Mortgage Balance and Allocation to Bonds

[CanadianCapitalist]

I'm interested to hear member thoughts on how they think about their portfolio allocation to bonds when at the same time they are carrying a mortgage. The argument against a bond allocation would be that it makes little sense to earn say 1 to 1.5 percent on your bond / cash holdings while paying a mortgage at 3 to 3.5 percent. The argument for a bond allocation would be that it still makes sense to hold bonds to lower portfolio volatility and consider the mortgage as simply a housing expense.

[MoneyGal]

I have skin in this game.

In my view, you need to think about the role of bonds in your portfolio. If you want to dampen volatility, they can serve that purpose. But if you are indifferent to volatility (like me) and you have a mortgage (like me), then (in my view) there has to be some other reason for bonds in your portfolio. What is it? If there's no good answer (for you) then there's no good reason to keep them.

[HaroldCrump]

If you compare holding bonds in a non registered account vis-a-vis mortgage payments, then yes there doesn't appear to be any good reason.

However, most investors probably hold bonds inside registered accounts like TFSA and RRSP.
That adds an additional aspect to the decision.
Inside a registered account, it provides either tax-free returns (TFSA) or tax deferred returns (RRSP & RESP).

To me, the primary purpose of buying bonds is to meet a known, future liability or financial committment with a degree of certainity.
Such as retirement (RRSP), education savings (RESP), saving for a future expense (home downpayment), etc.
No equity or equity-like instrument can provide that.
The cushion against volatality is a side-effect (and I don't consider it particularly valid since bonds can fluctuate quite wildly in uncertain interest rate or political environment).

For the above reasons, I see a role for bonds inside registered accounts like RRSP and RESP.

However, I don't see any rationale for holding bonds in non registered accounts while having a mortgage.
That said, it is perhaps not prudent to keep paying all your cash savings towards the mortgage every year.
It is better to keep some cash in a HISA or POSA and consciously not pay down the mortgage with all your free cash every year.

[CanadianCapitalist]

To me, the primary purpose of buying bonds is to meet a known, future liability or financial committment with a degree of certainity.
Such as retirement (RRSP), education savings (RESP), saving for a future expense (home downpayment), etc.
No equity or equity-like instrument can provide that.

That's true if the future liability is near term (less than 5 years away). When the future liability is far into the future (10 or more years), an investor has the time frame to make a higher allocation to riskier (in terms of volatility) asset classes such as stocks. Example: One can invest a very high proportion of a newborn's education savings in stocks because the liability is close to 2 decades in the future.

It's also true that most investors likely hold bonds in registered accounts. But some may have stock holdings in taxable accounts. In this case tapping the bond portion within the RRSP account is possible because one can sell bonds and buy stocks within the RRSP and sell stocks and raise cash in the taxable account.

[CanadianCapitalist]

I'll soon be in the same boat as you: mortgage and fairly indifferent to volatility. So, I've been planning on cashing in the bonds and taking on a smaller mortgage.

[Four Pillars]

Buying a new house are we? Make sure you have 19 years worth of expenses saved up first!!!

I agree with Harold - if the account is registered then that changes things.

If you have an non-registered portfolio, then I don't see much point in having any fixed income in that portfolio if you have any debts.

If it's registered, then you *can't* use the money to pay down the mortgage, so the whole mortgage/bond issue is irrelevant.

Of course, you could ask the question - should someone who is going to buy 25% fixed income in their RRSP, maybe not make those 25% contributions and use that money on their mortgage?

Maybe - but there are tax issues involved, so it's not too simple.

[CanadianCapitalist]

Yep, we recently bought a house. Fortunately, Ottawa is nowhere as bad as some other markets apparently are (at least according to the newspapers). As I noted in my reply to Harold, it's not *impossible* to tap into the bonds held in a registered account. There are some situations where it is possible to "swap" bonds in a RRSP with a taxable account. Of course, taxes should be taken into account.

[Sampson]

We hold only a very small portion of our money in bonds, mainly due to having great pensions, being young, and starting to invest in bonds in a low interest rate environment.

For me, the argument actually extends beyond bonds as an asset class. Historically, bonds have outperformed residential real estate and total returns have come from both interest and capital appreciation. Also, I'm not one to start timing my bond purchases and sales. Next, the benefit of keeping the mortgage is that you are locking in your debt at PV.

If you consider the real return you are getting on your equity investments, you could also argue that you should liquidate all of those and be completely mortgage free. But I don't think you would ever suggest that. So, I keep a little of this, a little of that, and knowing that our cash flow can handle the house purchase, I don't think twice about it.

Balance, it's the point of diversification after all right?