Another Mortgage Pivot

Every New Year's Day, Mrs. Done by Forty and I go to an uninspiring chain restaurant and plan out our upcoming year. We bring a little notebook, enjoy some some average-but-carb-heavy meal over bottomless sodas, and talk about everything. The trips we want to take. Babies we might want to make. Do we want more or fewer rental properties? Do we feel the same way about early retirement? What sort of fun stuff should we do if we do retire?

The Olive Garden, which is lovely, had been our usual spot for years. But it only took one meal with that dumb tablet on the table to ruin the place forever. Apparently I'm a luddite, since I don't think punching in my own order into an Amazon Fire is the best way to experience all the flavors of Tuscany.

So this year we went to Mimi's Cafe (the site of our very first date: I was also cheap way back then) to plan out all of 2018...in June of that year. And I'm just now writing about it in July.

Can we blame the baby?

Mimi's, unfortunately, was not as good as we remembered it being back in 2007. But we did get a good plan together. Here are the big takeaways:

• Now that we have Baby AF, we want to bump our emergency fund to $15k, up from $10k.
• We want to sell our last remaining rental property. Our plan calls for some money up front, to flip the property: roughly $15k. More on this in a future post.
• We'll split the profits from the sale, and our original down-payment, between a lump sum to make a principle-only payment mortgage ($40k), using the rest to set up a college fund for Baby AF (maybe $20k, depending on what the rental sells for).
• Oh, and we want to pay off the mortgage before declaring ourselves financially independent or pulling the trigger on early retirement.

The question I imagine some readers are asking is: why on earth would we want to pay down a 30 year fixed mortgage at 3.75%? 

Shouldn't we avoid opportunity costs, let the mortgage ride, and just invest the funds instead, earning way more than 3.75% on average over 30 years?

And while that was our original plan, the short answer to those questions is that we read Early Retirement Now's series on safe withdrawal rates. It should be required reading for anyone working towards FIRE.

And one of the eye-opening insights from 'Big ERN' is that a mortgage can really derail an early retirement, because it exacerbates Sequence of Return Risk: when you might average quite good returns over a long timeframe, but having losses in the very early years of a retirement dooms the portfolio's chances of success. A mortgage can increase this risk, because it forces early retirees to deal with a large, non-negotiable expense right at the start of their retirement.

Retirees might not want to sell stocks while they're down, but then there's the pesky fact that banks repossess your home if the mortgage isn't paid. The irony is that the mortgage expense goes away years down the line, after the Sequence of Return Risk has gone away, too.

How much impact can a mortgage have on your Safe Withdrawal Rates? Here's an explanatory chart from Big ERN:

Source: EarlyRetirementNow. Sustainable withdrawal amounts when targeting different failure probabilities.
Per $1,000,000 initial net worth, conditional on CAPE between 20 and 30. 1871-2015.

"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." [Source.]

Considering that our asset allocation is closest to the 80/20, that we also don't want to consider plans with failure rates of 25 or 50%, and that CAPE is now north of 30, we think entering retirement sans mortgage is the safe thing to do.

With all that said, here is our latest mortgage pay-down plan:

• Make one big payment to principle of $40k. Why did we choose this amount? It would make all of our future payments at least 50% towards principle, rather than interest. Sure, it's arbitrary, but we like the idea of our payments going mostly to principle. And since the Trump Tax Plan gutted the mortgage interest deduction by doubling the standard deduction, a big benefit of owning our new house and its big honking mortgage went away. Thanks a lot, Donnie.
• Going forward, half of our 'investment money' each year will be split evenly between paying down the mortgage and to funding our financial independence plans. The bottom line is that we'll put a lot less towards investments with this plan.
• However, we'll always be sure to max out any tax advantaged accounts we have. Currently that means a 401k and Employee Stock Purchase Plan for me, IRAs for both of us, and a family HSA. If Mrs. Done by Forty gets a full time job with benefits, we'd max out her 401k as well.

How quickly will this get the mortgage paid off? A whole lot depends on our job situation over the next five years. To be really conservative, let's assume Mrs. Done by Forty doesn't pivot to full time work, but somehow kept working part time as an RA/TA for five more years, really stretching out that PhD plan. (Not going to happen, but stick with me just for the sake of making a pretty chart.) We'd get the mortgage paid off in about five years. 

From calculator.net -- click image for bigness.

The catch is that, even if we throttled down our savings for financial independence to 50% of our current rate, we'd hit FI way before five years from now. (Note: the impending catastrophic market correction was not considered when making that statement.) So, we probably wouldn't actually need all five years to make that plan happen anyway if we hit our FI number somewhere along the way. 

But what if we put Baby AF in daycare, Mrs. Done by Forty got a full time job, and now could contribute all her take-home pay (after maxing out her 401k) to the mortgage payoff? Say, adding an additional $2,000 per month on top of the plan outlined above? Here's how that plan would play out, paying off the mortgage in a little over three years:

Of course, projections for these plans are really hard. We don't know when Mrs. Done by Forty will go back to work, but it's probably not any time all that soon. There's still her PhD to finish and we're really digging hanging at home with Baby AF. Let's say that's at least a year off.

And, hey, maybe the bull market will continue to run for a few more years. With some luck, stocks might do the heavy lifting for us, and we could sell some of our financial independence funds to pay off the mortgage in one fell swoop.

But in all likelihood, we really might not be done by forty. While it would be rough to miss the goal, especially so publicly, I think I'd be fine with that.

This isn't a race. We're not competing against anyone else, or the clock, either.

But this is a big, complicated plan with a very long retirement. There might be some real consequences if we get some of the major details wrong.

And there's a little freaking baby in the mix now. Nothing wrong with going a little slower, being a little more conservative, and making sure the plan is water tight for this little guy.

As always, thanks for reading.


*Photo is from Osbornb at Flickr Creative Commons.