# Does it make sense to overpay mortgage?



## Dagny Juel (29 Aug 2017)

I have been crunching some numbers lately and have started to question whether it actually makes sense to overpay my mortgage. 

An example scenario is as follows:

Overpaying mortgage by €200/month for 22 years would save me roughly €21k (based on online overpayment calculator, 3.3% interest with AIB).

However, paying into my pension €400/month would cost me €204/month. The tax saving over 22 years is almost €52k! And of course I would hope that the pension money being invested would grow as well.

Am I missing something?


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## Rebelrebel (29 Aug 2017)

If your mortgage was 350k @ 3.3% for 22 years, your monthly repayment amount would be 1,866 euro. If you overpaid by 200 euro a month you would save 21k over the term. But the term would also be reduced by 2 years and 11 months.

So that's 35 months that you would save paying the 1,866 euro. Which makes 65,310 Euro plus the 21k plus the 200 additional Euro you would have for 35 months (7k) so in total it would be worth 93,310 euro. (Versus 400 EURO a month to your pension for 22 years making 105,600 EURO)

So I don't think it is as straightforward as you make out.

Of course you would expect pension growth as well or you could start lumping the money into a pension after you pay off the mortgage early. But there are restrictions on AVC contributions depending on your age bracket to consider as well.

It may make more sense to do a combination of both and adjust over time.

Open to correction on any/all of the above however.


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## Dagny Juel (29 Aug 2017)

Thanks for this, interesting perspective. However, I'm not sure if including the savings from reduced term is accurate in this example. You are not actually saving any money; the mortgage amount is fixed, you're just repaying the capital sooner. The only actual saving is the cost of credit, i.e. the interest rate. Whereas the pension tax break is an actual saving. 

I think I need to look into this some more!


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## Brendan Burgess (29 Aug 2017)

You are making the question too complicated by looking at it over 22 years.

Your question should be - "Should I pay €100 today into my pension or pay the net amount off my mortgage?" 

If you can show that you should pay it into your pension, then that is what you should do. You can then review the question after a year and decide if the answer is still correct. 

What return will you get on the €100 after expenses?  It's very unlikely to be 3.3%. Maybe do the numbers at 2%. Then ask how will it be taxed when you retire? Probably reasonable to assume 25% tax-free and the rest taxed at your marginal rate. 

By paying it off your mortgage, there are some other advantages: 

You may lower your Loan to Value and so get a lower rate overall on your whole mortgage 

You can effectively access your money whereas a pension scheme locks it up until retirement age 

If you have a high mortgage, you reduce the risk by paying it down. 
So the answer is not clear.  If you have a huge mortgage and a well funded pension, you should probably pay down your mortgage. If you have a small mortgage and no pension, you should probably contribute to your pension fund. 

It may be helpful to recast the question: Would you borrow money at 3.3% to contribute to a pension fund?  I think that most people would not do so. 

Of course, if mortgage rates fall, you might well be prepared to borrow at 2% to contribute to a pension fund.

Brendan


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## Rebelrebel (29 Aug 2017)

Dagny Juel said:


> Thanks for this, interesting perspective. However, I'm not sure if including the savings from reduced term is accurate in this example. You are not actually saving any money; the mortgage amount is fixed, you're just repaying the capital sooner. The only actual saving is the cost of credit, i.e. the interest rate. Whereas the pension tax break is an actual saving.
> 
> I think I need to look into this some more!



Yea that's true enough. If looking purely from a saving perspective then you only save 21k by overpaying the mortgage versus 52k in tax saving - a difference of 31k. But I think it would be a mistake to ignore it completely. By overpaying the mortgage you are saving yourself from making 35 month of Mortgage payments. Though agreed it's not an actual saving.

I suppose I looked at it by looking at the total "value" of both after 22 years - which makes it much less of a difference (ignoring investment gain).

But, it's just a different perspective. Others might look at it differently again.


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## Sarenco (29 Aug 2017)

Personally, I think it would be reasonable to assume that the net, real return on a typical Irish pension fund will not be dramatically different to the weighted average, real interest rate on a variable rate mortgage over a 20-year period.

Given the tax relief on pension contributions and the tax treatment of drawdowns, I take the view that it invariably makes sense to prioritise maxing out pension contributions ahead of paying down a mortgage ahead of schedule out of after-tax income.


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## Gordon Gekko (29 Aug 2017)

I agree; subject to having an emergency cash reserve, I believe in maximising AVCs / pension before overpaying one's mortgage. A pension may also prove easier to access than the liquidity in one's home.


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## LS400 (29 Aug 2017)

There is also nothing as satisfying, or for that matter reducing life's stress,  as getting the deeds of your property years earlier than expected.

Brendan has tried to show me the error of my ways regarding the mistakes I made in paying off my mortgage earlier than planned, but there is less stress in it now should some disaster befall me.

I also think the examples of paying into your pension taking priority over everything else are really only for high earners or those in guaranteed employment, but let's not go there...

When I had a rough patch some years ago, I can guarantee you it wasn't the extra pension over payments that gave me head space, it was 1) the fact I wasn't going to have the mortgage company make me do a merry dance for them, and 2) the Kids wouldn't have to worry about not having a secure place should the worst happen.

Telling the wife, sorry about the house, but we will have a great pension in 20 something years didn't quite cut it for me.

So, unless your well clued in pension talk, have the guaranteed employment scenario, it's thanks but, no thanks.   Show me the Deeds.


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## Brendan Burgess (30 Aug 2017)

Hi LS 

Very well put.  It's hard to capture that in the numbers. 

Brendan


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## Brendan Burgess (30 Aug 2017)

Dagny

Here is a Key Post on the topic from 2014

*Pay down your SVR mortgage before starting a pension, but don't leave it too late*

It was done when

mortgage rates were higher.
House prices were lower so many people were in negative equity 

People were less confident about the economic outlook 

I am guessing that the principles are still the same, so the conclusions are still valid.

One issue today is that the overall stockmarkets may be fully valued.  If you have spare cash, it's probably still worth investing in them. But should you be borrowing at 3.5% to invest in today's markets, even if there is good tax relief? Probably not. 

I would tend to pay down the mortgage now and contribute to the pension in later years when your pension payments will be a lot lower due to the overpayments now.

Brendan


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## Gordon Gekko (30 Aug 2017)

Hi Brendan,

I'm struggling to make up my own mind on this. I don't overpay my mortgage (3%) and I maximise my own pension contributions (€23,000 per annum). I don't have the spreadsheet to hand, but I'm not convinced that I should divert the €14k (60% of €23k) towards the mortgage.

Gordon


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## Brendan Burgess (30 Aug 2017)

Hi Gordon 

There is no right answer. 

I think it's clear to overpay your mortgage in the following circumstances: 

You have a large mortgage relative to your income > 2.5 times 

You have a high LTV >70% 

You may be trading up at some stage in the future 

Your income is uncertain - maybe self-employed or a dodgy employer 

You are young - so you have plenty of time to make contributions later in life 

You already have a well funded scheme for your young age 

You are approaching the €800k funding mark 
I am not suggesting that you should not contribute to a pension. I am suggesting that paying down the mortgage is a priority. And doing this now will allow you make higher pension contributions in later years. 


The following factors would argue for contributing to a pension instead of paying down your mortgage 

Your mortgage is very comfortable 

You have a reliable income e.g. a public servant 

You are over 40 

You have a small pension fund


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## Gordon Gekko (30 Aug 2017)

My concern centres around the fact that once a personal contribution is not made for a particular year, the ability to make that contribution is lost forever.


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## Gordon Gekko (30 Aug 2017)

I need to do some work on this, but my sense is that seeking to accelerate the repayment of one's mortgage at the expense of AVCs is excessively prudent.

It should be a simple enough model, albeit based on certain assumptions.

For example, I have 30 years to retirement. It would not be unreasonable to hope that the €23k I invest this year will be worth €184k 30 years (basically compounding at 7% on average).

That's what I may forego by choosing instead to repay an extra €14k a year in relation to a mortgage that will be repaid anyway. And what good is extra "after tax" money to me down the line, when if I invest it, I get hammered for income tax and CGT on any return?


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## Brendan Burgess (30 Aug 2017)

Gordon Gekko said:


> €23k I invest this year will be worth €184k 30 years (basically compounding at 7% on average).



Hi Gordon 

It might not be unreasonable to _hope _for this. But it would be unreasonable to _expect _it.   Do you really expect this return? Which would be at least 8% before all charges? 

And even if you get this phenomenal return, you are not forgoing it. When it's paid out to you as pension, it will be subject to tax, in some shape or other. 



Gordon Gekko said:


> And what good is extra "after tax" money to me down the line, when if I invest it, I get hammered for income tax and CGT on any return?



I don't fully understand this argument. I am suggesting that if you meet the criteria above, you should prioritise your mortgage over your pension.  Over time, you will get older, your mortgage will get more comfortable, your LTV will fall. At that stage, you switch to prioritising your pension over your mortgage repayments. 

Brendan


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## Dagny Juel (30 Aug 2017)

Thanks everyone for your responses, plenty to think about.

I always thought that paying off my mortgage was a priority but as mentioned in the OP, have started to question this now. What insipred this post is this video I saw on youtube. I know that this couple live in the US and have completely different circumstances with college loans etc. but thought that perhaps some of the principles might be the same. Definitely worth watching.

https://youtu.be/CV3FjnKu314


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## Duke of Marmalade (30 Aug 2017)

Brendan Burgess said:


> It may be helpful to recast the question: Would you borrow money at 3.3% to contribute to a pension fund?  I think that most people would not do so.
> 
> Brendan


_Boss _sums up the financial aspect of this decision succinctly.  Of course, there is the emotional dimension as well which has been well articulated by LS.  But I will stick to the financial question thus recast.  If the answer is "no" then you should pay down your mortgage but by the same token if the answer is "yes" you should be constantly remortgaging to fund your pension which seems a bit counter intuitive.

There are shades of the great Mortgage Endowment debates which was of course the extreme in delaying paying down your mortgage so as to build up savings in the stockmarket.

The difference here is of course the tax relief on pension contributions and unfortunately there is no one answer.

If you already expect that your pension will put you in the higher income bracket then any additional funding is not really being tax advantaged as the extra USC on your pension will negate the tax free lump sum factor.  Of course the rules could change - but this in itself is a negative for pension funding because of its lack of flexibility - will that tax free lump sum anomaly always be there?

So let's say that you are in the position that the tax aspects are pretty neutral the question recasts itself even more starkly.  Should you borrow at 3.3% to invest in the stockmarket? IMHO No!


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## Brendan Burgess (30 Aug 2017)

Dagny Juel said:


> Definitely worth watching.



I tried three minutes of it. I really tried. I have no understanding of the US tax code. They talk about some debts being forgiven. Not sure why. It really has no relevance at all to Ireland. 

Brendan


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## Sarenco (30 Aug 2017)

Gordon Gekko said:


> It would not be unreasonable to hope that the €23k I invest this year will be worth €184k 30 years (basically compounding at 7% on average).



Hi Gordon

Unfortunately, I don't think that's a reasonable expectation (assuming you are talking about real (after inflation) returns, net of investment costs).

According to the 2017 Credit Suisse Investment Yearbook, the annualised (gross, real, total) return on a globally diversified portfolio of equities since 1900 was 5.1%.
http://publications.credit-suisse.c...fm?fileid=AE3E00B9-91E2-D1FA-6C18765D3A968D73

However, you really have to look at holding periods of 40+ years to get close to that historical average. Equities are obviously highly volatile and the average return over shorter periods has diverged sharply from the long-run average. For example, the annualised real return on a diversified portfolio of global equities so far this millennium (2000-16) has only been 1.9% (again per Credit Suisse).



Brendan Burgess said:


> Your question should be - "Should I pay €100 today into my pension or pay the net amount off my mortgage?"
> 
> What return will you get on the €100 after expenses? It's very unlikely to be 3.3%. Maybe do the numbers at 2%. Then ask how will it be taxed when you retire? Probably reasonable to assume 25% tax-free and the rest taxed at your marginal rate.



Hi Brendan

That still favours the pension option (100@2% over 22 years = 154.6, versus 60@3.3% over 22 years = 122.56).

Bear in mind that in addition to the 25% tax-free lump sum, a married couple are currently exempt from tax on their first €36,000 of income once one spouse reaches 65.  That level of income would require a pretty sizeable pension fund.


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## Brendan Burgess (30 Aug 2017)

Hi Sarenco

It may favour the pension option if the choice is between a pension and a mortgage payment. 

But the real choice is: 

Pay into a pension now 
or 
Pay down your mortgage now and make the pension payments later. 

For a young person, there will be plenty of time to contribute to the pension in later years. 

Brendan


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## Gordon Gekko (30 Aug 2017)

Hi Sarenco,

I was thinking in terms of a 7% nominal return (I'm invested 100% in diversified global equities with a 0.45% TER).

Brendan, the issue is the % restriction for personal pension contributions. If someone waits to (say) 50 to commence meaningful contributions, they're restricted to putting €34k a year into the fund. There is no scope to make "catch-up" contributions. Every year one doesn't contribute circa €30k, one is down between €100k and €200k at the end.


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## Sarenco (30 Aug 2017)

Brendan Burgess said:


> For a young person, there will be plenty of time to contribute to the pension in later years.



Hi Brendan

I think the fatal flaw with the argument that somebody should prioritise paying down their mortgage ahead of making pension contributions when they are early in their career is that it ignores the very significant dispersion of equity returns across different time periods.

I would actually be of the view that, all being equal, somebody that is early in their career should prioritise making pension contributions to maximise the possibility of capturing something close to the long-term average return on equities.  Conversely, somebody that is later in their career should prioritise paying down their mortgage ahead of schedule to gradually de-risk their position as retirement draws closer and their human capital (present value of future earnings) shrinks. 

To put it another way, by holding off making pension contributions while carrying a mortgage, an early career investor is missing an opportunity to "diversify across time" as he is concentrating his bet on the return on equities over a much shorter time period.


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## Brendan Burgess (30 Aug 2017)

Gordon Gekko said:


> Every year one doesn't contribute circa €30k, one is down between €100k and €200k at the end.



Not really. You are assuming that the person will be in a position to make the maximum contributions every year from age 35 to retirement at 65.

If they do that, they are going to exceed the €800k tax-free lump sum limit. 

Brendan


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## aristotle (30 Aug 2017)

Brendan Burgess said:


> If they do that, they are going to exceed the €800k tax-free lump sum limit.
> 
> Brendan



Thought the tax free lump sum limit is 200k ?


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## Brendan Burgess (30 Aug 2017)

Sarenco said:


> I think the fatal flaw with the argument that somebody should prioritise paying down their mortgage ahead of making pension contributions when they are early in their career is that it ignores the very significant dispersion of equity returns across different time periods.



That just doesn't sound right.

There are different risks involved.  You are advocating that people borrow money to invest in equities through their pension.  The tax reliefs make this worthwhile, but it's risky. I am advocating getting the borrowing down first and then investing in the pensions. I think that the Duke went even further and said, pay off your mortgage in full before contributing to a pension.

I would have thought that contributing over a 25 year period from 40 to 65 was plenty of "diversification over time".  Especially as one has dramatically reduced the risk of interest rate rises through paying down the mortgage.

My gut feeling, although I don't know how to demonstrate it, is that a smaller mortgage and a smaller pension fund, is less risky than a bigger mortgage and a bigger pension fund.

Brendan


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## Gordon Gekko (30 Aug 2017)

Brendan Burgess said:


> Not really. You are assuming that the person will be in a position to make the maximum contributions every year from age 35 to retirement at 65.
> 
> If they do that, they are going to exceed the €800k tax-free lump sum limit.
> 
> Brendan



€2m is the relevant number Brendan.

25% out by way of lump sum - €200k tax free and €300k taxed at 20%.

€60k tax on €500k is a stellar outcome.


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## Duke of Marmalade (30 Aug 2017)

Let's take the risk arbitrage out of the picture.  Let's consider investing the pension fund in risk free cash.  Lucky to get 0% after charges.  So we borrow at 3.3% to invest at 0%.  No way would any tax advantage compensate for that.

So make no mistake anyone who promotes pension funding over mortgage repayment is effectively advising retail investors to borrow to invest in the stockmarket.


Brendan Burgess said:


> My gut feeling, although I don't know how to demonstrate it, is that a smaller mortgage and a smaller pension fund, is less risky than a smaller mortgage and a smaller pension fund.
> 
> Brendan


_Boss _that doesn't sound quite right


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## qwerty5 (30 Aug 2017)

Duke of Marmalade said:


> Let's take the risk arbitrage out of the picture.  Let's consider investing the pension fund in risk free cash.  Lucky to get 0% after charges.  So we borrow at 3.3% to invest at 0%.  No way would any tax advantage compensate for that.
> 
> So make no mistake anyone who promotes pension funding over mortgage repayment is effectively advising retail investors to borrow to invest in the stockmarket.



There's a good chance I'm wrong here.

Suppose I've one year left before pension, and one year left before mortgage.

If I forgo €100 of my take home pay I'll get about €200 invested into my pension. Saving myself €100 assuming no growth or fees. If my pension is low (below €200K from the numbers above) I can take this out tax free or at 20% if I've €500K.
If I take the €100 of my take home pay and pay it off the mortgage I'll save €3 assuming I'm on a 3% mortgage.

Am I totally off the wall there. It is possible / likely.


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## Sarenco (30 Aug 2017)

@Duke of Marmalade

Would you advise a 30-year old with a mortgage on a tracker rate of ECB+1% to prioritise paying down their mortgage ahead of contributing to a pension? 

Or what if the mortgage rate was fixed for 30 years @3.5%?

I'm trying to tease out whether you have a principled objection to investing in a pension while carrying mortgage debt or whether your opinion is based on your expectations of future investment returns or interest rates over a particular timeframe.


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## Gordon Gekko (30 Aug 2017)

Duke of Marmalade said:


> Let's take the risk arbitrage out of the picture.  Let's consider investing the pension fund in risk free cash.  Lucky to get 0% after charges.  So we borrow at 3.3% to invest at 0%.  No way would any tax advantage compensate for that.
> 
> So make no mistake anyone who promotes pension funding over mortgage repayment is effectively advising retail investors to borrow to invest in the stockmarket.
> _Boss _that doesn't sound quite right



Is it not key that €100 goes into the pension to compound tax-free, whereas only €60 is paid off the mortgage?

Also, with regard to the leverage point, I don't believe it's particularly reckless to borrow at 3% to invest 100% in equities into a tax free environment over 30+ years.


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## Brendan Burgess (30 Aug 2017)

Duke of Marmalade said:


> _Boss _that doesn't sound quite right



Typo corrected. Thanks


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## Brendan Burgess (30 Aug 2017)

qwerty5 said:


> Suppose I've one year left before pension, and one year left before mortgage.



This overall debate is about funding a pension or paying down a pension much earlier. 

Close to retirement, especially a year to go, when the tax benefits are much clearer, it will be clear whether contributing to a pension is better or not. In the case you outline, with a small pension fund, maxing the pension contribution is the right idea. 

Brendan


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## Duke of Marmalade (30 Aug 2017)

Gordon Gekko said:


> Is it not key that €100 goes into the pension to compound tax-free, whereas only €60 is paid off the mortgage?
> 
> Also, with regard to the leverage point, I don't believe it's particularly reckless to borrow at 3% to invest 100% in equities into a tax free environment over 30+ years.


There are two points here,
Comparing risk free alternatives at today's interest rates there is no compounding at play in the pension fund.
On whether taking the investment risk on a tax free basis makes sense is debatable,  you seem to think yes, I'm not so sure.


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## Gordon Gekko (30 Aug 2017)

But where's the logic in only looking at risk free alternatives? The choice is not limited to those two options.


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## Gordon Gekko (30 Aug 2017)

Surely this is simple enough to model? I'll take a look tomorrow.

Take someone whose mortgage is at 3% with 30 years left on it. He's 35, with 30 years to go to retirement. He has a choice this year, invest €23k in his pension, or repay €14k of his mortgage.

I don't believe that it's unrealistic to assume an average annual nominal return 6.5% over a 30 year period from an all equity investment strategy (with a TER of, say, 0.5%).

What does that look like in terms of wealth creation vs early repayment of the mortgage and subsequent investment of the mortgage repayments that don't arise on foot of its early repayment?


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## Sarenco (30 Aug 2017)

Gordon Gekko said:


> Surely this is simple enough to model?



Hah!  If only.  

What assumptions are you going to use for future mortgage rates?  What about the sequence of returns on your equity investment? I assume you don't expect to achieve a constant annual return of 6.5% over the next 30 years.

Don't get me wrong - I would still recommend to somebody in their 30s to prioritise making pension contributions over paying down their variable rate mortgage. 

However, _Duke_ is absolutely correct when he suggests that recommendation implies taking a degree of investment risk and the market obviously has absolutely no obligation to meet my expectations - over any timeframe.

It's a judgment call.


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## Gordon Gekko (30 Aug 2017)

It most certainly is.

But isn't sequencing of returns irrelevant when no drawdowns are occurring and contributions are regular and consistent?

I absolutely agree re the market, however 30 years is a meaningful time horizon, and one where it is not unreasonable to expect returns in or around the long term averages.


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## Sarenco (30 Aug 2017)

No, the sequence of returns matters where there are contributions to or drawdowns from a portfolio.

Bear in mind that the first euro you contribute will be invested for a lot longer than the last euro you contribute.  Also, I think it makes sense to think in terms of your "euro weighted" time horizon.


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## Gordon Gekko (31 Aug 2017)

Sarenco said:


> No, the sequence of returns matters where there are contributions to or drawdowns from a portfolio.
> 
> Bear in mind that the first euro you contribute will be invested for a lot longer than the last euro you contribute.  Also, I think it makes sense to think in terms of your "euro weighted" time horizon.



But isn't it fair to say that the longer the time horizon, the more likely the investor is to achieve long term averages? And that 30 years is "getting there" in terms of a time horizon?


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## Sarenco (31 Aug 2017)

Gordon Gekko said:


> But isn't it fair to say that the longer the time horizon, the more likely the investor is to achieve long term averages? And that 30 years is "getting there" in terms of a time horizon?



Yes, historically that's certainly been the case.


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## Gordon Gekko (31 Aug 2017)

So...

€14k paid off a 30 year 3% mortgage today saves €20k over the lifetime of the mortgage.

A pension contribution of €23k invested 100% in global equities over 30 years could reasonably be expected to grow to €152k. €38k of that could be taken out tax-free (i.e. 25%), leaving €114k in the ARF.

Based on assumptions that aren't unreasonable, which would you prefer...to save €20k over the duration of your mortgage or to have grown your money to €38k in cash plus €114k in your ARF.


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## Sarenco (31 Aug 2017)

Hi Gordon

If you are going to assume that your pension will grow in line with long-term average equity returns then you should probably also assume that mortgage rates will also revert to their long-term averages over the next 30 years.

I believe the CSO maintains data on representative building society mortgage rates going back to the early 70's. Without reviewing the data, I would guess that the long-term average is probably somewhere around 6 or 7%.


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## Rebelrebel (31 Aug 2017)

Gordon Gekko said:


> So...
> 
> €14k paid off a 30 year 3% mortgage today saves €20k over the lifetime of the mortgage.
> 
> ...



Hi Gordon,

Would you also include the fact that you will have a term reduction on the mortgage and for those months or years, so you won't have to make that mortgage payment for those final months and years. And you could invest that amount into your pension at that stage also making a return. (Assuming the amount did not exceed the AVC limit - though you could then invest elsewhere)?


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## Gordon Gekko (31 Aug 2017)

Rebelrebel said:


> Hi Gordon,
> 
> Would you also include the fact that you will have a term reduction on the mortgage and for those months or years, so you won't have to make that mortgage payment for those final months and years. And you could invest that amount into your pension at that stage also making a return. (Assuming the amount did not exceed the AVC limit - though you could then invest elsewhere)?



I looked at that, but the term reduction was negligible (circa 9 months).


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## Gordon Gekko (31 Aug 2017)

Sarenco said:


> Hi Gordon
> 
> If you are going to assume that your pension will grow in line with long-term average equity returns then you should probably also assume that mortgage rates will also revert to their long-term averages over the next 30 years.
> 
> I believe the CSO maintains data on representative building society mortgage rates going back to the early 70's. Without reviewing the data, I would guess that the long-term average is probably somewhere around 6 or 7%.



I don't believe that would be reasonable (and not just because it suits my argument).

Prospective returns should in all probability be circa 7%.

But you would struggle to find anyone who would contend that Irish mortgage rates will be anywhere near their historic averages over the same period.

Long term Irish rates are surely irrelevant now that we're in Euroland in any event?

I guess that my contention would be 7% is reasonable for equity markets over the next 30 years based on current valuations but it is not reasonable for mortgage rates based on any number of factors.


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## Sarenco (31 Aug 2017)

Gordon Gekko said:


> I don't believe that would be reasonable (and not just because it suits my argument).



Fair enough but you are assuming in your model that the variable rate will remain at 3% over the next 30 years.  Does that seem reasonable?



Gordon Gekko said:


> Prospective returns should in all probability be circa 7%.



I certainly wouldn't agree that there is any _probability_ that equity returns are going to average 7% over the next 30 years.

My expectation for the next 30 years is that global equities will, on average, return around 4% over the risk free rate and that mortgage rates will average around 3% over the same rate.  No guarantees, obviously, but that's my expectation.


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## Rebelrebel (31 Aug 2017)

Gordon Gekko said:


> I looked at that, but the term reduction was negligible (circa 9 months).



But assuming using your figures on for example a 460k mortgage, Paying off 14k would save you 20k over the lifetime of the mortgage and would also save you 17 months of mortgage repayments (1,939 *17 = 32,963). So in terms of value over the term you would be looking at 53,963.

It still makes the Pension option of higher value using your investment return and mortgage interest rate conditions.

Edited as I realised my mistake!


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## cremeegg (31 Aug 2017)

Rebelrebel said:


> But assuming using your figures on for example a 460k mortgage, Paying off 14k would save you 20k over the lifetime of the mortgage and would also save you 17 months of mortgage repayments (1,939 *17 = 32,963). So in terms of value over the term you would be looking at 53,963.



Are you not double counting the saving here. The capital repayment is the same the interest is less. The fact the you end up with a shorter term just reflects that you make a capital payment already, and have less interest to pay.


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## Gordon Gekko (31 Aug 2017)

I think that equity returns will remain a function of dividend yield and comapnies' ability to grow their dividend, and that based on the world as things stand that 7% on average over the next 30 years is reasonable.

I believe mortgage rates will fall to 2% and will remain low for a generation because of the sheer volume of debt in the world post financial crisis. I don't think 3% is an unreasonable average.

My views on the above then obviously frame my opinion re pension vs mortgage.


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## cremeegg (31 Aug 2017)

Sarenco said:


> Fair enough but you are assuming in your model that the variable rate will remain at 3% over the next 30 years.  Does that seem reasonable?
> 
> I certainly wouldn't agree that there is any _probability_ that equity returns are going to average 7% over the next 30 years.
> 
> My expectation for the next 30 years is that global equities will, on average, return around 4% over the risk free rate and that mortgage rates will average around 3% over the same rate.  No guarantees, obviously, but that's my expectation.



Both Mortgage rates and return on equities should reflect, with many complications and lags, the risk free rate of return. 

Mortgages should be the risk free rate plus banks costs and profit.

Returns on equity should be the risk free rate plus the equity risk premium.

Gordon seems to have a cake issue here. To eat low rates on mortgages while having high returns on equities.


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## Rebelrebel (31 Aug 2017)

cremeegg said:


> Are you not double counting the saving here. The capital repayment is the same the interest is less. The fact the you end up with a shorter term just reflects that you make a capital payment already, and have less interest to pay.



I would agree that terms of savings alone you are correct. But I'm thinking more about comparing the value of both strategies at the end of 30 years. Instinctively it would seem to me that you should consider this as this is a monthly amount of 1,939 that you don't have to pay to your mortgage for a period and could use to invest in your pension fund.

I'm completely open to being corrected on this however.


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## Gordon Gekko (31 Aug 2017)

Rebelrebel said:


> I would agree that terms of savings alone you are correct. But I'm thinking more about comparing the value of both strategies at the end of 30 years. Instinctively it would seem to me that you should consider this as this is a monthly amount of 1,939 that you don't have to pay to your mortgage for a period and could use to invest in your pension fund.
> 
> I'm completely open to being corrected on this however.



It's double counting.

Your total interest saving (which is circa €20k) is delivered in the form of the repayments that you end up not making for circa 9 or 10 months.


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## cremeegg (31 Aug 2017)

Rebelrebel said:


> I would agree that terms of savings alone you are correct. But I'm thinking more about comparing the value of both strategies at the end of 30 years. Instinctively it would seem to me that you should consider this as this is a monthly amount of 1,939 that you don't have to pay to your mortgage for a period and could use to invest in your pension fund.
> 
> I'm completely open to being corrected on this however.



It has nothing to do with instinct or personal preference, this is just simple maths.

€14k over payment plus €20k less interest equals €34k.  17 payments of €2k equals €34k 

The only saving is the reduced interest approx €20k.


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## Sarenco (31 Aug 2017)

cremeegg said:


> Gordon seems to have a cake issue here. To eat low rates on mortgages while having high returns on equities.


Agreed.

However, even if you assume that the annualised rate of return on global equities will be the same as (or even somewhat lower than) the weighted average mortgage rate over the same period, the pension option still comes out well ahead due to the tax relief.


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## cremeegg (31 Aug 2017)

Gordon Gekko said:


> It's double counting.
> 
> Your total interest saving (which is €20k) is delivered in the form of repayments you don't make for circa 9 or 10 months.



Don't confuse him. Its 17 months reduction in term, €20k interest and €14k capital already paid.


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## Gordon Gekko (31 Aug 2017)

The term shortens by 10 months!


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## Gordon Gekko (31 Aug 2017)

cremeegg said:


> Both Mortgage rates and return on equities should reflect, with many complications and lags, the risk free rate of return.
> 
> Mortgages should be the risk free rate plus banks costs and profit.
> 
> ...



Not in a world where interest rates have to stay low.


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## Rebelrebel (31 Aug 2017)

Gordon Gekko said:


> The term shortens by 10 months!



It depends on the principal. Using the principal of 460k it shortens it by 17 months. Using the principal of 200k it shortens it by 3 years and 2 months.
Using https://www.drcalculator.com/mortgage/


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## Rebelrebel (31 Aug 2017)

cremeegg said:


> It has nothing to do with instinct or personal preference, this is just simple maths.
> 
> €14k over payment plus €20k less interest equals €34k.  17 payments of €2k equals €34k
> 
> The only saving is the reduced interest approx €20k.



Understood - thanks.

Personally one of the attractions of repaying a mortgage early is that the reduced term will free up a lot of cash once the mortgage is repaid.
But understood it's not a saving.


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## Codogly (31 Aug 2017)

The only issue I have with the Pension being the clear winner is that I believe its possible and even likely that have a decent pension pot in years to come might actually work against you in the form of means testing the state pension out from under neat you ...!!!

I've said it before on this site ..." Why did Robin Hood steal from they rich ... because the poor have FA. "

Extremely UNFAIR I grant but very possible IMHO.


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## cremeegg (31 Aug 2017)

Gordon Gekko said:


> Not in a world where interest rates have to stay low.



I accept that as you said there is a "(huge) volume of debt in the world post financial crisis" and that this means that interest rates may have to stay low. The debt could be inflated away and that would allow interest rates to rise, even real rates. However there seems to be little appetite for this among Central Banks anywhere.

However this does not justify your assumption that equity returns can break the connection with a low risk free rate.


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## Gordon Gekko (31 Aug 2017)

The interest saving is the key figure and that's consistent at circa €20k.


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## Sarenco (31 Aug 2017)

Gordon Gekko said:


> The interest saving is the key figure and that's consistent at circa €20k.



That is only true if you assume that the weighted average interest rate will be 3% over the 30 years.

Cremeegg is right - you are assuming in your model that the equity risk premium will be significantly higher than the ERP over the last 100 years.  Many commentators actually expect the ERP to be materially lower going forward.


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## Gordon Gekko (31 Aug 2017)

I've never once referred to the risk-free rate so how is the equity risk premium relevant?

Prospective mortgage rates in Ireland and the expected return from a diversified portfolio of global equities are what's being discussed.

The salient point is that even if we increase the 3% to (say) 4% and decrease the 6.5%, the pension contribition still wins.


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## Gordon Gekko (31 Aug 2017)

30 year fixed rate mortgages are available at 3.5% in Europe (ABN AMRO, ING, etc)...what does that suggest to you re mortgage rates?


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## Sarenco (31 Aug 2017)

Gordon Gekko said:


> I've never once referred to the risk-free rate so how is the equity risk premium relevant?


It's implicit in your assumptions.

For the sake of simplicity, let's assume that banks can borrow money at the risk-free rate ("T") and can lend money to home buyers at T+3%.

Over the last century, the equity risk premium has averaged around T+4%.

T happens to be (effectively) zero at the moment but that hasn't always been the case.  Over the last century, T has averaged around 3% in nominal terms.

So if you are going to assume average nominal equity returns of 7%, that implies that T will average at 3% over the period (assuming the ERP is constant).



Gordon Gekko said:


> The salient point is that even if we increase the 3% to (say) 4% and decrease the 6.5%, the pension contribition still wins.



Actually, the pension contribution "wins" even in circumstances where the annualised return on the equity portfolio is somewhat less than the weighted average mortgage rate over the period because of the tax relief.  

For example, 100 compounded @2% over 30 years comfortably beats 60 compounded @3% over the same period.


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## Sarenco (31 Aug 2017)

Gordon Gekko said:


> 30 year fixed rate mortgages are available at 3.5% in Europe (ABN AMRO, ING, etc)...what does that suggest to you re mortgage rates?



That these lenders expect rates to increase significantly over the next 30 years!  

3.5% is roughly double the variable home loan rates offered by those lenders on the continent.


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## Gordon Gekko (31 Aug 2017)

Sarenco said:


> That these lenders expect rates to increase significantly over the next 30 years!
> 
> 3.5% is roughly double the variable home loan rates offered by those lenders on the continent.



And conventional wisdom is that Irish rates will fall to European norms!


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## Gordon Gekko (31 Aug 2017)

Sarenco said:


> Actually, the pension contribution "wins" even in circumstances where the annualised return on the equity portfolio is somewhat less than the weighted average mortgage rate over the period because of the tax relief.
> 
> For example, 100 compounded @2% over 30 years comfortably beats 60 compounded @3% over the same period.



Doesn't that ignore the fact that the proceeds of the €100 are trapped in a pension structure, whereas the interest saving isn't?

Gross vs net basically.


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## Sarenco (31 Aug 2017)

Gordon Gekko said:


> And conventional wisdom is that Irish rates will fall to European norms!



Average rates on all outstanding Irish mortgages are actually pretty much bang in line with the equivalent Eurozone figure.  The difference is that the Irish bargain rates (low margin trackers) are no longer available.

Whatever about conventional wisdom, I don't think there is any prospect that rates on new Irish mortgages will fall to Eurozone average rates in my lifetime.  Our default rates are simply too high.


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## Sarenco (31 Aug 2017)

Gordon Gekko said:


> Doesn't that ignore the fact that the proceeds of the €100 are trapped in a pension structure, whereas the interest saving isn't?
> 
> Gross vs net basically.


Well, yes, pension contributions are made out of gross income whereas a mortgage payment obviously comes out of net income.  Is that your point?  I suspect I'm missing a subtlety in your post.


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## Gordon Gekko (31 Aug 2017)

Sarenco said:


> Well, yes, pension contributions are made out of gross income whereas a mortgage payment obviously comes out of net income.  Is that your point?  I suspect I'm missing a subtlety in your post.



No worries...the compounded return from the €100 is in the retirement structure, so there's income tax etc to get it out, whereas the accumulated interest saving is net of tax.


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## Gordon Gekko (31 Aug 2017)

Sarenco said:


> Average rates on all outstanding Irish mortgages are actually pretty much bang in line with the equivalent Eurozone figure.  The difference is that the Irish bargain rates (low margin trackers) are no longer available.
> 
> Whatever about conventional wisdom, I don't think there is any prospect that rates on new Irish mortgages will fall to Eurozone average rates in my lifetime.  Our default rates are simply too high.



Funny enough, I believe that in our lifetimes (assuming we're neither ill nor OAPs), it will be possible for an Irish person to borrow directly from European banks at the same rates as our fellow EU citizens.


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## galway_blow_in (31 Aug 2017)

cremeegg said:


> I accept that as you said there is a "(huge) volume of debt in the world post financial crisis" and that this means that interest rates may have to stay low. The debt could be inflated away and that would allow interest rates to rise, even real rates. However there seems to be little appetite for this among Central Banks anywhere.
> 
> However this does not justify your assumption that equity returns can break the connection with a low risk free rate.



surely low interest rates will drive people into riskier assets ?


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## cremeegg (1 Sep 2017)

galway_blow_in said:


> surely low interest rates will drive people into riskier assets ?



That boat sailed nearly 10 years ago.


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## galway_blow_in (1 Sep 2017)

cremeegg said:


> That boat sailed nearly 10 years ago.



really ? , bar the u.s market , the rest of them barely moved since this time in 2007


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## Sarenco (1 Sep 2017)

galway_blow_in said:


> really ? , bar the u.s market , the rest of them barely moved since this time in 2007


You're joking right?

$10,000 invested in Vanguard's Global (Ex-US) Index Fund (VGTSX) on 1 January 2007 would have been worth $12,954 on 31 July 2017 (with all dividends reinvested).  That's pretty remarkable given the 58.5% drawdown in 2008/2009.

Anyway, I think we are starting to drift away from the topic under discussion - whether it makes sense to prioritise pension contributions over more aggressively paying down a mortgage.


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## galway_blow_in (1 Sep 2017)

Sarenco said:


> You're joking right?
> 
> $10,000 invested in Vanguard's Global (Ex-US) Index Fund (VGTSX) on 1 January 2007 would have been worth $12,954 on 31 July 2017 (with all dividends reinvested).  That's pretty remarkable given the 58.5% drawdown in 2008/2009.
> 
> Anyway, I think we are starting to drift away from the topic under discussion - whether it makes sense to prioritise pension contributions over more aggressively paying down a mortgage.



if you invested $10000 today , would you be content for it to be worth $12954 on september 1st 2027 ?

its less than 3% per annum ! , so what if there was a 50% drawdown in 2008 - 2009 , the DAX dropped by nearly a third from mid 2015 to early 2016 , european markets are more volatile than u.s ones , they veer in and out of plus 10% corrections on a regular basis


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## Gordon Gekko (1 Sep 2017)

After being through the Financial Crisis?!

Yes


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## galway_blow_in (1 Sep 2017)

Gordon Gekko said:


> After being through the Financial Crisis?!
> 
> Yes



the same sum invested in the best paying savings account in sept 2007 would have delivered as big a return as some of them were paying 4% around 2011


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## Sarenco (1 Sep 2017)

galway_blow_in said:


> if you invested $10000 today , would you be content for it to be worth $12954 on september 1st 2027 ?



What has that got to do with the topic under discussion?  You said that non-US stock markets had "barely moved" since 2007 - which is very obviously untrue.

In any event, 10-years is a short time in the stock market - there have been plenty of 10-year periods where equities have produced lower returns than the last 10 years.

Whether I am "content" with the market return is beside the point.


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## Sarenco (1 Sep 2017)

galway_blow_in said:


> the same sum invested in the best paying savings account in sept 2007 would have delivered as big a return as some of them were paying 4% around 2011



Yes, I often make the point on here that it is not particularly unusual for the return on short-term fixed income instruments (including deposits) to beat the return on equities over surprisingly long time periods.  What of it?


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## galway_blow_in (1 Sep 2017)

Sarenco said:


> What has that got to do with the topic under discussion?  You said that non-US stock markets had "barely moved" since 2007 - which is very obviously untrue.
> 
> In any event, 10-years is a short time in the stock market - there have been plenty of 10-year periods where equities have produced lower returns than the last 10 years.
> 
> Whether I am "content" with the market return is beside the point.



my original point was that lower interest rates tend to entice people to invest in risk assets , this post was in reply to the poster who argued a low interest rate was no reason to believe the return on equities would be any higher than normal , if you think the return of the last ten years is nothing unusual and you may be right , is it not the case that markets are due a better coming ten years , the market in three of the large economies in europe ( france , italy , spain ) have barely budged in twenty years


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## Sarenco (1 Sep 2017)

galway_blow_in said:


> lower interest rates tend to entice people to invest in risk assets


If investors bid up the price of an asset then, all being equal, that lowers its expected future return.  Very basic economics. 



galway_blow_in said:


> the market in three of the large economies in europe ( france , italy , spain ) have barely budged in twenty years


Again, that is completely untrue!


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## galway_blow_in (1 Sep 2017)

Sarenco said:


> If investors bid up the price of an asset then, all being equal, that lowers its expected future return.  Very basic economics.
> 
> 
> Again, that is completely untrue!




https://markets.ft.com/data/indices/tearsheet/charts?s=IBEX:MCE

https://markets.ft.com/data/indices/tearsheet/charts?s=SPMIB:FSI

https://markets.ft.com/data/indices/tearsheet/charts?s=CAC:PAR

barely moved !


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## Sarenco (1 Sep 2017)

What are you talking about?

Those charts show that there have been dramatic movements in each of those markets since 2007!

In any event, what have the movements in any particular market got to do with the subject matter of this thread?


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## cremeegg (1 Sep 2017)

galway_blow_in said:


> in reply to the poster who argued a low interest rate was no reason to believe the return on equities would be any higher than normal



If this is my point in post no. 61 above that you are referring to, that is not exactly what I said.  I was suggesting that interest rates are expected to be low in the coming years, and that that indicates that equity returns may also be low as both are connected to the risk free rate of return.




galway_blow_in said:


> is it not the case that markets are due a better coming ten years



Markets are never due anything. The past is no guide to future performance.


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## galway_blow_in (1 Sep 2017)

cremeegg said:


> If this is my point in post no. 61 above that you are referring to, that is not exactly what I said.  I was suggesting that interest rates are expected to be low in the coming years, and that that indicates that equity returns may also be low as both are connected to the risk free rate of return.
> 
> 
> 
> ...



of course , that is true but has there ever been a period where markets underperformed in europe for more than twenty years as has happened since the year 2000 , even the FTSE isnt up that much since the turn of this century , emerging markets are below where they were ten years ago as well , granted they went up by a huge amount since the mid nineties until prior to 2008


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## Sarenco (1 Sep 2017)

Under-performed what exactly? 

The Nikkei has yet to surpass the heights reached in 1989 (when Japan was, briefly, the largest stock market in the world).  What of it?

If your point is that investors should only invest in stocks for the long-term and should always diversify widely accross companies, sectors and regions, then we are in full agreement.

If you are making some other point that has some relevance to the topic under discussion, can you please be more specific?

Are you suggesting that you have some key to outperforming the global equity market based on macro trends that are known to all investors?

I'm not trying to have a go - I'm genuinely at a loss as to what point you are trying to make.


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## galway_blow_in (1 Sep 2017)

Sarenco said:


> What are you talking about?
> 
> Those charts show that there have been dramatic movements in each of those markets since 2007!
> 
> In any event, what have the movements in any particular market got to do with the subject matter of this thread?



they also show no gains worth talking about since 1997 in the case of italy and spain , you earlier denied markets have gone nowhere in the past twenty years


Sarenco said:


> Under-performed what exactly?
> 
> The Nikkei has yet to surpass the heights reached in 1989 (when Japan was, briefly, the largest stock market in the world).  What of it?
> 
> ...



with respect sarenco , i did quote cremegg with my last post , i dont work in finance , im just interested in it , you seem to think its normal that fixed income does as well as equities since the year 2000 , i just must believe that that must change in the future as equities are meant to significantly beat savings or treasuries over the long term and twenty years is a long time , it looks to me like equities are seriously overdue a long bull run in equities in europe ,  you probably forgot more than il ever know about these things  but im entitled to offer opinions , the charts i provided with regard spain and italy in particular show their markets no higher than in 1999 , they are two large european economies , thats a fact ,  if my posts are that irritating to you , there is an ignore button

i wont contribute to this particular thread anymore however , i do not want to derail it as that appears to have happened


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## Sarenco (2 Sep 2017)

galway_blow_in said:


> they also show no gains worth talking about since 1997 in the case of italy and spain , you earlier denied markets have gone nowhere in the past twenty years


Sorry Galway but you said that those markets had "barely budged" in 20 years.  That is not true and the charts that you posted amply demonstrated that it is untrue.  You now seem to be saying something different.

You take the view that we will now see a long bull run in European equities because such a run is "seriously overdue".  That's not the way markets work but you are certainly entitled to your opinion.


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## RedOnion (2 Sep 2017)

galway_blow_in said:


> even the FTSE isnt up that much since the turn of this century


Probably worthy of a thread of its own, but you have to understand how these indices are composed, and how they change over time to know what to expect.
For example the FTSE 100 reached a peak in Dec 1999 that wasn't reached again until Feb 2015. At that time, only 49 of the companies from 1999 were still in the list. Some had disappeared, some had been bought privately, and others had just shrunk. In 1999 the index was weighted heavily by tech and telecoms (BT and Vodafone made up 16%), then by financials, and then by commodities. It's easy to see how it's performed historically when you see small sectoral concentrations that weigh heavily.
I'm not as familiar with CAC, but again it's just 40 companies dominated by Telco's, autos and fashion brands. All have had their problems in the last 10 years.


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## cremeegg (2 Sep 2017)

Sarenco said:


> Sorry Galway but you said that those markets had "barely budged" in 20 years.  That is not true and the charts that you posted amply demonstrated that it is untrue.  You now seem to be saying something different.



I have no idea what point is being made here or indeed disputed, but the first link GBI posted showed a market at over 15,000 in 2007, which fell below 7,000 and is now at about 12,000. While there has been plenty of movement along the way, "barely budged" seems a fair comment overall, on the 10 years.


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## galway_blow_in (2 Sep 2017)

cremeegg said:


> I have no idea what point is being made here or indeed disputed, but the first link GBI posted showed a market at over 15,000 in 2007, which fell below 7,000 and is now at about 12,000. While there has been plenty of movement along the way, "barely budged" seems a fair comment overall, on the 10 years.



actually cremegg i was trying to illustrate ( with that FT link )  how spain , italy ( and to a lesser degree france ) have barely moved in nearly twenty years , let alone since 2007 , i stand by that

broke my pledge not to comment again here but just wanted to clarify

i do accept that most funds or etf,s which covers europe have a disproportionate tilt towards the uk so spain , italy and france would perhaps not hugely  effect the performance of broad based european funds but even the FTSE hasnt rose that much since 2000 , germany is the outlier

people often talk about the performance of emerging markets in isolation , why cant europe be looked at in isolation too , almost as if if the usa has a good run , europe is included as also having done well , europe always goes down if the usa does but doesnt alway go up , perhaps that might change but while all the chat on cnbc etc right now is how europe is a better bet going forward , this is more the case for americans who have seen a miles better return on european investments due to the very large fall in the dollar , you would almost think americans are in a very advantageous position most of the time over europeans when it comes to equities

example 

january 1st a guy sitting in new york buys a dollar denominated etf which tracks the s+p , today he is up nearly 11 %

january 1st a guy in new york buys a dollar denominated etf which tracks the european market , today he is up nearly 19%

january 1st a guy sitting in dublin buys a euro denominated fund which tracks the s  + p , today he is down nearly 2%

january 1st a guy sitting in dublin buys a euro denominated fund which tracks the overall european market , today he is up around 4.5%


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## Sarenco (2 Sep 2017)

cremeegg said:


> I have no idea what point is being made here or indeed disputed, but the first link GBI posted showed a market at over 15,000 in 2007, which fell below 7,000 and is now at about 12,000. While there has been plenty of movement along the way, "barely budged" seems a fair comment overall, on the 10 years.



I am genuinely puzzled how you could say that index has "barely budged" over the last 10-years period - your figures show very material changes over the period.

FWIW, since 1998 MSCI France has grown at an annualised rate (NR) of 4.27%, MSCI Spain has grown at 4.13% and MSCI World has grown at 4.78%.

For the avoidance of doubt, I am not suggesting that there is anything actionable in that information.


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