**Update 12/4/2020:** I’ve been getting a lot of inquiries lately: Has my assessment changed in light of the record-low interest rates? My answer: Not really. Mortgage rates are low but so are my equity expected returns and bond yields. Right now I see 2.375% for the 15y and 2.75% for the 30y mortgage, so we’re about 1.0% lower on the mortgage rate. But with the CAPE>30 we also have a 1% lower equity expected return. It’s almost a wash. So, the gist of the article is still intact: Ask yourself, are you comfortable with a mortgage and 100% equities? I would not. If you do have bonds and a mortgage, is the bond yield lower than the mortgage rate? (Currently, it is: <1% for the 10y bond used in my simulations.) So, you’re better off paying off the mortgage with the bond portfolio.

Welcome back to the newest installment in our Safe Withdrawal Rate Series! If you are new to our site please go back to Part 1 to start from the beginning. Or check out the designated landing page for the SWR Series here.

But back to the topic at hand. It’s been on my mind for a long time. It’s relevant to our own situation and it’s come up in discussions on other blogs, in our case study series and in numerous questions and comments here on the ERN blog:

### Should we have a mortgage in Early Retirement?

The case for having a mortgage is pretty simple: You can get a 30-year mortgage for about 4% right now. Probably even slightly below 4% when you shop around. Equities will certainly beat that nominal rate of return over the next 30 years. Open and shut case! End of the discussion, right? Well, not so fast! As we have seen in our posts on Sequence of Return Risk (Part 14 and Part 15), the **average return** is less relevant than the **sequence of returns**. Having a mortgage in retirement will exacerbate your sequence of return risk because you are frontloading your withdrawals early on during retirement to pay for the mortgage; not just interest but also principal payments. In other words, if we are unlucky and experience low returns early during our retirement (the definition of sequence risk) we’d withdraw more shares when equity prices are down. The definition of sequence risk!

How badly will a mortgage mess with sequence risk and safe withdrawal rates? That’s the topic for today’s post…

### Our situation

Our situation is a bit unique in that we will move from our current location in a high cost of living area in an extremely high marginal tax state to a low cost of living area in a low or even no income tax state. Hence, we will certainly pay off our **existing** mortgage when we sell our apartment. We should be able to pay cash for a modest house in our new location and still have money left over to invest. But should we get a mortgage and invest even more money? It’s so tempting! And remember, I’m not foreign to the concept of leverage and I have praised it many times (see, for example, Seven reasons in defense of debt and leverage: Yes, you CAN have too little of a bad thing!). But that was when we were still saving for retirement. This time is different, though:

**Taxes:**In retirement, we expect to use the standard deduction. No more itemized deductions, hence, our mortgage interest is no longer tax-deductible.**The equity glidepath slope reverses in retirement!**As we detailed in the previous two installments of the series (Part 19 and Part 20), a glidepath shifting from a moderate bond allocation at the commencement of retirement to a mostly equity portfolio later in retirement can serve as a hedge against Sequence Risk. But with a mortgage, we’d do the opposite. Having a mortgage is similar (though not identical, I know) to a**short bond position**, and paying off the mortgage means we shift money out of equities and into bonds. The wrong direction! That can only exacerbate Sequence Risk!**Dynamic Withdrawal Rules:**Another tool we recommended to deal with Sequence Risk is to adjust the withdrawal rates according to how the portfolio performs. We like a CAPE-based rule (see Part 18 for more details) but others prefer the Bogleheads VPW (see Part 11 for a comparison of different dynamic rules). But using variable rules becomes harder when faced with the fixed expense of a mortgage. Imagine you follow the VPW rule and you have to cut your $4,000 monthly withdrawal by 50% in response to a 50% market drop. That’s painful. But with a $1,000 mortgage and a $5,000 initial monthly withdrawal, you’d cut your withdrawal to $2,500. After paying for the mortgage you’re left with only $1,500 in discretionary spending compared to $4,000. That’s a 62.5% drop in consumption! Thus, the**mortgage will magnify the consumption impact of market volatility!**

### Simulations and Limitations

The 30-year mortgage as we know it today didn’t even exist before the Great Depression. What’s worse, I don’t have a very long time series of 30-year mortgage rates. Even if I had a time series for mortgage rates I’d have to make assumptions, lots of assumptions, about if and how each of the cohorts since 1871 would have handled changing interest rates and potential prepayments and/or refinancing of mortgages. A can of worms!

So, studying the pros and cons of a mortgage-free early retirement would have to take a few shortcuts and hacking of my simulation engine. And once you start hacking, always keep in mind one of Big ERN’s fundamental rules:

### There is a fine line between **doing** a hack and **being** a hack!

So for full disclosure, today’s simulation results are mostly a thought experiment with the following assumptions:

- I calculate the mortgage payment of a 30-year and 15-year mortgage with today’s market rates and assume that the real, inflation-adjusted mortgage payments decay due to a projected 2% annual inflation rate going forward, see chart below.
- Given the mandatory real mortgage payments, what would be the experience of a retiree today if the real stock/bond returns of all the past retirement cohorts were to repeat themselves?

In other words, I don’t simulate how a retiree in 1929 with a mortgage in 1929 would have experienced the 1929-1989 equity and bond returns. I calculate how a retiree **today** with **today’s mortgage** parameters would fare if we hit him/her with the 1929-1989 real, CPI-adjusted stock/bond returns. And the 1928-1988 returns and the 1927-1987 returns, and the 1930-1990 returns, and so on.

You be the judge if this crosses the line. But remember, before yelling at me, please keep in mind another one of Big ERN’s fundamental rules:

### It takes a model to beat a model!

In other words, unless you have a better way of evaluating the mortgage vs. no mortgage tradeoff please don’t call me a hack. 🙂

### Simulation Assumptions:

- 60-year horizon, capital depletion target.
- We run monthly simulations through our Safe Withdrawal Rate Google Sheet. See Part 7 of this series for more information.
- We assume a 2% annualized inflation rate, so the mortgage payments, in real inflation-adjusted terms will decline over time.

We look at eight different models/parameter assumptions. They all have the same initial net worth but different assumptions about the mortgage, mortgage term and stock/bond allocation:

**Model 1 (baseline):**$1,000,000 portfolio, no mortgage, 80% Stocks, 20% Bonds.**Model 2:**$1,000,000 portfolio, no mortgage, 100% Stocks.**Model 3:**$1,200,000 portfolio, $200,000 mortgage, 30-year term, 3.875% interest. 100% Stocks.**Model 4:**$1,200,000 portfolio, $200,000 mortgage, 15-year term, 3.250% interest. 100% Stocks.**Model 5:**$1,200,000 portfolio, $200,000 mortgage, 30-year term, 3.875% interest. 80% Stocks, 20% Bonds.**Model 6:**$1,200,000 portfolio, $200,000 mortgage, 15-year term, 3.250% interest. 80% Stocks, 20% Bonds.**Model 7:**$1,200,000 portfolio, $200,000 mortgage, 30-year term, 3.875% interest. 67% Stocks, 33% Bonds. Why 2/3 Stocks and 1/3 bonds? That’s because $800,000 in stocks and $400,000 in bonds netted with a $200,000 mortgage brings us exactly back to the 80/20portfolio allocation in the baseline!**Model 8:**$1,200,000 portfolio, $200,000 mortgage, 15-year term, 3.250% interest. 67% Stocks, 33% Bonds.

### Results

To warm up, let’s start with a simple time series plot of the safe withdrawal rates of the 8 different models. All numbers are percentages of the initial Net Worth to account for the fact the models with a mortgage obviously have a larger portfolio value! I plot this just for the record because you can’t really make out the relative performance of the different rules. But notice how all 8 models drop below the ostensibly safe 4% mark for quite a few unlucky retirement cohorts.

Let’s see when the models do better than the baseline. In the plot below I display the difference between models 2-4 (Model 2 = 100% Stocks, no mortgage, Model 3 = 100% Stocks, 30Y mortgage, Model 4 = 100% Stocks, 15Y mortgage) and the baseline SWR. Notice how most of the time, models 2-4 do better than the baseline (lines above the zero line). Substantially better, in fact, by about a full percentage point on average. So, on average you can withdraw $10,000 more when you leverage your 100% equity portfolio with a mortgage. Nice! Unfortunately, the outperformance comes at a high price. You underperform when it hurts the most, namely, when the Safe Withdrawal Rate is low: During the Great Depression, the late 1960s and around the dot-com bubble.

Below is the same chart for the other four Models. Models 5 and 6 (80/20 portfolio with a 30Y and 15Y mortgage, respectively) have qualitatively the same features as models 3 and 4: outperform substantially most of the time thanks to leverage, but do worse when it hurts the most, i.e., when the SWRs are low during the major market events. Models 7 and 8 have a completely different pattern. They would have helped slightly during the Great Depression and dot-com bubble when bonds offered great diversification benefits. But that’s not thanks to the mortgage. It’s entirely due to the higher bond share. For example, a 67/33 Stock/Bond portfolio without a mortgage would have handily outperformed Models 7 an 8. Also notice that in the 1960s, Models 7 and 8 would have underperformed the baseline because bond returns suffered so badly during the 1970s, due to the inflation surge.

And finally, here’s a summary table of the safe withdrawal rates in the 8 different models. Same story again: Model 1 offers the best failsafe withdrawal rate but the mean/median/max look very mediocre compared to the others. Likewise, the models with the highest mean and median (Models 3,4) have atrocious failsafe withdrawal rates in the low-2%!

### Results conditional on an elevated CAPE Ratio

The unconditional distribution of safe withdrawal rates is interesting but it obviously ignores the fact that in light of today’s elevated CAPE Ratio equity returns could be slightly below average going forward. Let’s look at the safe withdrawal amounts when targeting different failure probabilities conditional on the CAPE between 20 and 30, see table below. The way to read this table: For example Model 1 (80/20 portfolio, no mortgage), an initial withdrawal amount of $33,262 (subsequently adjusted for CPI) would have been the failsafe. With $34,791 you would have run out of money 5% of the time, with $44,658 you would have run out of money half the time, etc.

According to this table, no mortgage and an 80/20 portfolio would have done the best if targeting a failsafe withdrawal amount and all other failure probabilities up to 10%. If you want to maximize the withdrawal amount to target 25% and 50% failure rates (which seems way too risky for my taste), then the 100% equity portfolio with the mortgage become the most attractive. But Models 3 and 4 with the most leverage also have the worst failsafe withdrawal amounts.

The lesson from this exercise: If you are risk-averse and like to hedge out the tail risk it’s best to have no mortgage and a moderate bond allocation. If you are a risk-taker (degenerate gambler?) then you might as well go all-in: Have a mortgage and 100% equities in the portfolio as well. Having both a mortgage and a bond portfolio doesn’t make any sense. And there is a reason for it: the bond return is likely inferior to the mortgage yield. This is beautifully consistent with an old vintage post from last year. If you want to use the mortgage as leverage to juice up your equity returns, that’s fine. It’s a matter of risk tolerance. But make sure you don’t use the mortgage to buy low-yielding bonds; leverage only works when your asset returns more than what you pay for your liabilities!!!

### Exceptions to the no-mortgage recommendation

Our case is special and probably not applicable to everybody in the FIRE crowd. I can think of at least a few scenarios where folks might want to keep their mortgage. For example, you might have a hard time paying down the mortgage all at once because you’d realize too much in capital gains. This could put you into the 15% tax bracket for capital gains and that additional tax burden would negate the mortgage paydown idea.

Another scenario: some early retirees simply don’t have enough in after-tax savings. This is a frequent issue in some of the case studies I have seen where people have saved a huge pile in tax-deferred accounts but have only very little in after-tax accounts. If your small taxable accounts barely last until age 59.5 (to avoid tapping tax-deferred accounts before the cutoff age) you probably can’t afford to pay off the mortgage.

Finally, I can see how at some point down the road interest rates could be much higher than today. If you retire in 5 years and still have 20 years left on your 3.25% fixed rate mortgage but bond interest rates are now 3.5 or 4%, then by all means, hold on to that mortgage. Now the mortgage vs. bond leverage works beautifully!

### Conclusion

The decision whether or not to keep a mortgage in retirement is not trivial. The comparison “expected equity return > mortgage rate” is just too simplistic. The median/average retiree will clearly benefit from the leverage but also remember that the median retiree never runs out of money either. For us, not having a mortgage might hurt us in the long-run but only in the scenarios where we’d become fabulously rich anyway. Who cares if we end up with $6 million instead of $7 million when we’re in our 80s? We are willing to pay that cost for the hedge against Sequence of Return Risk, i.e., the very unpleasant tail risk of running out of money after 30 or 40 years due to poor portfolio returns in the first few years after retirement.

Just to offer another possibility….

You can borrow money from Interactive Brokers at 2.36% — quite a bit below the 4% you describe.

The loan isn’t self-amortising, so if you want to cut expenses and only pay $100 towards it, that’s fine. You’re not going to default and have a loan officer calling you up.

There are downsides with this approach — the rate is floating and not fixed. In theory it could go up to 15% or higher, though that’s unlikely to happen very quickly and you’d likely have time to decide whether you wanted to do something about it.

The loan isn’t based on the house but your portfolio. Since portfolios can drop, you have to be comfortable that your portfolio is large enough that you won’t get a margin call at an inconvenient time.

Great point! I definitely plan to use the credit line at IB as an “emergency fund” with an extremely low interest rate. Not sure if I would have the guts to keep this running for years to last through an entire recession. Credit lines in the IB account can be cut at very short notice. Cheers!

Regarding the long run, that old adage of why keep on playing when you have already won the game is relevant here. Don’t need to go for that 7th goal when 6-0 up with 20 minutes left to play. Slowing the game down, enjoying keeping hold of the ball, playing some solid defense and avoiding injury is what is needed.

I can’t even imagine carrying a mortgage during that first decade on top of the other factors that are driving SoR risk. A sizeable market drop and still paying the mortgage would suck big time, based on our level of risk tolerance.

“If you are risk-averse and like to hedge out the tail risk it’s best to have no mortgage and a moderate bond allocation.”. Yep, that’s us. A nice summary of our approach/situation.

Will be interested to see how other commenters approach this and if they are carrying a mortgage, how they are handling the risk.

Thanks for sharing, Dr.PIE! Love the soccer/football analogy (too bad the U.S. boys didn’t qualify for 2018, argh). Yes, agree, it’s much easier to hunker down and adjust spending after a market drop without the housing payment. But it’s not easy to be mortgage-free when retiring. One the one hand I tell people to keep the mortgage for as long as possible during the accumulation phase (sequence of return risk), but how can you then be mortgage-free when you retire? It’s hard to pay down the remaining mortgage in the last year before retirement. Selling the home and moving to a cheaper place and pay cash might be the solution. But not everybody wants to do that. Early retirement is a tough problem!

This is the exact thing I’ve been contemplating lately. I have a mortgage on my house and it’s paying for itself right now with AirBnB so it makes sense to carry the mortgage and not pay down extra, but right now I’m only 26 and single and enjoying work. Eventually I’ll want to be living with a partner and kids, so should I keep my mortgage as is, pay off a chunk and refinance to a lower payment, or focus on paying off the whole thing before quitting, or just move since there’s already 50% equity? I could buy one heck of a house anywhere else. These are all really good first-world problems to have, so I’m grateful for that.

True! For young folks just starting out, it’s best to invest as much as you can, not pay the mortgage. I like the idea of geographic aribtrage: Keep a mortgage as large as possible on the house you have during the working years. Then sell that place and probably have enough equity to pay for cash in a cheaper area.

Hi. This discussion raises a question that I hope you (and perhaps other readers) don’t mind commenting on. I’m weighing 2 approaches to investment/withdrawal strategies: total return and asset liability matching. For total return, which I believe is your approach, it makes sense to spend from equities when they are high, however you determine that (CAPE ratio or whatever). Darrow Kirkpatrick’s blog post of Dec 28, 2015 (The Best Retirement Withdrawal Strategies) addresses this, as do many of your posts in this series. The asset liability matching approach removes any sequence of return risk. You have bond ladders for the first 6-7 years of retirement expenses, and replenish the bonds as they come due by selling equities, ideally waiting until equities recover if there’s a market slump. My question: do you think it makes sense to spend from a bond ladder even if equities are high? I’m attracted to an approach that eliminates or greatly reduces exposure to SOR risk, but am having a hard time accepting spending from bonds regardless of what’s happening with the CAPE ratio, etc. Is it relevant when you sell equities to buy the bond ladder? Maybe if you sell equities when the market is high you’ve at least taken advantage of good equity returns then? Any clarification of the issue and insight on this would be most appreciated!

Great point! Some of the glidepath intuition is exactly asset-liability matching: You live off your bond portfolio for a few years and then roll to a total return approach in the long-term. If you are uncomfortable with selling bonds while equities are so expensive why not use the “active glidepath” methodology I proposed in Parts 19/20: As long as equities are at (or close to) their peak, keep the asset allocation constant (then you’d automatically sell out of equities), but when equities go down you step up the glidepath. Best of both worlds.

The Holy Grail, of course, would be a dynamic rule that determines both the withdrawal amount and stock/bond share based on stock/bond valuation metrics. I will wrote about that in the future!!!

This sounds like reducing your productive capital by the amount of your bond ladder to me. It also sounds like market timing. How do you know when to replenish the bonds? What if we are in a period like the late 90s where stocks seemed overvalued but went up several more years? What if you deplete your bond ladder at the early signs of a downturn but it continues longer than expected and then you are forced to draw down equities at the rock-bottom prices anyway? At least if you were fully invested, you would have a better chance of growing your portfolio big enough to take the hit!

Good questions. I wonder if this post (link below) and the comments following might address them. I’m still pondering all this.

http://www.theretirementmanifesto.com/how-to-build-a-retirement-paycheck/

Thanks ERN for another great safe withdrawal rate post. I really appreciate this series. As far as I’m concerned, you’ve set a new standard for early retirement planning!

A few questions. Have you ever considered using a standby home equity line of credit to reduce sequence of return risk? Could a home equity line be drawn upon during market corrections to avoid selling equities at times of market stress, and thereby reduce sequence of return risk? Also, what do you think about a reverse mortgage? Could a reverse mortgage be considered as a “backup” plan down the road for early retirees who find themselves to be “unlucky” and negatively impacted by sequence of return risk?

The credit line idea is definitely an option. But right now, interest rates are already above 4%. And that wouldn’t be tax-deductible for us since we use the standard deduction. But then again, if it prevents you from selling equities at the bottom, it’s worthwhile!

A reverse mortgage is a bad option. You’re eligible only after age 62. By age 62, I hope that my wife and I are no longer worried about sequence risk. Besides, the fees and interest rates are horrendous.

Sequence of returns risk is one of the reasons we will be getting a home equity loan. We don’t plan to touch it in retirement but paying interest on a small loan for a few months to get you through a tough time seems a lot better than selling equity stocks at a loss. Yes, I know it depends on the numbers. An equity loan is like a warm fuzzy blanket that can be called upon in an emergency – and that comfort is worth something.

Big ERN. I too feel like SteveK…that the home equity line seems to be a good alternative to selling equities in a down market. But like all things related to safe withdrawal rates, the “devil is in the details”. Would you consider a future post on this topic?

I think that’s a good idea: what’s the success of a 100% equity portfolio when you use loans during drawdowns. Hmmm, have to think what’s the best way to do that.

Thanks for the suggestion!

A HELOC as an emergency fund, that is definitely something I would consider! If it’s short-term. Of course, the IB account is even cheaper…

Yes. I’d agree. My instincts tell me that the use of debt could be helpful over a relatively short downturn in equity prices. On the other hand, a protracted bad sequence of returns, like the decade beginning in 1966, most likely will still be a problem–the need for multiple draws on the line of credit, as well as compounding of the interest, is likely too great for a debt strategy to be helpful in reducing sequence risk. Then again, I’ve been surprised by many aspects of your work so far. If you do take on this type of analysis, I’m confident the numbers will tell all!

The Interactive Brokers margin debt line sure looks tempting! Lower is better! But, I’d personally be concerned about the potential for a capital call during a 2008 type market.

I think there’s almost no chance of a capital call. I mean, the scenario we are talking about is where you have your entire portfolio with IB and start out with $0 margin. If you withdraw and entire year of expenses at once (which is pretty unlikely), you’d have around 3-4% loan-to-value. The market would have to drop over 90% to even get close to a capital call scenario.

Even if the bear market extends for years and you continue to pull from the margin — after 3 years you would have withdrawn 9-10% (of your initial portfolio value). Even after a 50% drop, you’d be at 20% LTV, which is very very far from capital call territory.

BTW, 1966 didn’t have a “protracted sequence of bad returns”. The 1966 bear market started in February and a portfolio would have completely recovered by May 1967 — only 16 months later.

There was another bear market in 1969 — you’re right, we’d need to run the numbers to see whether the 2 years of “good times” in between were enough to make up for using margin.

1966 was the beginning of a bad sequence of return episode that ended in 1982. So, it’s not 16 months but 16 years. Most people don’t realize that one of the most unattractive retirement dates didn’t even have a big bear market right after that. It took 16 years to unravel!

Big ERN, I’m going to tell you something I bet no one has ever told you before:

You made this too complicated 🙂

On one hand: Ignoring possible tax benefits, if you have the “mortgage payoff” funds invested, simply figure out what are the odds that it will pay off the mortgage with money to spare in the end.That’s it. No charts that I can’t understand :), no confusion. Example: $100k mortgage at 4% is $478/mo. What are the odds your $100k invested would stay solvent until the end? That’d require a 5.7% W/D rate over 30 years. From a numbers standpoint, you retain access to the cash “just in case” and will likely end up with extra money in the end.

On the other hand:

-Paying off you debt feels good. Really good. No one could fault that choice.

-If you owned the house free and clear and could take out the mortgage to invest the money would you? Probably not, and practically no one does (except during the mid 2000s, ouch)

-Most telling – do you know of anyone that regretted paying off their mortgage? I don’t. Not one.

I’m on the cusp of being in the exact same position as you. I’ve thought, processed, and re-processed it. I STILL don’t know what I’ll do. But I appreciate you introducing the idea of Sequence of Returns in terms of paying down the mortgage. That I’ve never though of before, despite having a genius financial mind. Now if you’ll excuse me, I have some charts up above I need to dumbly stare at some more…

What, I made this too complicated? I haven’t heard that complaint for, uhm, probably at least 37 minutes now. 🙂

But let me return the favor to you: Your proposed calculation is a) just as complicated as mine and b) less informative.

I would still have to calculate the distribution of final values of that $100k portfolio after 30 years of withdrawals. Same calculation, using the same simulation framework. But what does it mean that there is a, say, 7% chance I’m underwater after 30 years? Will the bank forgive me the last 3 years of mortgage payments if I run out of money after 27 years? I guess not. Also, notice that the event of running out of money in the mortgage fund is highly statistically dependent with the SWR in my “main” investment account. So, exactly when I have to supplement the underwater mortgage payoff fund my main investment fund is close to being depleted, too. I’d like to know what’s the impact on my overall SWR. Both for the failsafe SWR and targeting other failure probabilities. Your calculation, for example, cannot tell me what are the odds of failure of a 3.5% WR with/without a mortgage. But that’s what I’m after! 🙂

Regarding the feel-good aspect: I would like to find out whether the feel-good solution is also the mathematically sound solution. There are examples where the two don’t align. See my post here:

Good Advice vs. Feel-Good Advice

When the two don’t align then it’s our duty to point out behavioral biases and make people feel better making the right decision. But I’m happy that in this particular case, being mortgage-free in retirement feels good and also seems like a prudent thing to do! 🙂

Agree with you on this one. A mortgage just makes it to hard to respond to market surprises.

Awesome! Glad we agree on this one!!! Cheers!

Amazing timing, Big ERN. I started a post last night titled “Why We’re Taking On Debt To Move From Good To Great”. We’ve been 100% Debt Free for 555 days, but decided to take on a mortgage when we moved to the “Great” cabin. You’ll have to wait for my article (after FinCon, most likely) to see our logic, but it’s essentially a pension deferral, low-cost optionality play. We’ll pay off the mortgage within 2 years, worst case. Gaining short-term liquidity optionality is worth the interest expense, in our view. We’ll also have the proceeds from the sale of our “Good” cabin available to pay off the mortgage at any time. Fascinating thought process. But, since I don’t have the ability to run your fantastical models, it’s possible that I’m just a hack! 🙂

Thanks Fritz! As I said in the post, there is no universally correct answer. There must be more cases where the mortgage makes sense in retirement. Looking forward to your post in a few weeks!

What is the cutoff rate for the recommendation to pay off the mortgage? My mortgage rate is 2.75%. Is it still a good idea to pay it off early?

Well, question back to you: Are you retired already? If, as a FIRE

Hopeful, you are still saving for FIRE, you want to keep the mortgage and keep close to 100% in equities/real estate, etc.If you’re retired already: if you have a 100% equity portfolio then a 2.75% isn’t so bad. But if you have bonds in your portfolio yielding less than 2.75% you’re losing money due to negative carry.

I plan to retire very soon, I have 10 years left on a 15 year mortgage, and I’m 70/30 stocks/bonds. The current yield on BND is 2.41%, but this is expected to rise over the next few years. Mathematically (and in terms of probability) I think it makes sense to keep the mortgage. However, SRR is lower with it paid off. Are there any calculations/charts/graphs that can sway this decision either way?

It’s more complicated than that. If bond yields were to rise to above your mortgage rate, sure, you’d have positive carry from that point forward. But getting there your bond portfolio will lose value due to the duration effect (bond yields up, bond price down). BND has a duration of 6.1, so if the yield were to rise by 0.34% to the mortgage rate you’d lose 2.07% in value. In that sense, it doesn’t make sense mathematically to keep the mortgage.

Also: do you keep the bonds in a tax-deferred or taxable account?

They are in taxable.

Whoah, that’s not right! Currently, you’re paying taxes on interest. In retirement, you might keep the bond interest income inside the “0% bracket” but this would still crowd out Roth conversions. I would check for the tax lots with losses or the smallest gains, sell those and pay off the mortgage. You are losing money on the negative carry!

This kind of “bond math” often doesn’t translate to the real world, making its use in guiding investments problematic.

Vanguard’s Long-Term Treasury fund has a duration of 16 years. There have been 2 rate hikes in 2017 so far for a total of 0.5%. So how much did Long-Term Treasuries lose this year? -8%, right?

Actually they are up by 7.11% so far. Being wrong by over 15% is a pretty large margin of error.

The long bond rate has actually declined:

https://finance.yahoo.com/quote/%5ETYX?p=%5ETYX

From above 3.06% on Dec 30 to now 2.8%. The bond math most definitely applies. But as you showed it only applies when using the “right” bond interest rate. The duration is impacted by the bond’s

owninterest rate, not the short-term Fed Funds Rate.More on the long bond: If in 9.5 months the yield goes from 3.06% to 2.80%, then you’d expect an approximate bond total return of 9.5/12×3.06% + 16x(3.06%-2.80%)=6.58%. This is just an approximation because there’s also another factor from the rolldown, which might explain the difference between your +7.11% and my +6.58%. So, as you see, bond math actually works quite beautifully!

I feel like the analysis here is a little too extreme (I hate resorting to feelings on such a math-centric blog, and I double-hate thinking this is incomplete, as almost all my other musings on FIRE have been covered here with much more rigor than I’ve been able to muster, so I’m probably getting something wrong), and perhaps also too simple (eek).

Very few people are on month 0 of their 360 / 180 month mortgages. I know that SoR overwhelmingly matters up front, but does the ‘tail’ end of the mortgage change things usefully (i.e., if I’m 5 years in, 10 years in, etc)?

I also wonder if this changes as the mortgage payment drops as a proportion of the total withdraw. In my case, our total annual mortgage spend is 25.6k, and we’ve got a portfolio of ~2.25m. A ~2% yield (dividends only) on that will produce 45k per year, so there’s a healthy margin before the mortgage forces me to actually sell assets at a loss. Does this matter for SoR? I know dividends aren’t guaranteed and can drop, but I’m curious if there’s a sweet spot where holding a mortgage isn’t dreadful or even dangerous with regard to SoR.

You mentioned having more bonds during SRR, then having less in bonds thereafter.

I’m confused. I thought the reason SRR was 10 yrs was because it took roughly 10 yrs to build up enough cushion to weather any storm thereafter. If you have more bonds during this period then aren’t you prolonging the SRR period because bonds won’t earn as much therefore prolonging the timetable to get to your safety cushion amount?

If it’s not the amount of cushion in your portfolio that determines the end of the SRR period then what is? Thanks! This question has been plaguing me for a while.

There are no strict timelines. Ideally, you have the highest bond share exactly at retirement, then walk that down. It’s an insurance policy that will underperform when equities keep going up early in retirement (but then you don’t care) but helps you a lot if equities go down. I posted a simple example in the SWR series part 20 that explains some of the mechanics: https://earlyretirementnow.com/2017/09/20/the-ultimate-guide-to-safe-withdrawal-rates-part-20-more-thoughts-on-equity-glidepaths/

How should the principal paydown portion of mortgage payment factor into the withdrawal rate? It’s not a true expense like living expenses or interest expense, so should the full mortgage payment be included within the retirees yearly withdrawal total?

I will ask a related follow up question as well. Consider a retiree portfolio of half rental properties and half stocks. An easy way to calculate the SWR is subtract net rental income from living expenses, and the remainder of expenses is divided by stock portfolio. However, what if there is a mortgage on the rental property, thereby reducing the net rental income, but the principal paydown (let alone real estate appreciation) is not accounted for within the calculation. Any suggestion? Perhaps add back the principal portion to the net rental income?

For that, too, I’d model the mortgage as a supplemental cash flow (negative in that case).

I would consider the mortgage a supplemental and temporary spending component (see the Google Sheet I use in Part 7). It increases necessary withdrawals early on but then drops to zero.