Gyroscopic Investing

So I'm planning on taking a mortgage out on a house.  The price of the house is about a quarter of my whole portfolio.  I use the permanent portfolio, so a quarter of my portfolio is treasuries.  So in some sense, I am borrowing from the bank to lend money to the government.  This doesn't seem smart.  The obvious solution is to just buy the house outright and not hold treasuries.  But then I don't have protection against deflation.  Also, I am probably way oversimplifying things, but I don't understand this stuff too well.

What would you do if you were me?  Keep in mind that I am pretty much semi-retired, so I'd like to have my money locked up in a safe portfolio with no weird risks popping up.

In Fail-Safe Investing and on his radio show HB recommended treating a personal residence as a consumption item; i.e. don't consider it as a part of your portfolio.  I'm not sure if he ever made a direct comment on his thoughts on mortgages, but from what I've read and heard from him I know he thought having debt to be unwise. 

In Why the Best Laid Investment Plans Usually Go Wrong he discussed the possibility of using zero-coupon bonds to hedge a mortgage, but I think at the time he was still looking at a personal residence as part of an investment portfolio instead of as a consumption item.  I haven't heard or read anything more recently from him that discusses the idea.

If I were you I'd buy the house outright and consider it a consumption item.  Then with your remaining portfolio go 4x25.  This is exactly what I will be doing with my own money in the next 1-1.5 years.  I personally don't like the emotional burden of a mortgage, and I'd rather earn interest than pay it. Many people will argue that some debt is good, say things about inflation and tax deductions, etc.  At the end of the day it all depends on your personal risk tolerance, and I find that I sleep better knowing I don't owe anyone anything, and whatever small amount I might gain by having the leverage isn't worth the loss in peace of mind. Either way, whether you choose to have a mortgage or not, I would consider it to be outside of the permanent portfolio.

P.S.

I see he discusses the topic a bit more in Rule 7 Part II in Fail-Safe Investing.  Make sure you can't lose more than you've put in in cash (non-recourse mortgage), and make sure you can afford to lose what you've put in.

is this the primary house that you'll live in?

"The obvious solution is to just buy the house outright and not hold treasuries."

I wouldn't do that.

I would say, that if you want to buy the house outright, the obvious solution to sell down ~25% of your perm port, selling all asset types in a manner that post-sale you perm port will be rebalanced, & buy the house with cash.

Or if you take the mortgage, keep a balanced PP & don't sell off your treasuries.

Don't "look at an isolated asset, look at the PP as a package"

Keep in mind 30 yr Treasuries (TLT) in 2011 was ~30% nominal return, & best PP asset in 2011.  Maintaining a balanced PP is essential to having the low drawdowns, which are a major feature that attracts us to the PP initially.

iirc there is a guy here who is a CPA accountant.  His take would be interesting, him being both familiar with the tax laws & the PP.  My wild guesstimate would be that buying the house with cash would be superior, despite the mortgage interest deduction.  Especially if at least 1/4 of your nest egg is taxable, & thus you could sell off a fund to buy the house without any 401k/IRA withdrawal penalties.

I think paying cash for a house and then trying to pretend it's not an investment is silly.

It makes more sense to get a mortgage and then account for it as a monthly expense just like rent. I believe this is more in line with HB's philosophy of treating the house as a consumption item.

Monthly accounting also makes it much more straightforward to decide whether you should buy or rent.

I have a problem with the assertion that a home/mortgage should be ignored.  Here's why.

All things being equal (assuming you would have rented the same type of home/condo you bought), locking in one of your largest expenses (isn't housing usually 20%-30% of your expenditures?) for 30 years vs having a year-by-year adjustment in prices is too big to ignore, IMO.  It may be a consumption item, but it's an especially long-lived consumption item, is one that could very well qualify as mostly a necessity, and one who owns a home has materially less exposure to inflation than someone who doesn't, all else being equal.  So the fact that it's a consumption item is almost irrelevent.  Shelter is a necessary consumption expense, and the degree to which you can lock the cost in of that expense for a long-period of time reduces your exposure to inflation.  Now getting into McMansions is a different story, but I think you see what I'm getting at with the core of this issue.  If you could also have a mechanism to lock in the cost of food, gas, college education for your kids, and utilities, would this be irrelevent to how you should invest?  I really don't think so.

So I DO think that a mortgage-financed home should adjust one's investing strategy to being LESS focused on inflation risk. 

Now there is the point that buying a home doesn't necessarily shield you from inflation because now you're more exposed to big repairs and utility costs than when you were living in an apartment.  Hence my point that you have to compare apples to apples.  Apartment vs. condo.... home rental vs home ownership. 

moda0306 wrote: I have a problem with the assertion that a home/mortgage should be ignored.  Here's why.

All things being equal (assuming you would have rented the same type of home/condo you bought), locking in one of your largest expenses (isn't housing usually 20%-30% of your expenditures?) for 30 years vs having a year-by-year adjustment in prices is too big to ignore, IMO.  It may be a consumption item, but it's an especially long-lived consumption item, is one that could very well qualify as mostly a necessity, and one who owns a home has materially less exposure to inflation than someone who doesn't, all else being equal.  So the fact that it's a consumption item is almost irrelevent.  Shelter is a necessary consumption expense, and the degree to which you can lock the cost in of that expense for a long-period of time reduces your exposure to inflation.  Now getting into McMansions is a different story, but I think you see what I'm getting at with the core of this issue.  If you could also have a mechanism to lock in the cost of food, gas, college education for your kids, and utilities, would this be irrelevent to how you should invest?  I really don't think so.

So I DO think that a mortgage-financed home should adjust one's investing strategy to being LESS focused on inflation risk.  

Now there is the point that buying a home doesn't necessarily shield you from inflation because now you're more exposed to big repairs and utility costs than when you were living in an apartment.  Hence my point that you have to compare apples to apples.  Apartment vs. condo.... home rental vs home ownership.  

This makes the most sense to me.  I'm buying the house, and am going to live in it.  It will be a significant part of my financial picture, and can't be ignored.  Regardless of how I should conceptualize real estate, I still need to figure out what needs to be done to achieve a good overall balance and be protected under most economic conditions.

Part of me thinks that focusing on the value of the real estate itself isn't as important as visualizing that you've locked in 20%-30% of your budget to a fixed price.  This is a part of your budget that would most often fall under "need," not "want" (depending, of course, on how lavish the home is). 

I've heard lots of good arguments on both sides of this debate but I think it all boils down to your personal preference and whatever makes you feel most comfortable. Some people like the idea of having a house paid off and no mortgage, especially if they intend to live in it for the rest of their lives (or at least a long time).

Personally I have the attitude that if I have enough money to pay off my mortgage (which I do) then it's as good as paid off and I don't worry about the mortgage. I would worry more about reducing the amount of money in my PP so it ain't gonna happen unless/until I have a lot more money.

Here's something else you may want to consider. Location.

I live in CA near an earthquake fault and have my house financed at about 70-75% loan to value, although I could have it paid off.  My reasoning is that if we have a major earthquake and my house falls down, I want the bank as my partner.  If the house is free and clear, I'm on my own.  With the bank as my partner I may or may not have some negotiating power.  In any event, aside from the moral issue, I'm free to walk away and let the bank have the property if they refuse to help or participate in the reconstruction.  My hope is that they would help me in that situation.  Not sure what I would do if that situation occurs, but at least I have some options.

It seems like whatever makes you most comfortable (mortgage vs. outright purchase) would both be just fine.  Whichever way you go, I'd just stick with the Permanent Portfolio with your remaining funds.  No need to try to outsmart yourself IMO.

There are a few things to consider about a mortgage.  With a 30-year at 3.75% and a 15-year at 3.1%, you would be borrowing at a very low rate of interest.  These rates are well below the mean performance for a Permanent Portfolio (8-9%) so if you go strictly by the historical numbers, the mortgage would not be hurting you (in fact, quite the opposite.)  Nothing is guaranteed but I think it's worth keeping in mind that historically speaking the PP will usually beat the 4% that the mortgage is costing you.

I'd also consider whether you would face any tax consequences by going through the process of scraping together the cash for an outright purchase of the house.  If it will force you to sell assets on which you have unrealized capital gains, the mortgage would give you additional flexibility.

On the other hand, you may also greatly value the peace of mind of owning your home outright.  It's hard to put a price on that.