There’s some good advice in this article – with one glaring exception. Most of the article covers some of the common mistakes people make when retiring – things like not getting the most out of Social Security, missing Medicare deadlines, or not knowing what you actually want to do in retirement.
Those are great reminders, but I want to dig into their suggestion about “interest rate arbitrage.” Arbitrage is a fancy word that makes whatever you say sound smarter to a lot of people, so the financial press loves it. And as you can guess, it gets horribly misused.
An arbitrage opportunity is not just somewhere you can make a lot of money. It’s an opportunity where you can make money without any risk. So for example, if I can buy a widget at $10, and then immediately turn around and sell it at $20, that would be an arbitrage opportunity. These are incredibly rare.
The “interest rate arbitrage” that the article is describing is not, in fact, an arbitrage opportunity. The article claims that if your long-term investment returns are greater than the interest rate on a debt, then you shouldn’t pay it off. They say you should capture the difference between your long-term rate of return and what you are paying on your loan.
To be clear, this is completely ridiculous. You may or may not want to pay off your debts as you enter retirement. That’s something that will depend on your exact situation. But simply comparing your investment returns to your debt’s interest rates isn’t even a massive simplification of the analysis. It’s just nonsensical.
The problem is that you are comparing a fixed expense with a volatile asset. You know that you will need to pay off the loan. You do not know what your investment returns will be.
The market is going to do what it’s going to do. Over the long term, it can be an incredibly powerful tool to help you reach your financial goals, but in any given year there’s no way of knowing what will happen.
The market doesn’t owe you a retirement. And it certainly doesn’t owe you any “interest rate arbitrage” on your mortgage.
McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.
The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. MAMC only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.