The average five-year performance of the Dow following an all-time high, since 1915, has been 31.7%. So I don’t know that all-time highs tell us that much.
As you say, there is no comparable period of interest rates. The last two relative lows were 1962 and 2002. Both would have been fine times to invest in index funds, as far as I can tell.
I would quibble with going back as far as 1915 and also with using 5 year periods (you were going with 15 years earlier). (Also, it’s unclear how the guy is calculating his averages - the arithmetic mean is an invalid method, but it’s frequently used anyway.)
Generally speaking, periods of low interest rates will be great times to invest in the market. Because while the eventual rise in interest rates will be a damper on values, the low rates will be the result of a weak economy and low stock prices, and the eventual rise will itself be the result of a strengthening of the economy and business activity, the positive aspects of which outweigh the rise itself. The issue at this time is that at this time the low rates are accompanying relatively high prices, which is unusual. As above, this means that in order for prices to rise there has to be enough upward pressure from an already-high starting point in order to overcome the interest rate headwinds. That’s a tough road, and not comparable to a period of low interest/low stock prices.
What is the reason to think that the 15-year is over 25% worse than the 5-year? Or that the result changes significantly if you start in 1930 or 1960 or wherever you like?
Genuine questions. It’s not obvious to me that that would be the case, just looking at the Dow over time, but I could be missing something.
Hmm. But isn’t the whole point that you don’t know that we’re in a period of low stock prices for the relevant definition of low? IOW, one meaning of “low” is relative to prior peaks. We are certainly not low by that definition. But another meaning of “low” in terms of the prices relative to the actual value (or expected future value) of the companies. Presumably (or not?) it is the latter definition that is relevant for your statement about the difficult of continuing a bull market when interest rates are expected to rise.
The first is about the duration of bull runs. Imagine a hypothetical scenario in which all bull runs last 10 years and the market quadruples in that time (doubling every five years) followed by bear markets lasting 5 years in which the market drops by 50%. In such a case, the market would start hitting new highs 5 years into the bull run, and at that point the next five years would feature all increases. One year out, the next five years would feature 4 rising years and 1 declining one, and so on. If you had a longer period, then you would include a more representative number of bull versus bear years.
The numbers above are all illustrative - the general idea is that new highs tend to be made during the course of bull runs, and you need a long enough period such that you capture the inevitable downturn.
Or, alternatively, you can use a shorter period, but then you need to measure from when the market first began hitting highs. Meaning, you don’t include the first highs - rather, you say “this bull market is now 7 years old (or whatever) - what happens on average in the next 5 years after the seventh year of a bull market?”
In theory, yes. But the “actual value” is only relative to other available investments. And other investments are driven by interest rates.
So suppose, for example, that such-and-such company would in “ordinary times” be worth trading at a12X multiple of projected earnings, based on risk. But that’s where the risk-free rates are 4%, and the slightly higher risk investments are 6% etc. But suppose the risk-free rate has been driven down to 2%, then the slightly higher risk investments are now going to yield only 4%, and now if you want more than that you need to take on more risk, which pushes equities higher and now the above company is suddenly trading at 16X projected earnings. (All numbers again are illustrative.)
In sum, by pushing down the interest rates for economic reasons, the Fed has “artificially” pushed down the yield - and thus inflated the value - of all sorts of other investments, which are competing for the same investment dollars. Which is fine as long as it lasts. But since no one thinks the Fed will continue this forever - and they say explicitly that they will not - the eventual removal of this prop will be a damper on future returns. Once interest rates rise, then the rates on competing investments will also have to rise, and this will push yields up and values down. (Again, not that they have to decline in absolute value - they could make more money than they’re making now, and rise even if the yield increases - but it’s a damper on their value, and biases expected returns to the downside.)
I would argue that you should also account for the current market valuations when performing this exercise. Right now Shiller’s PE10 is over 30, indicating that valuation levels that are well above their historic average. Historically, US equities have not performed over the subsequent 10 to 20 year periods when valuations were at such a high level:
How old is the OP? … or better, how many more years will the OP be working? …
I ask because if the OP is close to retirement, then they may want to avoid risk-of-default, with adequate retirement funds in hand, equities to any large degree would be counter-indicated … on the other hand if the OP still has plenty of working years left then maybe the higher risk/higher return investments are more suitable …
Paying off the mortgage isn’t low risk … real estate is the very definition of liquidity risk … if the OP ties up all his cash in the home, he my well be stuck living there for a long time watching all those 12% IBM bonds sell … ouch … however, by not paying “rent” we don’t have top-line income, but it might as well be for our bottom-line earnings … if the OP wants to live in his current home for a long time … maybe clearing the current mortgage is the safest way …
This all depends on how much longer the OP plans to work …
The strongest reasons to not pay down a mortgage would be if the person did not have an emergency fund (of some months to a year or so expenses), was not maxing out 401k and/or was not making max non-deductible IRA contribution (to ‘backdoor’ convert into a Roth-IRA every so often). Since you’re not in any of those categories, it tilts the answer toward paying it down compared to the general (‘it depends’) answer.
And it seems you might take the approach, if you end up not paying down the mortgage, of basing your investment in risky assets on what you think the market is going to do and when. That’s a mistake for the great majority of people. They should choose a risky asset allocation depending on their own circumstances and change it according to changes in their own circumstances, with as neutral as possible a view on what the market is going to do, since the fact is nobody knows that. Making allocation based on how you like market tends for most people to result in bailing out near the lows during downturns.
I’d say pay down the mortgage based on the limited info available about you.
As to returns in general, it’s fundamentally dubious to judge the expected return of the stock market independent of what ‘riskless’ (low risk) bond yields are. How likely is it the market really offers the free lunch of an expected return that’s the same when real (after inflation) treasury rates are 3%+ as when they are less then 1% (like now)? But that’s what you would be doing to by looking at ‘all of history’ (which actually tends to mean one country, the US, over at most 100 yrs or so) for when returns exceeded 4%. You’d want to look at when they exceeded the then prevailing mortgage rate. And using overlapping periods just confuses the issue with auto-correlation. Valid long term returns analysis looks at consecutive non overlapping periods. So there aren’t really that many independent 15 yr periods limited to the US before you go back far enough that it might have been too different a world.
Exactly, no job, no cash, a paid for house worth a third what you have in it if you could sell it, but you can’t, and nowhere to go. With the mortgage you can mail the keys to the bank and walk away letting them hold the bag.
That depends on jurisdiction. In some places, you mail the keys to the bank, you still owe the debt. They can realize on the security (that is, sell the house) and still come after you for the rest.
Yes, you can lose your house and end up on the street if you choose to invest rather than paying off your mortgage. Is this supposed to be an argument* in favor* of leveraging your assets by investing rather than paying down the mortgage?
We paid off our 30 year mortgage in 13 years and we feel it was a great decision. We didn’t get to deduct the mortgage interest (we haven’t been able to itemize for quite a few years) so that helped in the decision. I believe we saved about $80,000 in interest. And we now have all the money we were paying towards the house (we made the house payment + quite a bit each month) to invest as we want. Our savings is going up an amazing amount now that we have no debt at all.
Which would you rather have, a house you paid $200,000 for currently worth $70,000 and no cash, or no house and $200,000 cash?
Right. Although the further complication is that banks are limited going after going after certain assets like money in 401k’s even in US states where they have ‘recourse’. Which is the majority of states, but the states where most or all mortgages are written ‘non-recourse’ includes some of the biggest by population (like CA and TX).
Anyway I think the original point about the problem of paying down a mortgage then having insufficient liquidity is at least partly if not wholly addressed by OP’s statement there is an ‘emergency fund’. And like I said there not being one would be a good reason not to pay down a mortgage, unless/until one has been established. But once there are sufficient emergency reserves, and the question is investing further in stocks rather than paying down a mortgage, you shouldn’t be depending on selling stocks to raise cash in emergencies anyway.
Forgive my ignorance, but don’t you have to pay capital gains taxes on the money if you don’t plow it back into a new house? Or does the cost of the new house offset the capital gains even if you don’t use it that way?
Define “sufficient emergency fund”. Sure perhaps you have six months worth of living expenses socked away. But what if you’re out of work for two years or more?
Minus closing costs for a new loan.
Forgot to address this earlier. I’m not sure but I suspect that the market in the first half of the century was more prone to great swings than it is now. This due to the great boom in the 20s followed by depression in the 30s, followed by WW2 and then the great post-war economic expansion. The upshot of this is that you would expect longer and stronger bull markets (the Crash and Depression would cancel out some of this, but there weren’t highs being made at that time :))
I don’t see why there’s an issue with auto-correlation, and I think the correct way is to use overlapping periods.
I think not. Getting a low-risk return of 4% is hard to find right now. Putting your nest egg into a long-expanding stock market sounds… bad. Unless you’re willing to sit on it until the next economic downterm.
On the other hand, making accelerated payments might be a good middle way to capture that 4% return without locking up all your liquidity.
The first $250k of gains from a primary residence sale is exempt from capital gains tax ($500k for a married couple), since 1997.
Pay off the mortgage.