Mortgage Payment as Investment

May 13, 2014 by

diversify

Diversity is good for your portfolio too!

Investment advisors and experts are virtually unanimous in recommending diversification when choosing where to park your cash, especially cash intended for retirement. Stocks, bonds, real estate or REITs, precious metals, commodities, collectibles, bank CDs—spreading your savings among these and other investments reduces portfolio risk because rarely do these categories rise or fall in unison (and some, like bank CDs, never fall). You’ve probably heard this simplified with the cliché about putting all of your eggs in one basket: if that basket were to drop, all of your (nest) eggs may break!

Risk Diversification

I think investment advisors would also be virtually unanimous in recommending that your portfolio be risk diversified too. You wouldn’t want all of your savings in either high risk or low risk investments.

Spreading your savings among many types of investments—stocks versus farmland, for example— cuts overall risk because inherent differences between investments makes their returns subject to totally different economic forces and because investments vary with respect to riskiness.

Investment Comparison

With that bit of background and discussion, let’s compare two investments:

→ Investment A: Guaranteed, risk-free 4.25% return annually for a known number of years

→ Investment B: Unknown and not guaranteed future return, but B has produced a 7% return historically

Question: Do you think both of these opportunities likely have a place in most people’s investment portfolios?

You may differ, but to me the answer is clear: YES!

That’s all well and good you may be thinking, but where the heck am I supposed to get a 4.25% guaranteed, risk-free return in today’s ultra low interest rate environment? Following up on my “Best Way to Prepay a Mortgage,” if you’re a homeowner, the answer is simple: your mortgage, at today’s national average 30-year / 0-point rate.

Think of Your Mortgage as an Investment Opportunity

I recommend that homeowners think of their mortgage as an investment opportunity. Here’s why:

If you’ve got 29 years left on your 4.25% mortgage, each principal payment is mathematically identical to putting that same money into an investment offering a guaranteed, risk-free return of 4.25% for 29 years.

I’ll add two caveats:

  • If you were deducting mortgage interest on your taxes, your return on a mortgage principal payment would be less than 4.25% because with each payment you’d be losing a bit of the tax benefit of the mortgage interest deduction.
  • If you pay off your mortgage sooner than its 30-year term, the annual return on your principal payment will end when you fully repay the mortgage.

Stocks Versus Your Mortgage

My Investment B above of course represents stocks, in which most people invest the lion’s share of their savings, per the advice of Wall Street and many personal finance bloggers. I’m not suggesting you avoid stocks completely and put all of your surplus cash into your mortgage. But I am suggesting a certain mind-set that I think most people lack: think of your mortgage as an investment opportunity competing for your savings along with the usual suspects: stocks, bonds, real estate, etc.

Maybe in the context of your portfolio your required monthly mortgage principal payment is sufficient investment in a guaranteed, risk-free vehicle. But maybe by thinking of your mortgage as an investment opportunity, you’ll feel excited about making extra principal payments, earning a return equal to your rate and perhaps achieving debt freedom that much sooner (which has its own, separate benefits!)

What Do You Think?

What do you think of my suggestion to consider a mortgage as an investment opportunity, just like stocks, bonds, etc.?

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