Would you borrow big to bet on stocks?
Is it really any different than buying stocks instead of paying off debt?
This article concludes that tapping your 401(k) to pay off a mortgage isn’t a good idea. I agree with the gist of the conclusion, but the reasoning is full of holes big enough to drive a truck through.
They are basic math errors in which unlike variables are compared as if they were the same. Quick … if you start with six apples and subtract four oranges, how many bananas will you have left?
This is essentially the kind of math involved in comparing past stock returns with future interest costs. To wit:
“IVV’s 324% decade return and DGRO’s dividend nearly doubling since 2014 make liquidating either fund to retire a 5% mortgage a costly trade.”
This is faulty logic. That 324% return for IVV (an S&P index fund) is for the past ten years. It is not comparable to the 5% per year interest cost that would be saved in the future on a mortgage.
There is no way to capture that bygone IVV return on any decision made today. But not paying 5% interest over the coming years on a mortgage is something you can do in real life.
Money saved by paying down debt compounds just the same as money earned on investments. And paying off debt is a certain return. What you might earn by investing in stocks is not. If it were possible to achieve a certain return on any investment greater than what you’re paying on your mortgage, why is your lender even bothering to lend to you?
Paying off debt in preference to making portfolio investments doesn’t just “feel” smart. Failing to do so is not fundamentally any different than borrowing to invest. It might pay off, but it might ruin you too. You can’t go bankrupt without being in debt. Invest money you have, not money you don’t.
In reality, the legitimate reason to be reticent about liquidating 401(k) funds to pay down a mortgage has more to do with taxes and limits on one’s ability to replenish 401(k) funds. But it’s far from the slam dunk decision this article implies. The “invisible” costs it refers to are worse than that; they’re imaginary. If you try to subtract four oranges from six apples you’re bananas.
I have personal experience with this. In 1998 I used exactly this reasoning to sell off all our portfolio investments to pay off our mortgage. It was one of the best financial decisions I ever made. Had I just looked at what the stock market had returned over the past ten years and compared that with what I would save by paying off my mortgage, I would not have been able to retire in 2005. As it turned out, there was a major bear market in those intervening years, and the cash flow from having eliminated the mortgage payments made it possible to take full advantage. You don’t know that anything like that will happen in the years following your debt payoff, but you likewise don’t know that it won’t.