Don't Pay Off Your 0.5% Mortgage!: Asset Management in the Age of Inflation

Serious Japanese people tend to think, "Debts should be paid off quickly." However, current variable interest rates at Japanese net banks are at an abnormally low level globally, around 0.3% to 0.5%. In this environment, making prepayments must be called a "mistake" from a financial perspective.

The Problem: Value of Money and Opportunity Loss

Suppose you prepay 1 million yen on your mortgage. If the interest rate is 0.5%, the interest you save annually is only 5,000 yen. On the other hand, suppose you invest that 1 million yen in global equities (All Country) through the new NISA, earning an average annual return of 5%. The profit is 50,000 yen. The difference is 45,000 yen. This is "opportunity loss." The key here is to understand that the low interest rate on your mortgage means that the benefit of prepaying is significantly reduced, while the potential returns from investing in equities are much higher.

To illustrate this point further, consider the following example:

You have a mortgage of 10 million yen with an interest rate of 0.5%.

You want to prepay 1 million yen.

By prepaying, you save 5,000 yen in interest per year.

If you invest the 1 million yen in global equities instead, you could earn 50,000 yen per year.

Over 10 years, the difference in returns would be 450,000 yen (45,000 yen per year x 10 years).

The Pain: Inflation Melts Debt

Inflation has started in Japan too. As prices rise, the value of cash decreases, but the value of debt also effectively decreases. Continuing to borrow money at a 0.5% interest rate while converting your cash on hand into inflation-resistant assets (stocks or real estate) is the strongest inflation hedge (defensive measure) an individual can take. Rushing to repay means throwing away this hedge yourself.

Inflation can be a significant factor in reducing the burden of debt. For example:

If you have a mortgage of 10 million yen with an interest rate of 0.5%.

Inflation is 2% per year.

Over 10 years, the value of the debt would decrease by approximately 1.8 million yen (10 million yen x (1 - (1 + 0.02)^(-10))).

This means that the effective burden of the debt would be reduced, making it even less beneficial to prepay.

The Solution: "Accumulating" Instead of Repaying

The strategy is simple: 1. Pay only the "scheduled repayment (monthly minimum)" for your mortgage. 2. Direct the funds you intended for prepayment into index funds in the New NISA. 3. In 15 or 20 years, if interest rates skyrocket, you can simply sell part of the accumulated investment trusts and repay in a lump sum. Keeping liquidity (assets that can be converted to cash) on hand is true risk management.

By following this strategy, you can take advantage of the low interest rates and potentially higher returns from investing in equities, while also maintaining a hedge against inflation. It's essential to remember that the goal is to maximize your wealth over the long term, rather than simply focusing on paying off debt as quickly as possible.

Verification with Amorti

Paradoxically, let's confirm that the effect of prepayment is "low." 1. Set the interest rate to 0.4% in AmortiApp. 2. Simulate a prepayment of 1 million yen. 3. You will be surprised by how small the "Total Interest Saved" is. Look at this number and rest assured that "I don't need to pay this back." Then, put that money into investments. Fully utilize the privilege of low interest rates.

Some key takeaways to consider:

Low interest rates reduce the benefit of prepaying debt.

Investing in equities can provide potentially higher returns than prepaying debt.

Inflation can reduce the burden of debt over time.

Maintaining liquidity is essential for risk management.

Using tools like AmortiApp can help you visualize the impact of prepayment and make informed decisions.

By understanding these concepts and adjusting your strategy accordingly, you can make the most of the current low-interest-rate environment and work towards achieving your long-term financial goals.