Just a Theory

Dave says that Alex's theory of only putting down 20% on a home if you have a million dollars in the bank, so that you leave the rest in mutual funds is risky.

QUESTION: Alex presents a theory. If you have $1 million in the bank, why would you take $300,000 out to buy a house instead of just putting 20% down and keeping the money in the mutual fund to make money? If need be, he can pay off the house. Dave tells him about the two major factors that he doesn’t factor into his equation.

ANSWER: The spread that you’d make between the mortgage (at 6%) and the mutual fund )at (11% or so) is about 5%, and that’s assuming nothing goes wrong and that you can get your mutual fund out if you need. What you’re talking about is a theory, and what I’m talking about is actual life. In your theory, you’ve left out two major issues … paying taxes on the mutual fund (which makes your yield less) and risk.

You’ve compared a zero risk investment with a risk investment, and you don’t do that. You must factor in risk so you accurately compare one investment to another. Every time you pay your mortgage off, the bank no longer charges you interest. That’s a zero risk, compared to a mutual fund that does have risk. Remember, if your house was paid for, you would not borrow $300,000 against it to invest in mutual funds.