is not allocated 100% to stocks, paying off the mortgage and increasing the portfolio's equity allocation may result in higher expected returns.

Q: What is the impact of leveraging when keeping the mortgage and investing in a 50/50 portfolio?

Keeping the mortgage and investing $900,000 effectively means investing $500,000 of your own money and borrowing the remaining $400,000, resulting in increased risk.

Q: How does paying off the mortgage eliminate a fixed expense?

Paying off the mortgage eliminates the guaranteed mortgage interest cost and the fixed outgoing cash flow, freeing up cash flow and reducing the financial burden.

Summary & Key Takeaways

• Many people believe it is more logical to keep their investment portfolio intact and benefit from the higher expected returns of financial market investments compared to the relatively low cost of mortgage debt.

• However, if the investment portfolio is not allocated 100% to stocks, paying off the mortgage and increasing the portfolio's equity allocation may lead to higher expected returns.

• A comparison is made between keeping the mortgage and a 50/50 portfolio and paying off the mortgage while increasing the portfolio's risk level to 95% stocks and 5% bonds, showing similar risk and return characteristics.