Pay off the mortgage or invest your savings in the market? If there was ever a ninja vs. pirate debate in the FIRE community it’s this one. My foray into the debate is inspired by another article on the subject posted on a blog called Their Money Goals. The authors argued that comparing the inflation return on a house of, say, 2% vs. the 8-10% you get with that money in the stock market is wrong. Since you are really borrowing the house from the bank until the mortgage is paid off – at a rate of 4% today in the U.S. – then you are really paying 4% for a loan to finance that 8-10% gain. If the true market return then is 4-6%, its foolish to invest everything in the market because the return is really low for the risk involved.
This blew my mind when I first read it. Of course! Why didn’t I think of that! However, now that I read it I actually think that the authors underestimate the costs.
After all, while people mention that home values increase about the same as inflation, they rarely mention that stock market gains are also affected.* If we truly bring inflation into account, then homes would gain 0% in value over time outside of improvements, and the 8-10% gains in the stock market would be reduced to 6-8%. Once you add the mortgage back into the mix, the gains are further decreased to a pitiful 4-6%.
But wait, this doesn’t even take investment fees into account! 🙂 Fortunately, ETFs today are dirt cheap, but the average performance of a portfolio after inflation, fees and mortgage loan interest is still sub-4% to 6%. That is nothing to be excited about and makes rental properties look even better, given the many ways you can make money with them.
This is why I continue to advocate for learning how to trade stocks. It is totally possible to earn more than 8-10% in the stock market with education and practice. It is totally possible to limit your losses in the face of major recessions with stop-loss rules. It is totally possible to benefit from recessions and make money by going short on stocks. Implementing even minor trading principles in your portfolio can help you accelerate your gains faster than the usual discussion suggests.
But…if you don’t want to go down that route, paying off the house quick is the best bet for long-term security.
*After all, it’s called the 4% Rule and not the 7% Rule because a sustainable portfolio is estimated to have an average annual gain of 7% – 3% inflation, for a net gain of 4%. This is the amount you can pull out every year without dragging it down excessively. (in theory).
I’ll stay out of the stock picking fight because you might be that unicorn that actually can beat index funds consistently. On the mortgage thing I did pay mine off early but I don’t think it is a critical decision if you bought a house you can afford. By that I mean a mortgage that is no larger than 2 times your family annual income. My first and only house bought decades ago cost me less than one year’s income and while it was smaller than my friends McMansions I’m a millionaire and early retired and most of them are not and are still working. We chose to live frugally in spite of having a good income. A mortgage larger than twice your income is a huge amount of leverage and leaves you awfully exposed if the housing market crashes or your income hits a snag. Sure it might not work in a high cost market and if so, then I’d say you can’t afford to buy and need to rent or move somewhere with reasonable house prices if you really want to own a house. But I do agree with your math and I’m surprised so many other bloggers do not see it your way. Great post!
Hi Steve,
I’m glad you like the post. I have a high opinion of stock trading, but the logic even has me reconsidering. I totally agree that people shouldn’t have a mortgage twice the family income. Mine is borderline and I’d definitely be feeling it without the rental unit in the basement. I got lucky though that I at least bought mine in mid-2015, and in the Midwest, so the market was still affordable. I have no idea how people buying in the last year or two can afford it, especially on the coasts. Otherwise, thanks for commenting 🙂 I’ll be sure to check out your blog too.