The case for not repaying debt #1 - the returns

My previous post considered whether it was a good idea to make early repayments on my home mortgage and concluded that I was probably going to be better off not making early repayments. The logic for not making early repayments is (i) that the expected return on other investments is higher than the cost of the interest on the mortgage loan and (ii) with a reasonably long time period to work with, the risk of being undone by a run of below average returns on investment can be substantially (but not completely) discounted. In practical terms, the cost of mortgage finance is currently between 4.7% and 5.0% and the long run average return on the stock market is around 10%.

If this logic is correct then there also has to be a case for:

1. moving to interest only debt. This frees up more cash flow for those other investments;

2. increasing debt levels as high as the banks will allow and you can comfortably service. This puts the maximum amount of dollars to work exploiting the spread between borrowing costs and expected returns on other investments;

3. carrying debt into retirement. This would enhance my retirement income.

If the debt was used to acquire an investment property and the money not spent on principal repayments is invested in equities then, as a private individual in Hong Kong, the spread is increased by the effect of tax. The interest will be tax deductible but I will pay no taxes on the equities.

Looking through the lists of the richest people in various countries, it will be evident that many, if not a clear majority, of the people listed use considerable amounts of leverage in their investments or their businesses. Coincidence? I don't think so. In my view it is no accident, that there is an apparent (I have not verified this with a hard analysis) correlation between the use of debt and wealth. Put differently, while striving to be debt free may appear to be a worthy objective, it is unlikely to be a strategy that will maximise your return on investment or your financial wealth.

I recognise that this strategy carries with it increased risk which I will consider in part 2 of this topic.