Financial Planning Market Analysis

Carrying a Mortgage and Investing the Difference

Should you carry a mortgage, service the debt, and invest the difference in retirement? We will explore the popular “carry a mortgage and invest for a higher rate of return” position many advisors seem to take in this month article.

Google search “Should I Pay Off My Mortgage Early,” and you will likely find many publications highlighting the strategy of carrying a mortgage and investing your excess cash reserves in marketable securities. Historically low mortgage interest rates and higher long-term investment returns seem to be the backbone for this stance.

The basic assumptions of the Pro mortgage invest the difference community are:

  1. Mortgage rates are historically low. A 30-year fixed rate mortgage rates are just shy of 4% Annual Percentage Rate (APR).
  2. Investing money in the market would likely fetch 8-9% market-based returns applying historical market returns of major market indices like the SP500.

It’s not hard to see why this would make for a compelling argument. With historical market returns double that of current mortgage rates it seems like an easy decision.

According to the website Don’t Quit Your Day Job’s SP500 Calculator ( the max historical rate for the SP500 with dividends reinvested was 9.002%. When adjusted for inflation the return drops to 6.83%. The calculator draws data from the time period beginning 1871 through 2018. That is 147 years of data. Of course, you can manually adjust the time frames in order to review smaller chunks of data to see returns over various periods such as a specific decade or two.

Most mortgages are 30 years in length, not 147 years. Many folks nearing retirement have less than 30 years remaining on their current mortgage. Still, over a 30-year time frame the SP500 returns still look pretty good. From January 1989 thru 2018 the return with dividends reinvested was 9.93%, and 7.28% adjusted for inflation.

Even 30 years seems to be enough time to offset the volatility of the market. If you can put your money away, and not touch if for three decades, an average a return of more than 8% seems reasonable. However, many folks nearing retirement don’t have 30 years to put their money aside and forget about it. 

Is a Decade too Short?

30 years is a long time. It’s longer than a 3rd of the average life expectancy of person born today. What happens over shorter periods of time?

Over the past 10 years (Jan. 2009 through Jan. 2019) the SP500 has returned nearly 14%. That’s 55.55% better than the historical average rate of return of the SP500. That’s pretty amazing. 

So far, I’m feeling like my typical position of paying off the mortgage early using cash reserves instead of investing it might be a mistake.  Maybe carrying a mortgage into retirement isn’t such a bad decision after all. The evidence is pointing towards investing the difference for higher rates of return.

However, then you begin to look at other 10-year periods, or shorter, and things don’t look so good.

Average Is Somewhere Between Highs And Lows.

You see, if there are periods like that last 10 years with market returns in excess of the historical return by more than 55%, there has to be proportionality poor periods to bring that average back down, right? That’s how averages work.

From Jan 1999 to Jan of 2009 the SP500 with dividends reinvested returned – 1.98%, or -4.41 % when adjusted for inflation. Often referred to as the “lost decade,” this period of market returns was historically low. In fact, it was approximately 10% less than the earlier stated historical returns.

Imagine it’s the late 90’s and you are preparing to retire! Yippee, the market has been good for nearly two decades. You have managed to accumulate a pile of money for the future. You needed some of your pile in the next 10 years to maintain your lifestyle, including money to pay your mortgage principal and interest. Then we have a period of 10 years like the lost decade.

How would you have to change your lifestyle to avoid depleting your pile of money before you run out of breath? Would you sell investments at a loss in order to maintain your desired lifestyle? Would you reduce your lifestyle? Could you go back to work? Would there be a job waiting for you? While distributing from the pile of money in the short-term future, can you have it at risk of loss in the market?

Purpose and Timeline Of Money

We like to say, “every dollar has a purpose, and a timeline.” The purpose and timeline should be determining factors as to where your money is allocated. Either it is saved in interest-bearing accounts, or invested in a portfolio of securities for market-based returns.  

If the timeline is short then the purpose of low risk and high liquidity rules the day. For example, imagine tomorrow you’re going to the store to buy groceries. That money should be somewhere void of risk, and immediately accessible. Your checking account is probably appropriate. Don’t you think?

You will need it soon. How soon? Tomorrow! It has a definite purpose. What’s the purpose? Feed your family and yourself. Therefore, you probably don’t want to gamble whether it will be there or not based on short term market volatility. You’re likely not going to earn a much interest on this money, but who cares because you’re going to spend it tomorrow and you can sleep tonight knowing it will be there when you need it.

On the other hand, you likely have dollars that you don’t need in the next 15 + years. Although that is a much longer timeline, the purpose may still be definite. You’ll need the money in order to maintain a comfortable lifestyle in retirement. However, you don’t need it tomorrow. Therefore, it may be appropriate to take on some market risk with some of these dollars in search of a higher rate of return. After all, inflation will erode the purchasing power of your money by nearly 40% over that timeframe if you stuff it under your mattress.

Peaks, Troughs, and Breakeven Points

Market pull backs could last months, or even years. It is foreseeable that a recession could create a situation where your investments experience multiple years between peak to trough, and back to the breakeven point. Selling investments to maintain any portion of your lifestyle during this period forces you to accept a loss.

Do Mortgage Payments Have Definite Purpose and Timeline?

What if the purpose of your dollar is to pay your mortgage? Next month? Next year? 5 years from now, or even 10? How do you have to adapt where and how you either save or invest these dollars?

Imagine your mortgage includes $1,500 worth of monthly principal and interest payments. That equals $36,000 over 24 months. Over 5 years it adds up to $90,000, and $180,000 over a 10-year period.

How would you invest the dollars you need next month, next year, the next 5 years, or over a decade?

Are you a risk taker willing to allocate 100% to stocks?

Maybe you’re more conservative and prefer a blend of bonds and stocks?

Would some of it need to be in cash at the bank earning very little interest to be certain you can cover short term payments?

What is the blended rate between short-term low-risk interest bearing accounts, and longer-term at-risk positions? 

Has the return on investment rates fallen below the point at which the return is better than mortgage interest rate being charged against the balance of principal?

Likely, under circumstances ensuring the money will be there to pay your mortgage over the next 10 years the money must be invested in a much lower risk, lower return portfolio.

Mortgage payments in the next 24 months = Approximately $36,000

Would you accept stock market risk on money that you need to pay your mortgage in the next 12 to 24 months? If not, where might you keep it? How about an online bank account? You might earn 2% before taxes, and 1.5% after the federal and state governments have their share. In that event, it might make sense to pre-pay your mortgage principal down with the dollars because earning 2% less taxes won’t offset the mortgage interest rate of nearly 4%.

Mortgage payments in years 3 to 5 years = Approximately $54,000

How much might you be able to earn on these dollars designated to pay your mortgage payment in the next three to five years? How much risk are you willing to accept on money with a 3 to 5-year timeline that has a definite purpose of keeping a roof over your family’s head?

Are you willing to accept the risk that your investment might be worth less than what you paid for it at the time you need to sell it in order to generate the money necessary to pay your mortgage?

Some folks will be, and others may not be. If you do accept a level of risk, how much? What type of return might you earn with that level of risk? Will it be more or less than the rate of interest you pay on your mortgage?

Mortgage payments in the next 5 to 10 years = Approximately $90,000

Stretching 5 to 10 years out, you might feel more confident to accept additional market risk. Perhaps you are willing to invest in the equities market and have the potential to earn return more closely resembling that of the historical returns or the SP500. Nevertheless, it comes with significant risk.

The maximum drawdown on the SP500 during the subprime mortgage crises was nearly 50%. A loss of this magnitude requires a 100% return to get back to breakeven. It took nearly 4 years to recover after the market began to slide.

The tech bubble in the early 2000’s experienced a similar slide, but it took nearly 7 and ½ years from the peak to the trough and back to break even. Taking significant loses near the time you need the assets to pay for known expenses could result in being forced to sell investments at a loss.

Working Years vs Retirement Distribution

Does it make sense to pay off your mortgage or carry it while investing the difference. I suppose it depends.  What state of life you are in? Are you in the early stages of your income earning years?  If your paycheck is covering your mortgage you could likely invest in the market any additional resources that you have each month and be OK.

Are you transitioning into retirement? Your income years are nearly behind you, and your paycheck is soon to be retired as well. You’ll have to manage distributions from your retirement assets to replace your earned income? Maybe you won’t have the luxury to take as much risk as what is needed to justify carrying a mortgage into retirement and investing the difference. 

“Investment Adviser Representative of and advisory services offered through Royal Fund Management, LLC, a SEC registered investment adviser.”

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