Gil Baumgarten, financial advisor and president of Houston-based Segment Wealth Management, says a recurring theme with his clients is whether they should use excess cash to pay off a mortgage, or invest their funds in stocks or bonds.
“Assuming the home has proper equity, we most often advocate paying off a mortgage rather than having a portfolio chock full of bonds,” says Baumgarten. “One of the many reasons for this is that the risk you know is better than the risk you don’t.”
Baumgarten explains that a bond is simply a debt instrument held by an investor which offers interest payments and a return of the original sum once paid off. The same is true of a mortgage. It is a debt instrument to the lender with payments along the way until paid off.
“Think of it this way, you could pay off your mortgage instead and essentially ‘buy’ your own bond. That results in interest savings of the coupon rate on the mortgage. Any higher earnings rate through investments in the marketplace would come with greater risk, and you incur advisory fees as well. If you have a choice of investing in the known risk of your own debt or becoming an owner of some other unknown entity’s debt, why would you take that risk?” says Baumgarten.
Another reason Baumgarten advocates paying off a mortgage before owning bonds is that he believes in a “save money to make money” strategy. Extra principal-only payments on a mortgage loan will reduce a homeowner’s overall cost to own their home so, depending on the mortgage interest rate, the cost savings would be comparable to the yield of a tax-free bond, he says.
Baumgarten says there are numerous arguments out there against this strategy, from liquidity to tax deductions, but what it comes down to is whether the benefit outweighs the risk.
“When deciding what to do with excess money – pay off mortgage or invest in bonds – investors should ask themselves if they would borrow money to purchase a bond,” says Baumgarten. “The answer should always be no.”
Segment Wealth Management is Houston’s seventh largest wealth manager with more than $1 million investment minimum according to the February 2017 Houston Business Journal. Gil has been named by Barron’s magazine as one of the 50 best advisors in Texas and most recently as one of America’s top 1200 Financial Advisors, while the Financial Times has named him one of the 300 best advisors in America. Segment is located at 3040 Post Oak Blvd., Ste. 1725. For more information, please call 713.800.7150.
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