Why do you want to buy bonds? There are good reasons for it, but the decision of whether to buy them, and which bonds to buy, depends a lot on your reason.
The most likely reason is that you want to reduce your portfolio risk; that is, you are continuing to invest new money, and would like to do this without taking even more risk in the stock market. That is the reason for the comparison between buying bonds and paying down your mortgage: either one allows you to pay money now and get a larger amount of money later. That is the reason for this comparison:
(One reason for "close" is that bond investments may have other benefits, such as liquidity. But since you have a large taxable account, you probably don't get much value from the liquidity.)
However, it is necessary to use the right bonds for comparison. There are 12 years left on your mortgage, so if you make a mortgage payment, you get a guaranteed amount of money in 12 years, which is what you would get if you bought a 12-year bond. If you pay off the mortgage, you get a guaranteed amount of money every year for the next 12 years, which is what you would get if you bought a bond portfolio with a 6-year duration. You don't need to buy these specific bonds, but they make for a fair comparison; if you choose to buy Total Bond Market Index with its 7-year duration rather than paying down the mortgage, you take slightly less interest-rate risk for a lower return.
For you, the most fair comparison would be Vanguard Long-Term Bond Index Admiral shares, which yield 5.06% with a 14-year duration; if you are in the 24% tax bracket, that is a 3.85% yield after tax. So that is a significantly better investment than paying down your mortgage. I would not recommend this fund in a taxable account because of the tax cost (and it wouldn't be my choice even in a 401(k); I prefer the intermediate-term duration of Total Bond Market Index, although you may be limited by the funds available).
The most likely reason is that you want to reduce your portfolio risk; that is, you are continuing to invest new money, and would like to do this without taking even more risk in the stock market. That is the reason for the comparison between buying bonds and paying down your mortgage: either one allows you to pay money now and get a larger amount of money later. That is the reason for this comparison:
This is close to the right comparison even if the bonds are in a 401(k), as long as you are maxing out that 401(k). If you sell stocks to buy bonds in your taxable account, you give up the after-tax return of stocks and get the after-tax return of bonds. If you sell stocks to buy bonds in your 401(k), you get the higher pre-tax return of bonds, but you give up the pre-tax return of stocks.Your mortgage of $250k at 2.5% is a negative bond. If you are going to invest in bonds, you should aim to exceed at least this return after taxes. Therefore, at least 2.5% ÷ (1 - 24%) = 3.3%.
Otherwise you would be essentially borrowing at 3.3%, but turning around and lending that same money (positive bond) at a lower return.
(One reason for "close" is that bond investments may have other benefits, such as liquidity. But since you have a large taxable account, you probably don't get much value from the liquidity.)
However, it is necessary to use the right bonds for comparison. There are 12 years left on your mortgage, so if you make a mortgage payment, you get a guaranteed amount of money in 12 years, which is what you would get if you bought a 12-year bond. If you pay off the mortgage, you get a guaranteed amount of money every year for the next 12 years, which is what you would get if you bought a bond portfolio with a 6-year duration. You don't need to buy these specific bonds, but they make for a fair comparison; if you choose to buy Total Bond Market Index with its 7-year duration rather than paying down the mortgage, you take slightly less interest-rate risk for a lower return.
For you, the most fair comparison would be Vanguard Long-Term Bond Index Admiral shares, which yield 5.06% with a 14-year duration; if you are in the 24% tax bracket, that is a 3.85% yield after tax. So that is a significantly better investment than paying down your mortgage. I would not recommend this fund in a taxable account because of the tax cost (and it wouldn't be my choice even in a 401(k); I prefer the intermediate-term duration of Total Bond Market Index, although you may be limited by the funds available).
Statistics: Posted by grabiner — Sun Dec 01, 2024 8:01 am