Should You Pay Off Your Mortgage Early or Invest in Stocks?

Key Concepts

• Dollar-Cost Averaging (DCA): Investing a fixed amount of money at regular intervals, regardless of market conditions.
• Valuations (CAPE Ratio): Measuring the price of the S&P 500 relative to its earnings, used as a potential (but unreliable) timing indicator.
• Mortgage Rate Impact: The effect of interest rates on the decision to pay down a mortgage versus investing.
• Currency Risk: The impact of exchange rate fluctuations on international investments.
• Home Equity as Wealth: Assessing whether home equity represents genuine wealth or a potentially illiquid asset.
• 401(k) Investment Strategy: Determining the appropriate asset allocation within a retirement account based on individual circumstances.
• Liquidity: The ease with which an asset can be converted into cash.
• Adjustable Rate Mortgage (ARM): A mortgage with an interest rate that adjusts periodically based on a benchmark index.
• Target Date Fund: A mutual fund designed to become more conservative as the target retirement date approaches.

Investment Strategy & Market Valuations

Ben Carlson addresses the question of whether to invest in the stock market or pay down a mortgage when rates are high (6% or higher) and valuations are also elevated. He strongly advises against trying to time the market based on valuations, citing historical examples (1929, dot-com bubble) where high valuations did not predict market downturns. In fact, the S&P 500 increased 230% after reaching historically high valuations in March 2017. He emphasizes that valuations are better used for setting return expectations, not for market timing.

He argues that the appropriate time to pause dollar-cost averaging (DCA) is when other financial goals (down payment, wedding, debt repayment) take priority, or when an individual’s risk profile or time horizon changes. The core benefit of DCA is removing the need to predict market movements and diversifying investment timing. He quotes, “Valuations don't matter as nearly as much as we think.”

Mortgage Paydown vs. Investment

Carlson provides a rule of thumb for prioritizing mortgage paydown:

• Under 4-4.5%: Do not pay off the mortgage; inflation and the mortgage interest deduction make borrowing effectively cheap.
• 7% or higher: Consider making extra payments.
• 4.5-7%: “Dealer’s choice” – a grey area where individual circumstances dictate the best course of action.

He illustrates the impact of extra payments on a $470,000 mortgage at 6.375% using a mortgage calculator. An extra $100/month saves over $60,000 in interest and shaves 3 years off the loan, while $500/month saves significantly more and reduces the loan term by 10 years. However, he cautions that most people don’t hold a mortgage for its full term, and emphasizes that locking up capital in a house limits liquidity. He suggests a balanced approach: make some extra payments while continuing to invest in the stock market.

International Investing & Currency Effects

The discussion addresses the challenges faced by American expats investing in US markets from Australia. He explains that Australian-listed US index ETFs often underperform their US counterparts due to three factors:

• Currency Effects: A strengthening US dollar negatively impacts returns for foreign investors, and vice versa. He references a 45-year historical trend showing US stocks outperform during strong dollar regimes and international stocks outperform during weak dollar regimes.
• Fees: Australian ETFs typically have slightly higher expense ratios than their US equivalents.
• Tax Drag: Potential withholding taxes on dividends can reduce returns.

He advises consulting a local tax expert in Australia to understand the specific tax implications.

Home Equity & Net Worth

Carlson defends the inclusion of home equity in net worth calculations, despite acknowledging that it’s an illiquid asset. He points out that a significant portion (66-70%) of the wealth of many Americans is tied up in housing and retirement accounts. He argues that home equity provides benefits like a down payment source for future purchases and the potential to borrow against it. He highlights that wealthy individuals often leverage debt strategically, using assets like homes to access capital without triggering taxable events. He states, “Being a millionaire is not spending a million dollars. It's saving and investing a million dollars.”

Short-Term Homeownership & 401(k) Strategy

For those planning to live in a home for only 5-10 years, Carlson suggests that mortgage rates and term length may be less critical. He proposes considering adjustable-rate mortgages (ARMs) or lower down payments, but emphasizes the importance of investing savings elsewhere if equity building isn’t a priority.

Regarding 401(k) investments, he stresses the importance of understanding individual risk tolerance, time horizon, and emotional capacity for handling market volatility. He recommends target-date funds as a simple starting point, but emphasizes that a “good enough” portfolio that an investor can stick with is more valuable than a perfectly optimized one they abandon during market downturns. He cautions against blindly following investment advice from external sources without considering personal circumstances.

Data & Statistics Mentioned

• S&P 500 Performance (2017-Present): Increased 230% after reaching historically high valuations in March 2017.
• Mortgage Rate Thresholds: Under 4-4.5% - don’t pay down; 7% or higher – consider extra payments.
• US Millionaires: 24 million US households (nearly 1 in 5) are millionaires, with 66-70% of their wealth in housing and retirement accounts.
• Dollar/International Stock Performance: US stocks outperform during strong dollar regimes; international stocks outperform during weak dollar regimes.
• Mortgage Interest Breakdown: In the first year of a 30-year mortgage, over 80% of payments go towards interest.

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