From a purely expected return perspective it only makes sense to pay back debts vs investing if the credit spread in the debt is larger than the investment’s risk premium.
For secured debt (like a mortgage) held by someone with reasonable credit the equity risk premium is most likely larger than the credit spread.
The analysis becomes more complicated when you take into account an uncertain income stream to use against the debt. Paying off your mortgage is like buying insurance against the tail event that you lose your house because you can’t make your mortgage payments.
Insurance is generally a negative expected return activity. But the value is in reshaping the outcome distribution. Your average outcome is lower but you’ve flattened out the tail.
I’ll readily admit that my situation isn’t common. I almost have enough money in my TFSA alone to wipe out my mortgage. But I’ve easily gained several years worth of interest expense. And while I don’t expect that it’ll stay that way forever, a drop of more than 10 or 20% is… unlikely.
In fact, you’ve got me thinking that when my mortgage comes up for renewal in a couple years, I may opt to cash out some savings to wipe out the mortgage, and take another look at early retirement.
From a purely expected return perspective it only makes sense to pay back debts vs investing if the credit spread in the debt is larger than the investment’s risk premium.
For secured debt (like a mortgage) held by someone with reasonable credit the equity risk premium is most likely larger than the credit spread.
The analysis becomes more complicated when you take into account an uncertain income stream to use against the debt. Paying off your mortgage is like buying insurance against the tail event that you lose your house because you can’t make your mortgage payments.
Insurance is generally a negative expected return activity. But the value is in reshaping the outcome distribution. Your average outcome is lower but you’ve flattened out the tail.
I’ll readily admit that my situation isn’t common. I almost have enough money in my TFSA alone to wipe out my mortgage. But I’ve easily gained several years worth of interest expense. And while I don’t expect that it’ll stay that way forever, a drop of more than 10 or 20% is… unlikely.
In fact, you’ve got me thinking that when my mortgage comes up for renewal in a couple years, I may opt to cash out some savings to wipe out the mortgage, and take another look at early retirement.