If an individual were to borrow $300,000 with a 30-year fixed rate mortgage at 2.5% they would have a payment of $1,185.36/month. Assuming the $300,000 was invested in a brokerage account, a systematic withdrawal strategy could be established to make the payments directly from the account. If the individual instead were to pay cash, they could systematically invest the $1,185.36/month in a brokerage account.
Which approach would produce the better financial outcome over 30 years? To answer this question, let’s turn to the data from 1990-2019, which is the last 30 calendar years. We’ll assume the investment used is a globally diversified equity index from Dimensional Fund Advisors.
Finance with 30 yr mortgage: $1,185.36/monthly payment made from $300,000 fully invested brokerage account. Account value at the end of 2019: $3,556,328
Pay cash and invest the payment: Invest $1,185.36/month into the equity index every month from 1990-2019. Account value at the end of 2019: $2,640,176
The last 30 years are one investment path traveled that is likely to be different over the next 30 years. In order to estimate different potential outcomes over the next 30 years, we can use Monte Carlo simulation. This technique takes the monthly returns from the 1990-2019 data set but reorders them to create 10,000 different simulations of potential 30-year outcomes. To illustrate the concept, imagine each monthly return is a ball in a bucket. You draw out a ball and write down the number. You then put the ball back in the bucket and take out another until you come up with 30 year’s worth of monthly returns. You then repeat this process 10,000 times and analyze the data.
Finance with 30 year mortgage: $1,185.36/monthly payment made from $300,000 fully invested brokerage account. Potential results after 30 years.
- 5th percentile: $39,070
- 25th percentile: $1,356,445
- 50th percentile: $3,506,039
- 75th percentile: $7,545,503
- 95th percentile: $19,611,719
Pay cash and invest the payment: Invest $1,185.36/month into the equity index every month from 1990-2019. Potential results after 30 years.
- 5th percentile: $842,846
- 25th percentile: $1,785,961
- 50th percentile: $2,966,124
- 75th percentile: $4,876,722
- 95th percentile: $9,565,885
This may lead an individual to different conclusions than only looking at the last 30 years of realized results. Note how the 5th and 95th percentile outcomes are vastly different, and if we consider the 50th percentile the expected value it favors the borrowing strategy. Someone with less tolerance for risk would prefer to pay cash and invest the equivalent of the mortgage payment, whereas someone with greater risk tolerance may be willing to take on the mortgage debt.
Taxes are an additional variable that should be considered. If someone was taking the standard deduction, they may prefer to pay cash as mortgage interest would not be deductible. They may also be able to make the monthly investment into a tax advantaged account such as a Roth IRA or 401(k) where growth would accumulate tax free. Looking at this data, I personally lean towards paying cash or making a substantial down payment and investing the payment. There is value associated with the peace of mind in knowing you have little or no debt and therefore no risk of lower than expected investment returns or a bad sequence of returns. What do you think? Feel free to share in the comments section below!
Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University.