00:00:00
Yeah, it's probably people's
largest monthly or recurring payment is that mortgage.
00:00:06
And it's there for,
you know, 10, 15, typically 30 years. So it's it's definitely a stressor
from a psychological standpoint.
00:00:16
But I think if people understand
the mechanics, the basic finance of of a mortgage
and the broader picture of their finances,
00:00:24
it can be less of a stressor
and actually become a potential asset. Welcome to the Ripple Effect,
00:00:30
the podcast that takes you on a journey
through the minds of work and faculty. I'm your host, Melanie,
00:00:36
and in each episode will be diving deep
into the inspiration behind the groundbreaking research
that Wharton professors have conducted
00:00:43
and exploring how their findings
resonate with the world today was. We have hit the New Year.
00:00:49
Many people look to make changes
in their lives so that they can have a better lifestyle, but that can cover
a variety of different elements.
00:00:58
And when you think about one's finances, you can look at so many other
different things to improve
00:01:04
your financial health, even something
like paying off your mortgage. Michael Roberts is a professor of finance
here at the Wharton School.
00:01:12
Michael, great to have you in the studio. Great to be here. So the element of paying off the mortgage,
00:01:16
obviously, is something
that so many people deal with. But right now,
it's probably even in more focus of
00:01:23
being able to handle it, especially with
how interest rates have gone up. And that can obviously provide
a lot of stress for people.
00:01:30
Yeah, it's probably people's largest monthly
or recurring payment is that mortgage
00:01:37
and it's there for,
you know, 10, 15, typically 30 years. So it's it's definitely a stressor
from a psychological standpoint,
00:01:48
but I think if people understand
the mechanics, the basic finance of of a mortgage
and the broader picture of their finances,
00:01:57
it can be less of a stress or
and actually become a potential asset. How so? So, you know,
I'll use myself as an example.
00:02:05
We had bought a home seven
or eight years ago and had refinanced into a mortgage
00:02:11
that was 2.75%. Oh, God bless you. Forget forgetting that low mortgage.
Yeah. Yeah, yeah.
00:02:18
We then sold the house,
but that's another story. So? So we had a 2.75% mortgage.
00:02:25
Now, you know,
three, four, five, six years ago, that was certainly low, but it wasn't low relative
to what I could invest money in and earn.
00:02:37
Basically a guaranteed
or very safe return. Right. If I put it in Treasuries,
I wasn't earning 2%.
00:02:43
I was lucky to get one. Yeah. Okay. But fast forward
now, three years to today. And if you're sitting on a 2.75% mortgage
00:02:53
and interest rates
on Treasury securities for example, or CDs are above five, well,
that's an opportunity.
00:03:02
Sure. Right. So, you know, you want to
you want to think about a mortgage which,
00:03:08
you know, as rationally as we can
in terms of our opportunity cost. Right. If I'm paying 2.75 on a mortgage
that I originated five, ten years ago,
00:03:19
and now I can earn five
plus basically guaranteed. There's really no incentive for me to pay
that mortgage down.
00:03:26
I'd be throwing away money effectively. Yeah. How much do people consider
the elements of the benefit
00:03:34
that they can gain from
that type of scenario? Because I, I wonder if sometimes that's an element
that is missed along the way at times.
00:03:42
It is, and understandably so, because, you know, ultimately
that decision is a broader trade off.
00:03:48
It's not just a simple well,
you know, I'm paying 275. I can earn five. It's obvious we need to think about
tax implications right.
00:03:56
Because I've got to pay taxes
on any of my earnings. But as much as it pains me
00:04:02
to admit it,
I have to because it I see it in myself. You know, there's a psychology
magical value to not having
00:04:09
what what academics
like to call debt overhang and Simpsons. Right. Being free and clear on the house
and not having to make
00:04:15
that monthly mortgage payment. There's a there is a real psychological
benefit to that.
00:04:21
And depending upon your personal makeup,
that might outweigh the additional money
00:04:27
you could be making by
not paying it down more quickly. And I guess it really ends up
being the individual's decision,
00:04:35
what their scenario is,
because even something like paying off an extra $100
a month mortgage on your mortgage
00:04:42
can be such a benefit longer term
when you when you look down the road, no doubt about it,
you'll you'll shorten that mortgage rate.
00:04:48
So you will be free and clear sooner. But but I worry
that some of the other benefits of
00:04:56
of not paying down that mortgage and investing or saving that money
sometimes get lost in the discussion.
00:05:01
You know, one of the one of the issues
with paying that mortgage down quickly is
you're basically investing in the house.
00:05:08
Right. That's you're reallocating your investment
from a stock stock market, bond market,
whatever it it may be into real estate.
00:05:17
And that can create problems. Number one, you can become
incredibly under diversified, right.
00:05:22
If all your wealth is sitting
in that house and anything happens to that one asset, you got a big problem.
00:05:28
But number two,
that's a highly illiquid asset. So you start plowing all that savings
into the house
00:05:34
and something bad happens, you know,
medical emergency, whatever it may be. And you need money.
00:05:41
You've got a problem. Right. And in many cases,
there's just not the flexibility
00:05:46
with paying
into that or paying extra into that than, say, you know, having the savings
in a in any other type of account.
00:05:53
Exactly. I can sell stocks instantly
or bonds instantly. So you give up a lot of liquidity.
00:06:01
You give up some diversification benefits
when you go all in on the home side. I think people need to think
00:06:06
about these other considerations
in the context of their broader portfolio. It's also,
I guess, part of the larger discussion
00:06:13
about the element of saving
that we have right now. And in many cases, this is a larger discussion
about when we are younger
00:06:21
about financial literacy at younger ages,
when kids are coming up through school
00:06:25
so they can be prepared for
when they go out and get that first job. There's an element of that understanding
that really plays a huge factor,
00:06:32
isn't there? Yeah, look, I mean,
one of the first things we do when we talk about financial literacy is, is
we show the power of compounding, right?
00:06:41
Saving $100 for me, now that I'm over 50. You know, has a much smaller effect than had
I saved that save $100 when I was 21.
00:06:52
Sure. And so just that basic understanding,
you know, not not a deep, intricate knowledge of all the details
of finance, but just a basic understanding
00:07:01
of some basic financial principles
when you're in high school or college can pay massive dividends, pun intended,
going forward.
00:07:10
For years. It just it's a huge stress reducer. Yeah. Are you a believer that
that the beginning of the year is really
00:07:18
a good time of the year
to take a stake of of where you are and to kind of either adjust the plan
that you have or kind of,
00:07:28
you know, look longer term at the changes
you need to make. Yeah, it doesn't
have to be beginning of the year.
00:07:34
But if that's what motivates people,
then by all means, yes, I think a more disciplined approach.
00:07:40
You know, every quarter, once every quarter, once every year
to just take stock of, you know,
00:07:45
where your finances are, you know, what
where your expenses are headed and whether or not you have
00:07:51
enough liquidity today and whether or not
you'll have enough savings in the future.
00:07:54
It's it's always a good time
to have a look at that. Now, that's costly, right?
I mean, we're busy people, sure.
00:08:01
But if we can do that,
you know, a few times a year away, again,
it's just going to have huge benefits.
00:08:07
And most likely what you're also doing
at the same time is if you do it on a regular basis,
00:08:13
especially if you're somebody
that maybe hasn't had that background in the past of doing it
and then gaining the greater understanding
00:08:21
gives you that benefit over the next
five, ten, 20 years where you're able to make changes
that can benefit you longer term.
00:08:30
I mean, again, whether you're 50 or 20,
there are elements of that that will play in
no matter what age you are.
00:08:36
No, absolutely. In fact, in fact, what what I do is
I pay bills once a month on.
00:08:42
And when I pay bills, rather than just
paying the bills, I pay the bills. And then I just do my budgeting
and look at my investments
00:08:49
and make sure nothing weird is happening
there. There's no great science to it. It's
just a way to discipline me.
00:08:55
So instead of spending 10 minutes
paying bills, I spend an hour just sort of looking at
what's going on.
00:09:01
So you do that on a monthly basis
once a month, even with the investments? Yeah, absolutely.
00:09:06
Now, I'm not doing anything fancy
with my investments. I'm simply looking okay,
Am I on on course to where I need to be
00:09:15
when I retire or even before that,
You know, where my kids go to school? Go to college, Right.
00:09:20
Am I on track?
If not, what do I need to do? I need to save a little bit more. Can I spend a little bit more?
Yeah, these sorts of things.
00:09:27
What's the advice that you give for
those people that are maybe having issues
00:09:31
doing that right now? What's the path that they maybe
need to consider, do you think?
00:09:35
Okay. So, so my path to doing
that was pure necessity. I basically got very lazy,
didn't look at my finances, didn't
00:09:44
think about what I was making
and what I was spending, and frankly, ran into trouble.
00:09:49
Now, fortunately, I married
someone far more successful than myself, and so it really wasn't
00:09:54
a big deal for the family,
but it was a big wake up call for me. So rather than people having
00:10:00
that sort of slap in the face,
I think just the next time you're paying your bills is to just pause
and take a look at the bigger picture.
00:10:08
Again, it's an hour at most. Yeah. And I think the other scenario
that's being talked about a lot now
00:10:15
is the rise in credit debt and the concern that maybe we have as a country right now
on that rise
00:10:22
and what that may mean over
the next 12 to 18 months. Yeah, I mean, I'm not going to get into
forecasting the macro economy.
00:10:31
I'll leave that to Jeremy,
who's much better than me at that. But but what it does mean is,
00:10:38
you know, if you're looking for a house
now, you're paying 7%. You know, if you're lucky, maybe six.
00:10:44
And while there's lots of talk about,
well, don't worry about it,
interest rates are going to go down.
00:10:48
Well, look, if we knew where interest
rates were headed, we could make a ton of money.
00:10:53
The reality is
we don't know what's going to happen. So the real question is, are
we prepared for what may happen in terms
00:11:00
of how much money we have on hand,
how much we have saved, etc.. But even where interest rates are right now,
I think the the safe expectation is
00:11:11
we're not going to see two and three
quarter 3%, three and a half percent, maybe for a long, long time.
00:11:18
So at least you can put that level
of expectation in there right now
with maybe some some wiggle room in there.
00:11:24
100% agree with that. And in fact, my parents,
I remember them paying 21% on their mortgage in 81
when rates were up at 15, 16%.
00:11:34
Yeah. So, you know, 7% people feel the world's
falling apart hardly on a historical perspective,
that's not terribly high.
00:11:43
How often do you think people think
about their home as an investment? Do they do they think about it enough?
00:11:50
No, not often. And that's why I brought up those
two points earlier that you need to think
00:11:55
about your home as part of your savings,
your investment portfolio. And so any equity in there,
that's an investment.
00:12:02
It's a risky investment
and it's an illiquid investment. Yeah. And I think the other part to
00:12:07
it is when you go back to the time of the
pandemic, when we saw so many when we saw home prices rise as quickly
as we did,
00:12:15
I think people bought
into the incredible value that was added to their properties and the fact
that it was going to be there forever.
00:12:22
There's never a guarantee
that that's going to be the case. No, I mean,
if we just have to go back to 2000,
00:12:28
2008, 2009
and the great financial crisis, yeah, real estate values can fall
and they can fall dramatically.
00:12:37
What about the psychological benefits
of having a focus on your on your investments, on your funds,
on your savings, and the benefit
00:12:45
that that can provide you of being on top
of that of being truly prepared for as many eventualities as you can,
as you can foresee in the future.
00:12:55
I think it takes a balanced attitude. And what I mean by
that is if you're looking
00:13:00
at your investments on a daily basis,
pulling your hair out because the stock market went down today,
that that's the wrong approach.
00:13:08
Right. I'm looking
making sure that my money's still there, that it hasn't been absconded
or there's an error or otherwise.
00:13:17
Otherwise I'm just leaving it. And so I the the approach I'm really trying to encourage
among people
00:13:27
is one of awareness, use and knowledge more than, you know,
some sort of strategic
00:13:35
investing strategy because most of us
are not professional traders. I'm not despite my,
you know, profession as an academic, I'm
00:13:42
not a professional trader. So I'm really just trying to make sure
my investments are structured
00:13:48
in a way that they reflect my risk
tolerance, my family's risk tolerance, and that they put me on a path
to where I need to be.
00:13:54
But let me touch on that as we
wrap it up here. That importance of awareness
and what that can bring
00:14:03
to a person, a family of
just having that awareness and having, you know, just focusing on it at whether
it's monthly or quarterly, whatever it is.
00:14:12
But to have that awareness
and the benefit that that can bring, yeah, it's peace of mind.
00:14:16
And that to me is invaluable
knowing that I'm going to be okay. Now. Now, when you first do this
for the first time,
00:14:24
it can be a slap in the face and scary. And I think that prevents people
from taking that initial first step.
00:14:30
But boy, once you get on top of it,
it's just a different world. Great to have you here.
00:14:36
Thanks very much, Michael. Thanks for having me. All the best, Michael Roberts, who's a professor
of finance here at the Wharton School.
00:14:42
Thank you for listening
to the ripple effect. We hope you found this episode
informative and engaging.
00:14:47
Don't forget to subscribe
and leave us a review so that we can continue to bring you
the best insight from the Wharton School.