RETHINKING MORTGAGE DEBT (EP.5)

Episode Summary

Executive Summary: Benjamin Felix and Cameron Passmore discuss the Rational Reminder podcast’s origins and then dive into two core themes: how to think about credit health and mortgage-payoff decisions, and why simple index investing often competes with complex institutional strategies. They argue that mortgage debt and investment leverage should be evaluated on a combined balance-sheet basis, and that public pension fund results and VC data often do not justify higher fees or complexity over indexing.

Main Topics: Podcast introduction and listener feedback (Priority: 3/5): The hosts briefly reintroduce themselves, explain the show’s purpose for new listeners, and note encouraging feedback from the newsletter and desire for audience questions. Credit scores and practical credit management (Priority: 4/5): They discuss using Credit Karma, checking credit files regularly for fraud, understanding utilization, hard inquiries, payment history, and credit mix as drivers of credit scores. Mortgage payoff vs. invest decision (Priority: 5/5): A detailed mathematical and behavioral discussion of whether to pay off a mortgage or keep it and invest, including the Smith Maneuver, leverage, and portfolio construction equivalence. Risk, leverage, and asset allocation equivalence (Priority: 5/5): They argue that keeping a mortgage while holding bonds can resemble leverage/short-bond exposure, so a paid-for house can justify a more aggressive investment allocation in a balance-sheet framework. Valuation and tech bubble comparisons (Priority: 3/5): The hosts compare current megacap tech valuations to the dot-com era and note that high market caps are less extreme when measured against sales multiples and current fundamentals. Canadian pension funds and private assets (Priority: 5/5): They review data on major Canadian pension plans, highlighting large private-asset allocations, expenses, and returns versus a low-cost index portfolio. Index funds vs. complex investing and venture capital (Priority: 5/5): They cite skewed VC outcomes and a college endowment using only index funds to reinforce the case that simple low-cost indexing can rival or beat more complex approaches.

Key Arguments: Credit scores are heavily influenced by utilization, payment history, hard inquiries, and credit mix; checking credit files regularly helps detect fraud and errors. A mortgage and an investment portfolio should be assessed together on the balance sheet; the apparent benefit of keeping the mortgage while investing may be overstated if leverage is ignored. If a portfolio contains bonds and a mortgage exists, the debt effectively offsets fixed-income exposure, making the overall position closer to a much more equity-heavy portfolio than the account statement suggests. When comparing a mortgage-paid-off portfolio to a mortgaged portfolio, the risk/return difference can largely disappear once asset allocation is adjusted for leverage. A paid-for house can reduce required cash outflows in retirement, which may allow for higher equity exposure and better sequence-of-returns resilience. Canadian pension funds manage huge assets and often hold substantial private investments, but their long-run returns are not obviously superior to a simple low-cost index portfolio. Venture capital returns are highly skewed, so most individual deals do poorly or break even, making it difficult for ordinary investors to capture top-quartile outcomes. Simple index funds can produce competitive or better returns than more complex endowment or institutional strategies at far lower cost.

Data Points: Episode number: 5 - The hosts note this is the fifth Rational Reminder episode. Cameron Passmore industry experience: 27 years - Cameron says he has been in financial services for almost 27 years. Benjamin Felix industry experience: 7 years - Benjamin says he is going on his seventh year in the industry. Credit utilization threshold: around 30% - They mention credit scores start to suffer when utilization gets near 30% of available credit. Example home value: $500,000 - Used in the mortgage-payoff example. Example mortgage balance: $400,000 - Used in the mortgage-payoff example. Example investment portfolio: $900,000 - Used in the mortgage-payoff example, invested 50/50 stocks and bonds. Example net worth: $1,000,000 - The household’s net worth in the mortgage example before choosing either strategy. Leveraged exposure: 45% leverage - They describe the $900,000 portfolio with a $400,000 mortgage as effectively using 45% leverage. Effective asset mix with mortgage: 95% equity / 5% fixed income - They argue the mortgaged 50/50 portfolio is economically closer to a 95% equity portfolio. Financial crisis drawdown of 50/50 portfolio: -20.58% - Worst 12-month loss cited for a 50% stock / 50% bond portfolio in the financial crisis. Loss on $900,000 leveraged portfolio: $185,220 - Dollar loss on the $900,000 portfolio during the financial crisis scenario. Effective loss on own capital: 37% - Loss on the $500,000 of personal capital after accounting for mortgage leverage. Total loss including mortgage interest: more than 39% - They add 3% interest on the mortgage to the leveraged portfolio loss scenario. Loss on 95% equity portfolio: -38.92% - They say a paid-for-house investor with a 95% equity allocation would have lost 38.92% in the same crisis period. Canadian institutional investors’ combined assets: $1.4 trillion CAD - Assets of the large Canadian pension funds analyzed by PWL Research. Average 10-year pension fund return: 6.4% - Average 10-year return across the large Canadian pension funds. Average private assets weight: 37% - Average allocation to private assets across the pension funds. CPPIB private assets weight: 48% - CPPIB has the highest private-asset allocation among the funds discussed. CPPIB MER: 0.53% - Reported average expense ratio across the funds, with CPPIB noted as the highest. HOOPP 10-year return: 9.5% - Highest 10-year return among the pension funds discussed. HOOPP MER: 0.29% - Lowest expense ratio among the pension funds discussed. HOOPP private assets weight: 25% - Lowest private-asset allocation among the funds discussed. Canadian Couch Potato portfolio return: 6.41% - A simple 75/25 index portfolio over the same 10-year period. Canadian Couch Potato portfolio expense ratio: 0.15% - Expense ratio for the simple three-fund style portfolio. VC transaction sample size: 21,640 transactions - Correlation Ventures dataset covering realized venture outcomes from 2004-2013. VC outcomes of 0x to 1x: 65% - Share of venture deals returning either nothing or just principal back. VC outcomes of 1x to 5x: 25% - Share of venture deals producing moderate positive returns. VC outcomes of 5x to 10x: 6% - Share of venture deals with strong returns. VC outcomes of 10x to 20x: 2.5% - Share of venture deals with very strong returns. VC outcomes of 50x: 0.4% - Share of venture deals with extreme outlier returns. Carthage College endowment 12-month return: 11% - Example of an endowment using solely index funds. Median endowment return: 7.4% - Median return across endowments of all sizes in the cited comparison. Microsoft market cap in dot-com bubble adjusted to today: close to $1 trillion - Comparison used to contextualize Apple’s current valuation. Microsoft price-to-sales ratio in 1999: 32 - Dot-com era valuation benchmark. Apple current market cap: $1 trillion - Current valuation compared to Microsoft’s bubble-era scale. Apple price-to-sales ratio: 4 - Current ratio cited as much lower than dot-com era levels. Hypothetical Apple valuation at dot-com P/S multiple: $8 trillion - Illustrates how extreme the 1999 Microsoft multiple was relative to today’s Apple.

Pivotal Quotes: "It’s kind of like taking the fixed income out of your portfolio and using that to pay down a chunk of your mortgage." — Benjamin Felix: Summarizing the balance-sheet logic behind paying down a mortgage when holding bonds. "If you have a paid-for house, I think emotionally, people would be able to withstand more volatility." — Cameron Passmore: Discussing behavioral comfort and risk tolerance when the mortgage is eliminated. "The returns were between zero and 1x. So that’s either you’re getting your money back or you’re losing everything. 65%." — Benjamin Felix: Explaining how skewed venture capital outcomes are for most investments.

Implications: Listeners should assess mortgages, portfolios, and retirement risk on a combined balance-sheet basis, not in silos. The episode reinforces that simplicity and low costs often beat complexity, especially when institutional-looking alternatives hide leverage, fees, and illiquidity.