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Mortgage and Cash Holdings in Investment Portfolio

Lupo Lupus

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My first post!


A question that should apply to many investors, but which I have not seen discussed, is the following: How do you think about holding cash in your portfolio if you have at the same time a mortgage outstanding?


I have been thinking about this for a while but have not found an ultimate answer yet.


Here is my thinking so far.


The knee-jerk answer is of course to use the cash to pay-down the mortgage, as the mortgage rate will surely be higher than the interest rate on cash. But I am not convinced:


I have two motivations for holding cash in my portfolio


1. To mitigate risk. Cash (or high quality fixed income) lowers drawdowns in portfolio (think of Great Depression style scenario)

2. Option value of cash. Cash allows me to take advantage of crashes/fire-sales. Also I can benefit from rebalancing benefits.


Motivation 1 indeed suggests to use the cash to pay down the mortgage as drawdown in my wealth does not depend on whether cash is held in my investment portfolio or in my house investment. Motivation 2 however speaks against using it to pay down on the mortgage as it is not easy to reverse the downpayment of the mortgage, at least in my jurisdiction (that is, to take money out of the mortgage when a crash occurs to invest in stocks). So my preliminary conclusion would be that cash should only be held if one believes in a significant option value of it.


Any thoughts on this?



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This has been discussed multiple times in the past and even recently somewhat. (One related thread: http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/cash-for-real-estate-vs-mortgage-vs-margin/ ). I don't think there has been a single definitive thread on this.


The answer is of course "depends". Depends on your age, on your employment status, salary, the size of the mortgage, the size of the cash (compared to mortgage and salary and investment portfolio), what kind of investor you are, etc.


The somewhat "situation independent" answer is what you thought yourself: cash is option, once paid into mortgage it is not easily obtainable again, so don't pay off especially in the cheap mortgage environment we are in. Like Buffett said in 2010 (?) 30 year mortgage is the best investment available. And I'll say that 30 year mortgage is an asset and not a liability.

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Basically cash in a portfolio just gives you optionality and sooner or later a crash will come.


As for paying down mortgage it's basically the same as buying a AAA bond. Whether the do it or not it depends on where you are and your equity/fixed income allocation. Regarding location basically in the US is not that good because mortgage interest is tax deductible and refinancing is costlier and cumbersome. For people in Canada where I am however paydown is a better deal. Because mortgege interest is not deductible the coupon on my AAA paydown bond is r=i/(1-t) where i is mortgage interest and t is the marginal tax rate making it a much better deal than a gov't bond. Also refinancing is really easy (takes about 2 days) and very cheap compared to the US. So if I need the cash back I refinance and get it back pretty quick.

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I have a Heloc on my house, that is 80% LTV and prime+0.5% rate. As I paid down principal, the Heloc availability increased, so I wasn't losing cash availability. I would absolutely draw it down in a crisis to invest, so I'm keeping the option value.

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Regarding location basically in the US is not that good because mortgage interest is tax deductible and refinancing is costlier and cumbersome.


In my country (the Netherlands) there is an interesting quirk regarding mortgage deductibility. Interest is tax deductible but banks have come up with a way to keep full deductibility when paying down mortgage. Basically, they split an annuity mortgage in an interest rate only mortgage and a savings account. The interest rate only part is never paid down and hence full tax deductibility retained.



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