There are a handful of questions that most financial planning clients bring in our front door. The answers can vary widely, of course, since the situations folks face are so very different. But there are some commonalities, some points of contact — and in this series, we look at a few of these key questions, and see what general answers we can offer.
For most Americans, our homes represent the largest part of our total net worth — about a quarter of our aggregate net worth is tied up in home equity. The vast majority of us borrow money from a mortgage company in order to make our home purchases, at least for our first homes. But as we move forward in our lives, some of us find that we have enough other assets that we need to make a choice: Should we invest that money, or pay off our mortgage?
Allan Roth, a Colorado Springs-based investment advisor and writer on financial planning topics, published an article this week in the industry magazine Financial Planning, in which he says that not paying off your mortgage is one of the “5 Dumbest Investing Bets” we could make. After all, why would a client want to borrow money for 4% while investing in bonds that only return about 2%? Sure, there are tax advantages to paying mortgage interest, but in Roth’s experience those don’t end up making enough of a difference to justify keeping the mortgage.
Fair enough. But I think that the comparison is a bit too quick and easy. Yes, current mortgage rates are right around 4%, if you have pretty good credit, for a 30-year fixed loan, and a brand-new 10-year US Treasury bond would pay a little more than 2%. But Roth may be missing some opportunities: Global “total bond market” funds and ETFs appear to be paying between 4% and 5%. And broadly diversified, well-constructed portfolios of both bonds and stocks can be expected to offer a significant performance advantage, especially over the 30-year life of a mortgage.
And the simple financial calculation is not the only factor, of course. For many of the clients we work with, the peace of mind offered by the thought of owning their home outright is hard to price. On the other hand, paying off the mortgage might be seen as turning liquid investment assets into illiquid property — and a sudden emergency need for cash can be met easily from an investment account, but might require a lengthy and complicated application and approval process for a home equity loan. I can only imagine a long list of other psychological benefits & burdens that might weigh on the decision, as well.
So, unlike Roth, we don’t think that this is an easy question with an obvious answer. There are reasonable investment options that he doesn’t consider, after all. And there are non-financial issues at play, as well, like psychological comfort and liquidity issues. To reduce this complex decision to a simple “borrow at 4%, earn 2%” calculation is to refuse to consider very much of a complex decision-space — and to miss an opportunity to provide real advice to real human clients.