A primary home can be a wonderful investment, especially if you enjoy living in it. However, it’s good to keep in mind that real estate historically appreciates at about the rate of inflation. This is less than the historical appreciation of stocks.
But if you can afford your home and you plan on living in it for at least six years, then the leverage of a mortgage and tax benefits can be quite beneficial. At the end of the day, home buying decisions are likely to make a significant impact on your overall net worth and portfolio.
Paying Down Your Mortgage vs. Investing
One question that is commonly asked is, should you pay down your mortgage or should you invest? The answer isn’t simple. Do you believe equities will perform reasonably better than your after-tax mortgage rate? For example, these days most people have a mortgage with a relatively low interest rate (3% or 4%) and that rate is locked in for 15 or 30 years. In contrast, a standard rate of return of a diversified portfolio from 12/31/2011 to 3/31/2018 is 7.6%  (based on representative benchmarking) —greater than the borrowed mortgage rate. In this case, you may want to maintain a relatively high mortgage balance and invest the money in markets.
Of course, this depends on your risk tolerance – and everyone’s is different. And because there is a real risk of loss, being completely leveraged is not generally recommended. The actual ratio should be dependent on current mortgage rates, equity expectations and other risk tolerance factors such as other assets, income and personal preferences.
There are also tax-related variables that impact your decision, since tax reform has impacted whether you may end up itemizing or taking the new increased standard deduction.
Stocks and Your Mortgage
There are many factors that impact your stock allocation and its relationship to your mortgage. Some of these include taxes, mortgage interest rates, inflation, and, of course, market and equity returns. Time horizon also plays a big role when considering your portfolio; what happens in a decade will be different from what happens in two and even three decades – not just in the world of finance, but also within your own life and long-term goals.
When it comes to your mortgage and your stock allocation, one theory is that it’s better to keep a high mortgage and invest the money in stocks (rather than paying down your mortgage). But it’s not without risk. There are no guarantees stocks will go up, so some balance between the two strategies is optimal. But if you are still working, especially, it can be a big mistake to opt for reducing your mortgage such that you do not have a significant portion of your total net worth in stocks.
Bonds vs. Your Mortgage
Another common question is, does it make sense to own bonds and have mortgage debt? If the interest rate on the bonds is meaningfully lower, the answer is probably no, but this depends a lot on the specific bonds you own. Taxes – as usual – can complicate this, especially taking into account the new allowable deduction on mortgage interest rates. And if your bond fund is owned in a taxable account, the yield may decrease.
Liquidity becomes one of the primary reason to not sell bonds and pay down your mortgage, since having access to liquid assets may be important. Of course, many types of bonds pay higher yields than current mortgage rates but introduce default or currency risk. While many investors own bonds and have a mortgage, it usually doesn’t make sense to have a high allocation to bonds that pay significantly less than your mortgage rate. This includes low-paying CDs and savings accounts that are not part of your emergency cash cushion. Don’t forget transaction costs and management fees when considering bond yields.
Risk Tolerance and Your Mortgage
Risk tolerance is another crucial component when it comes to owning a home and how it impacts your portfolio. When the financial crisis hit, many of us saw our net worth greatly impacted because property made up so much of it. Even though everyone’s risk tolerance is different, property (especially for first-time home buyers in expensive areas) can comprise the majority of your net worth. This is usually okay for most people, but it’s good to remember that property, as mentioned before, is one of the least liquid investment classes.
Some investors are simply too risk averse to tolerate market volatility, which means you may elect to pay off your mortgage because of the peace of mind it brings. The same applies if you simply cannot tolerate debt. Or, you may have stronger risk tolerance and will weather market cycles by maintaining a diverse and balanced portfolio.
A registered financial advisor can help you determine how this type of investment fits into your overall financial strategy.
To learn more about first-time home buying and how it fits into your overall financial plans, download our free Personal Capital First-Time Home Buyer’s Guide.
 Representative Benchmark: 41.7% US Equities (VTI), 20.8% International Equities (VEU), 23.4% US Bonds (AGG), 4.1% International Bonds (IGOV), 10.0% Alternatives (equal split VNQ/IAU/DBC) from 12/31/2011 to 3/31/2018 [Inception Date 12/31/2011]
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