I think you’re right, Rand, to a large degree, but I think the factor you’re not considering is that Joe and Jane Average are not mathematically or economically sophisticated. I think when you get to higher levels of economics, investing vs. saving vs. buying a house with cash is a complicated equation, but back on the levels where most people are living, paying interest on debts is bad - it’s giving your hard-earned money to the banks for virtually nothing.
While I agree that one must look at risk rationally, I don’t agree that the situation is symmetrical. Take too much risk and you may end up destitute and/or homeless. Take too little, and you may never be wealthy.
“Never being wealthy” is, for most people, a better fate than “destitute”. It all depends on your goals and tolerances.
Cat–and that’s why I’m discussing these issues–to help those folks raise their level of thinking on these issues.
M–well, the principle applies in the middle of those extremes as well. For example, a 22 year old with their 401(k) all in a money market account or muni bonds is taking too little risk IMHO. The result will be less money for retirement.
Malthus, also, if you don’t have $10, then you don’t have $10. It doesn’t matter whether you had $10 and lost it or didn’t take an opportunity to earn $10, the result is the same.
I’m still parking all my RRSPs (401ks) in money markets until the global economies settle down. 
The situation is more like ‘you have $10 you have earned, and you can live on $9, including debt payments. Invest the $10 in the hopes of eventually making $20 (which will allow you to easily pay your debt etc.), or pay down your debt?’
The problem here is that, if your risk doesn’t pay off, you could be left being unable to meet your obligations.
I definitely agree. As I said, all depends on goals and tolerances.
However, it is a rare and lucky 22 year old indeed who is faced with the “buy my house for cash?” dilemma. 
What I’m saying is that for most people, being sensitive to investment risk is not irrational even though in a games-theory sense it may not be the optimum strategy to maximize potential for wealth - because their goal is not maximizing their chance for wealth, it is ensuring that they maximize wealth only insofar as it does not expose them to too great a risk of losing their home.
Huh? “The situation” is not necessarily anything like that at all. I was simply making a point about money you don’t make being the same thing as money you lose, which is responsive to one of your posts but doesn’t really have anything to do with the general topic here.
I find it odd that you keep looking at extremes. We have no reason to believe that the OP is talking about spending his bottom dollar on a house–dude could be loaded for all we know.
I agree with you that risking homelessness for a chance at getting filthy rich is a bad idea, but not all investment decisions are like that. They are much more often like the 22 year old with the 401(k)–he’ll either have $x or $y come retirement time, with no chance of being homeless or fabulously wealthy no matter how he invests it.
But that’s the issue. We are not talking about money in the abstract sense, but about the “invest in mortgage vs. invest in equities” type decision.
The issue which keeps cropping up seems to be that the natural tendency of many middle-aged, middle-class type folks to prioritize getting rid of the mortgage over earning with equities or other investments is irrational or financially illiterate. I’m pointing out why this is not necessarily so - you have to add risk tolerance to the decision-making equation.
I knew if I slogged through the thread someone would say this for me, and better than I could.
For basic necessities: employment, housing, utilities, etc. I have zero risk tolerance. I’m just too much of an Eeyore by nature. If/when I get the cash, the mortgage is on my short list of targeted debts.
My pucker factor for retirement investing is another thing entirely because there’s not much chance of me turning 65 tomorrow when I was really counting on it taking another 20-odd years. That’s where I think “aggressive” investing makes sense. Perhaps I AM financially illiterate, or at least unwise. But: “Let him remain happy in his ignorance who is happy in his ignorance.” Guess that’s not really an appropriate approach for The Straight Dope, is it?
Malthus, I think we agree entirely we’re just emphasizing different things. I’ve been responding to people who think “debt is bad” on reflex, so I’ve been saying that debt is not necessarily bad. You are correct that it’s not necessarily good either and it’s up to each individual’s risk tolerance. I just think that the extremely risk intolerant should understand the price for their beliefs.
The situation here is how to invest a given pot of money. The OP can put it in a single, non-liquid investment returning around 4% or in a diversified basket of investments, probably a lot more liquid, returning likely much more than 4%. Unless your investment strategy is quite stupid, you will not lose all your money in any conceivable market decline. if you lose your job, you would draw down some of the money to live on and to pay your mortgage. If you lost your job and put it all in your house, where is the property tax payment coming from?
Taking a mortgage and then blowing the money on hookers and blow is indeed a bad thing. Increasing debt to finance consumption through home equity loans is a bad thing. But what we are talking about here are two investment directions, one of which has major psychological baggage which seems to make it look better than it is. This is exactly the kind of thing my daughter is doing her PhD research on, and I love it.
Fair enough. Neither is inherently good or bad, it is just a question of matching actions with goals.
Ah, but studies of loss aversion show that money you lose is considered as much worse than not making an equivalent amount, which I think is what we are seeing here.
Risk tolerance is a part of any investing equation. The reason mortgage rates are so low in normal times is that mortgages are very safe investments for banks. If someone is so risk averse that anything with a higher risk than a mortgage is unacceptable, fine. It returns more than a T-bill at least, though it is still riskier. However you are giving up money, and there are options (and not just equities) which might offer an acceptable risk and a greater return.
If you are truly risk averse, put it in T-bills. There are situations where you cannot get money out of your house, but that is not going to happen in the case of a T-bill.
The issue is not that some investmejnts earn more than 4%, it is that most of those are equities (bonds and GICs are not earning more than 4% these days).
With equities, historically returns are greater than 4%, but that greater return masks some pretty severe downturns - like the one we just had. Unfortunately, downturns in the stock market are often also associated with lowering of incomes or loss of jobs.
Most folks could scrape by paying property taxes if they were out of work for a while, but paying mortgage on top would be more difficult - if they just took a bath in the market, because it just collapsed, they may end up having to liquidate their investments at the bottom of the market, to pay their mortgage, right when they ought to be buying equities - which would definitely be sub-optimal as a strategy.
Or as you put it:
How on earth could that be a good financial idea in a stock market crash? “Buy high, sell low” is never a great idea, is it?
Without knowing what goals the OP has, you can’t state with any certainty that one of the actions “looks better than it is”.
This is a case where the dumb response of the masses is based on a certain amount of financial reality - most middle-aged, middle-class-type folks have some reason to be wary of the financial risks of equities, since chances are they will experience in their lives a market crash or two.
All other things being equal, it is a dumb idea. But “all other things being equal” is a pretty big caveat.
My husband had trouble accepting this. I won the argument when I pointed out his parents are millionaires (on only public school teachers’ salaries, even), and the first step in their path was to pay off their mortgage. This is a concept echoed in books like Millionaire Next Door – there appears to be something about being debt-free that sets humans on the mindset to build wealth. You can chalk it to any number of factors.
For example, I haven’t heard of anyone panic-pulling equity out of a home during a downturn, but it’s well established that people will panic-pull out of the stock market during a crash. And, no cite, but I do believe that the “buy high sell low” impulse is much reduced with the stability that having no mortgage brings.
If you’re Data, then it’s a dumb idea. But, IMO, it’s much safer to bet that you’re human and that at some point you’ll probably do dumb things with the stock money or spend it.
There’s also the possibility that the assumption here might not be exactly true. I’ve never gotten a straight answer as to why banks are lending out money at 4-5% for 30 years rather than investing it in the market.
See earlier in the thread for an answer from me on this.
There is something to that. Its the reason that Dave Ramsey’s snowball method works really well for getting rid of debt - even if the math says “highest interest debt first.”
Money (like food, like sex) is really tied into us emotionally. When dealing with those types of things, its a good idea to understand yourself and make a decision that is going to work emotionally as well as rationally.
Well, some people pay hookers to kick them in the balls. Doesn’t mean you’d recommend that to someone looking for a good time.
The compulsion to repay low-interest debt instead of investing is (IMHO and for many but not all people) something that should be resisted in favor of more profitable alternatives.
Also, Dave Ramsey is an idiot. He doesn’t educate people, he gives them mantras and easy “solutions.” It irked me when his show was on a business radio station–it belongs on the Christian station (he very much loves him some Jaysus).