(beeping) Welcome back to Ask The Compound, where I think we have one of the most intelligent audiences in all of financial entertainment. The people who ask the more in-depth questions have always done their homework. The people who ask more general questions seem to always be on the right path, so I like that we get a kind of mix of the two.

We're gonna talk about a mix of those two today. Remember, if you have a question for us, email us, askthecompoundshow@gmail.com. Today, we are sponsored by our friends at Bird Dogs. One of the things I like to do in the summer, I like to be a little active, so I take the kids on a bike ride once or twice a weekend, and I like to be both stylish and comfortable because I'm riding the bike, and I still have one of my little ones on the back with me, on those little trailer bikes, you know?

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I had a friend last week, said, "What are those shorts?" I said, "Oh, come on, these are Bird Dogs." Get yourself a pair, so I think I talked him into them. Remember, if you go to birddog.com/atc, you get one of these free tumblers, which is kind of nice. You got one, too?

- I remember mine today. - Do we still have to use the code to get it or not? - No code, just the URL now, /atc. That does it. - Screamin' deal. All right, let's do a question. - Yep. Okay, up first today, we have, "I'm in my mid-30s and my business "has done very well over the past three years.

"I'm trying to decide what to do with the savings "I've stacked away in a high-yield savings account. "I was planning to pay off my $150,000 student loans "and invest the rest, "or I could pay off my $500,000 3% mortgage, "but I can't do both. "I'm weighing my options here while considering "that a recession could significantly reduce my income.

"Which option is going to give me "the biggest nest egg in retirement? "Pay off my mortgage and use my mortgage payment "for investments, pay off my student loans, "and dollar-cost average into investments. "Keep my mortgage, make monthly loan payments, "and DCA, dollar-cost average, into investments." - Now, I feel like we're kicking this off with a not-to-brag today, but do the six figures and student loans also counteract that not-to-brag?

And make it a little bit, right? - Yeah. However, it means that maybe they're pretty highly educated, so maybe that's a form of not-to-brag. - It sounds to me like the student loans were a pretty good investment. So let's go through each. We've got three options here. Let's go through 'em one by one.

Pay off the mortgage and use mortgage payments for investments. I don't like this one one bit. I'm anti-pay off 3% mortgage. I have been for a while. I just see no reason to get rid of that when inflation is so high, interest rates are so high. I mean, yes, it would free up monthly payments, but why would you decrease your liquidity, especially if you're worried about what a recession might do to your business for variable income?

Plus, that 3% mortgage is currently below probably what you're earning in your online savings account. Put that in T-bills, you're talking about 5%. I mean, you're essentially paying for your mortgage if you're doing that, and you have some left over. So I think either one of those options. I just, I don't like paying off the 3% mortgage.

It makes no sense. I mean, I just, over my dead body, I'm letting go of this 3%. I wish I could like extend it to like 90 years and just never pay it off. So, I mean, you could dollar cost average into the market, but why would you do that with your monthly payments and not just do it with the cash?

So the next one is pay off the student loans, but then you have some more money. I guess if this person can pay off their 500K mortgage, they have a decent amount of money. Saved up. So you pay off the student loans and then you DCA. This one depends on your rate for student loans.

Are they more than say, I don't know, 5%? At that level, maybe it makes some sense to pay them all off. If they're below 5%, I think I might hold off a little bit, unless that debt makes you just violently ill. I just don't see the rush when interest rates are so high and inflation is so high.

The third one is keep the mortgage, make the payments, DCA into investment, right? Keep all the debt. If you're okay keeping the debt, this probably makes the most sense with a caveat. Like you mentioned, the potential recession could reduce your income. So I think if you're in a cyclical business with a variable income like this, maybe increase your margin of safety and have a little bit more of an emergency fund.

So I'd keep a cash cushion, potentially. But there's another option too, where you don't have to make one big decision with the money. There's no one forcing you with a gun to your head, saying you have to do this. Pick one, two, or three, door one, two, or three, right?

You could pay off a small chunk of your student loans. You'd set aside some money for an emergency fund. You could even do a small lump sum into the stock market and then dollar cost average the rest. So you don't have to make one choice. You could kind of diversify your options, which helps minimize the regret, I think.

But I don't know. It sounds like you're in a pretty good place to me. And if the yields on those loans or the interest rates on those loans are still pretty low, as long as you're okay holding the debt, I see no problem holding that for a while. And then you can always pay it off in the future as well.

You don't have to make a rush decision now. - Right, yeah. And they mentioned that, you know, given the current environment for student loans, but yeah, we don't really know what the future holds, so it's hard to bank on. - Yeah, they kind of said people, you know, the government's been pretty, you know, liberal with student loans lately and payments.

And yeah, I don't think there's a rush to do that, but especially a 3% mortgage, when T-bill yields are higher than that, that just, I don't see how that ever makes sense in today's environment. - Yeah, and so as far as debt goes in general, what is your number of like where you draw that line?

- Well, T-bill yields are 5% right now, right? That's a pretty good place to start, I would think. Right, because that's your hurdle rate. Let's do another one. - That question's from Zachariah, by the way. So up next, we have a question from Casey, who I recognize from social media or the chat or somewhere.

So Casey writes, what's the incentive here to buy AAA corporate debt versus just buying U.S. treasuries that are yielding slightly higher and are risk-free? Is this normal? - Casey, a very astute member of our audience here. No, this is definitely not normal. John, do a chart on. I have good data for the Federal Reserve on AAA-rated corporate debt and three-month T-bills going back to 1934.

So the average spread of AAA corporate bond yields over T-bills is 2.4%. We've had T-bill yields higher than corporate bonds before, but it only happened in the early '80s and the 1970s, which makes sense, like now, inflation was much higher, interest rates were rising. However, this is very rare to see this.

So there's almost 1,100 months in this data. These are month-end data from the Fed. By my calculation, 33 of those months saw T-bill yields greater than corporate bond yields. So we're talking like 3% of the time. This is very rare to see an inverted yield curve between short-term treasuries, ultra-short-term treasuries, and corporate bonds.

So why should there be a spread? 'Cause corporate bonds are riskier, right? In corporate bonds, the default rate is relatively low, but businesses can and do get in trouble, and you could have some defaults. You also have the potential for getting downgraded from that triple-A rating, going into double-A or single-A, and then maybe, or high-yield, even.

And at that point, the bond price is gonna get disrupted, and corporate bonds have a much higher drawdown risk than treasuries, especially short-term treasuries. So John, do another. We'll throw a second chart on of the day. This is just the drawdown profile for LQD, which is a corporate bond ETF, versus BIL, which is a one-to-three T-bill ETF.

And you can see in 2008 crisis, corporate bonds fell 17%. They fell 20% in the corona panic, and then they fell 25% last year when the Fed cut rates. So those other two ones, it was relatively quick. You had this huge V down and V up, and that happened mostly because people were panic selling back then.

They only wanted to own treasury. So corporate bonds got dinged. But this is the kind of thing in corporate bonds, you can get dinged like that during a financial crisis or a panic situation. So if the question is, do corporate bonds make sense right now relative to T-bills? No, they don't.

The yields are higher in T-bills, and you have much less volatility as per interest rates. But we don't know how this, that's short-term. Short-term T-bills make a lot more sense. But long-term, corporate bonds still should, if there's any relationship between risk and reward, and I think they are always attached at the hip, although sometimes they break up.

They go on a break, Ross and Rachel style. They still have those Friends reruns on all the time on TBS. So I just saw that we're on a break one the other day. Sometimes risk and reward go on a break, right? And don't get me in the comments here about how Friends is overrated.

We had like 100 million people watching that show back in the day. I mean, hey, if Michael can say that Steve Carrell's not funny, then anyone can say anything. You know what I mean? Nothing is properly rated in the internet era anymore. John, do another chart on here. This is my table of long-term performance of different bond yields.

So we're talking long-term corporates, long-term government bonds, five-year treasuries, and three-month T-bills. And the reason I wanted to show this is because you can see the highest returning asset is corporate bonds over this period from 1934 to 2023. Next comes long-term government bonds, then five-year treasuries, then three-month T-bills.

And this makes sense. And you can see the volatility kind of goes in the same order as well. I was a little surprised to see long-term government bonds more volatile than corporate bonds, but they're still in the same ballpark. So this makes sense because risk and return, especially in bonds, are attached to the HIP where if you're gonna earn a higher yield, you should expect a higher risk and especially higher volatility.

So I don't expect this current situation to last. I talk about how rare it is. This situation has basically been caused by the pandemic and government spending and the Fed. And so in the short term, things are weird and out of whack, and it seems like T-bills are the right choice to make.

Over the long-term, you'd still expect corporate bonds to have higher long-term expected return once rates somehow normalize, if there is such a thing. Now, what are you supposed to do with that information as an investor? You could just change your allocation based on the risk reward profile all the time, or you could stand pat and say, you know what, I'm not gonna try to guess.

I'm just gonna pick an allocation and fix something that works for me, and I'm gonna stick with it. And I think you just have to do what works for you. That's kind of where I fall down on this. I don't think there's a right or wrong answer here. - I have maybe a dumb question, but a junk bond, is that always a corporate bond, or can it be like a sovereign bond of a really risky country?

Is it like a yield or what? - There are emerging market bonds, which could be sovereign bonds, but high yield is typically corporate bonds, just lower rated corporate bonds. So same thing, just a higher default rate in much riskier companies. - So perfect for my portfolio, is what you're saying?

- You could buy some oat milk high yield bonds probably. - Okay, I might look for that. - Okay, up next, we have a question from Eric. One of the biggest tells for the housing bubble in the 2000s was the income to housing price relationship. I'm pretty sure Michael Lewis even wrote about this in the big short.

I know the housing market is different this time around, but there is no way incomes have kept up with housing price gains, which are even bigger this time. Help me understand how this is not another housing bubble. This always sends a shiver down my spine just because that was such a rough period.

I graduated college right in the middle of that. It was not good. - I think one of the first people I ever saw write about that relationship of incomes to housing was our very own Barry Ritholtz. Let's bring him in to help out on this one. Barry, you were writing about this.

Was it for the street.com or the big picture? One of those two, I can't remember. - That was probably the big picture. I was writing "Bailout Nation" on the blog chapter by chapter. I'd throw up a couple of paragraphs. People would say, have you seen this data? What about this chart?

What about this guy? And really, I had like a thousand co-authors. So it was really helpful. Remember back in the 2000s, the big driver of the bubble. First, it was really more of a mortgage bubble than a housing bubble. But the big driver was securitization. We're gonna take all these mortgages and slice and dice them and spread out the risk.

But what fed that demand, what really drove that was all of these non-bank lenders that were popping up and writing mortgages for everybody. Remember all the nomenclature back then, the ninja loans, no income, no job, no assets. Yeah, exactly. No docs, stated income. The traditional FDIC banks weren't allowed to do that.

They had to do conforming loans. But all the crazy loans, the 228, zero interest for the first two years, all that stuff came from the sort of, calling it the shadow banking sector is wrong. These were just non-bank lenders. And when you drop lending standards to zero, well, guess what happens?

You're gonna give a ton of people access to capital that wouldn't have. It also, adding to the flame to the fire, was you had a period of flat wages while everything gradually increased in price. It wasn't very inflationary, but over time it adds up. And so people hate lowering their living standards.

And so people were taking HELOCs and people were refinancing or just flipping houses. And that was credit-driven. When you look at today, you have two problems. One is after the financial crisis, builders just pivoted to apartments and multifamilies and underbuilt single-family homes for almost a decade. Depending on who you listen to, either the real estate agents or the Builders Association or whatever, we're two, three, four million houses short relative to how many new households and new people we have in the country.

We're well over 330. - The irony of the last bust is that it helped create this boom, essentially, 'cause they didn't build enough 'cause everyone was so scared. - The fear of the last bust sent builders into apartment buildings and things like that, which by the way, arguably, we don't have enough of those, but there's a giant shortfall.

The pandemic certainly helped create. People were buying second and third homes out of their primary city. Today, you have two problems. So you have too little supply. And then making that worse is when the Fed raised rates, hey, if you have a 3.5% mortgage, you're talking to the earlier question, a 3% mortgage, you're gonna be really reluctant to say, I'm gonna sell this and buy another house where my mortgage might be 6.5%.

That's locking a lot of people in place. Perversely, the higher rates are causing, to some degree, higher home prices and higher rental prices. It's really a challenge. I think the Fed has kind of raised as far as they should. Otherwise, they're making the housing situation worse. So this is not so much a bubble problem or a demand-driven problem as it is a supply problem.

We just need a whole lot more housing. - And the other part, John, throw up the mortgage origination chart here, my credit score, do the next, there you go. And so this shows people taking those mortgages in 2020 and 2021 had much higher credit scores. So the people who are sitting in these houses, even if housing prices were to drop 10 or 20%, like some people want to see happen, those people are still gonna be able to make their payments unless they lose their job.

So that's the problem. Last time around, we saw all these people who couldn't make their payments. They're having these mortgages reset higher 'cause they took on the adjustable-rate mortgages. This time around, it was mostly fixed-rate mortgages. And so the people who have been buying homes are also much higher-quality borrowers.

So it's not just the lending standards, it's that the borrowers themselves are in a much better position. - Yeah, look at that light blue. Those are all your best 760 and up. When you go back to the period before the financial crisis, they're a fraction of the borrowers here.

They're the vast majority of the borrowers. - Yeah, so, right. It seems like if you just took prices alone and you mapped 'em onto what happened the last time around, you'd think this has to be worse 'cause prices are up more, but it's a much different situation. And it's probably more frustrating for people who want to see prices crash, like Duncan.

- Yeah, yeah, I mean, it's unimaginable to buy a home right now for a lot of us. - It's tough. - We can dream. Not that we wanna GFC again, but prices to come down. - Right, okay. This next question actually is someone who is thinking about buying a new house.

So let's see this one. Okay, up next we have a question from Zach. "My wife and I do fairly well, "but I'm a classic conservative planner/spender "and struggle to upgrade our life "or know when it's prudent to do so. "I would love to get a bigger home for our kids "as they grow, but also don't want to be irresponsible.

"I'm 36 and make $300,000 a year. "My wife is 34 and makes $85,000. "We have $125,000 in brokerage/savings "and $400,000 in retirement. "I have $750,000 in equity at work, "but it's a liquid for the foreseeable future, "three plus years, though it does pay "a monthly distribution of $2,500, "which we currently save.

"We have a modest home, 1,500 square feet "with a $2,500 mortgage and about $400,000 in equity. "We pay $15,000 a year for private school "and would like to not be house poor." Second page. "The problem is that we live in Orange County, California "and upgrading to a 2,000-square-foot pool home "would be in the mid-$1 million range, "and today's rates don't help.

"I'd love to keep our home and rent it, "but we'd be really cash-strapped without a HELOC, "and I don't think we want the headache of being a landlord. "I'm completely paralyzed to make a move. "My kids are eight and five, "and I would love to give them a fun house "to grow up in for the next 10 years, "but I'm also trying to be responsible.

"I'm well aware that I'm blessed to be in this position, "but it weighs on me nonetheless." - Okay, so as we mentioned in the last question, this is probably the worst time ever to be a homebuyer, supply being low, mortgage rates being high. The good news is this person has some home equity, but as with most things, there's a trade-off, especially when you're living in California, right?

You could stay in your current house and sacrifice size, or you could move to a more expensive house and probably sacrifice some savings, or maybe move somewhere else, but then you have to give up on living in Orange County. So this is obviously more of a psychological question than it is a financial one.

This person seems to be doing very well financially for someone in their mid-30s, so it's really like how do I get over that psychological hurdle of, I know that there are going to be trade-offs, and I know that whatever move I make, I'm gonna have to be giving up on something.

So what is that thing? So how do you think about making financial decisions when you are kind of paralyzed and you know, I have this thing tugging me this way, but this one tugging me the other direction, and I can't figure out which one is which? - You know, you hinted at it.

All these decisions involve just two simple aspects, human psychology and math. So if you're wrapped up in the psychology, do the math first. All right, they have four, first let's get being a landlord out of the question. When my wife and I got married, she was living in a co-op, she moved into my apartment in the city, we were a landlord for 12 years.

It's a big pain in the ass, it's a job. - It doesn't sound fun to me. - And you really, you know, if you're busy, if your career is throwing off that much money at a young age, focus on that, not a side hustle for this particular person of being a landlord.

It's really a job, and you probably have other things you wanna do with your time, so that's number one. Number two, the math sounds like, A, if they wanna renovate their house, spend a couple hundred thousand dollars, a HELOC is a really easy way to go. They have a ton of equity, they're not gonna cash-strap themselves, so that should be a no-brainer decision.

The real question is, hey, do we wanna move out of this house to something that's a million and a half, $2 million, and that really depends on laying out a budget, looking at what you're spending, and saying, do we wanna do this? It looks like they'll be able to roll a half a million dollars or so out of this house between their savings.

- And there's a down payment right there. - Right, so in other words, it's not like they're going out and dropping, hey, I'm gonna take a 7%, $2 million mortgage. If they move to a house that's a million and a half dollars and they're taking a million, they're putting half a million dollars down, well, even at 6%, it looks like 5,000 a month won't make them cash-poor, but they have to get past the psychology.

If they feel like that's gonna be too much and that's gonna, then stay where you are, do a HELOC. Listen, when we moved into the house we're in now, which was a debacle and needed everything, we knew that going in, we just were, every year we took a HELOC, we did a project, we'd pay it down as fast as we could as soon as the HELOC was down to around 10, 20 grand, we'd do the next project, and every time you need a new roof, you need new windows, you have to replace all the flooring in the house, you have to, I mean, this was a real project house, the only way we could afford it was it probably would have been double what we paid for if it was in nice shape, and we got to do it the way we wanted to over time.

So if they wanna stay where they are, HELOC is really easy to do. - Yeah, that's why-- - As long as you manage it and you pay it down quickly. - If you're in a position of already owning a home and you have equity, you're in a way better position than a first-time home buyer, sorry, Duncan, but 'cause you have that equity to play with where you can use it as a down payment or for the current house to fix it up.

So I'd say, yeah, I would use that equity and then you can slowly pay it off, you don't have to pay it off right away, and then you're not having to touch these other forms of income, and then if you have that equity come through from his job, that sounds like it's a ton of money, you can pay it off with that eventually.

- Just keep in mind, by the time they have a liquidity event for that job, typically the tide is raising all boats and that might be sending home prices up 'cause he won't be the only person having that windfall. So that's always the trade-off, is you have to think a couple of steps ahead.

Hey, when my ship comes in, are lots of other ships coming in and the prices are gonna go up? So it seems crazy to think that at this hour, I'm gonna be able to lock in $2 million as a ridiculous home price. Nobody knows what they're gonna look like 10 years from now.

- I'm guessing California has the most challenging state of all in terms of making these housing decisions. - Especially in areas like Silicon Valley and near LA and San Diego. There's still pockets that are less expensive, but it's expensive for a reason, a lot of people wanna live there.

- Right, all right, we got one more, Duncan. - Question about that real quick though, what's the size square footage-wise that a family of four really needs, you think? It's very skewed for me in my mind because I lived in a 385 square foot place during the pandemic, so.

- I had a 400 square foot apartment that was essentially a fridge and a bed and a bathroom. That was way back in the day. - We had a pocket door, we had a pocket door. - Depends if your kids are okay with, give 'em the pool, they'll probably take less square footage because that counts as part of the house in California.

- And that's the nice thing about outdoor living is you don't need a giant house if, especially in places where the weather's so nice, you could be out all the time. That said, 2,000 square feet gives you a guest bedroom or a home office or a little breathing space.

Sometimes if, especially these days where people are working remote, kids underfoot, it's not easy. So you could see why there's a desire for a little more elbow space. - Our debate on Animal Spirits was what size house gives you a mansion? And we landed on 5,000, so I say cut that in half.

- That's my number, 5,000, right. - 2,500, cut that in half. 2,500 is probably good for a family of four. - 5,000 is just giant. And by the way, if you wanna live in certain areas and you don't want a giant house, you want a small house on a lake, on the water, in the mountains, everybody is building these immense things.

There's no, you know, 2,500, 3,000 square feet for a couple that's downsizing. The kids are out of the house. Really hard to find things like that. - Yeah, unfortunately. - Also, personal finance tip. Give the kids the choice. Would they rather have a pool or go to private school?

You know, let 'em pick. (laughing) - There you go, got those lessons early. - All right, up next we have a question from Cameron. What are your thoughts on what will happen to the economy when $18 billion in monthly student loan payments are turned back on? It seems as though it will significantly affect consumer spending and savings.

- We've got a number of questions on this. So I think there's something like 27 million borrowers that were part of that moratorium, put their payments on hold. The idea is those people have turned those savings into spending, right? That was a boost for a lot of people, helping make it through.

Now it's been a couple years, and it's gonna be hard for those people to go back to making the payments again. And friend of the show, Sam Rowe, put together a compilation of these estimates on his sub-stack. JP Morgan said it's gonna be like 0.1% of GDP. Goldman Sachs said like 0.2% of GDP.

I think a couple of them said, you know, handful, it's like a handful of basis points. Sorry, not 0.2, but like 0.02. So it's a handful of basis points. And John, throw up the chart here of total household debt. Total household debt's like $17 trillion. Student loan is 1.6.

That's pretty close to auto loans too. Mortgage debt is the big one at 12 trillion. So student loan debt is like 9% of total debt. But then you also have to take the percentage of those people in student loans who are going to have trouble making the payments. And I think that's where the rub comes.

A lot of people think everyone's gonna have trouble making those payments, and I don't think that that's going to necessarily be the case. So I think a lot of people would like to see this be like an end times thing, and I think it's gonna be a much smaller impact than most people assume.

- So let's put some meat on those bones. The U.S. economy is about 23 and a half trillion dollars. 2/3 of that is consumer spending. Let's call that 15 trillion dollars. And the question was 18 billion with a B. 18 billion a month. You're barely up to 216 billion dollars if everybody has problems.

And you know that the vast majority of these folks aren't gonna have problems. So this is a rounding error. And this is also one of my favorite pet peeves, which is people looking at the liability side of the equation, but not looking at the asset side. What matters isn't total debt, because every year there's more people, there's more debt.

Debt is always at a record. It's a scare chart. What you really wanna look at is the ability for individuals to service that debt. What's the ratio of total debt to discretionary income? And it plummeted following the financial crisis, and then went down even more after 2020 when a lot of pandemic money flowed into people.

- So I'll share that chart with you guys. It's really very, very manageable. Now when it reverses, when the discretionary income to debt spikes, it's telling you people are having a harder time carrying their debt and managing it. But all these issues, it's called double entry accounting for a reason.

Liabilities on this side, assets and income, the ability to pay. On the other side, if you look at one without the other, you're only getting half the picture. - I showed the total liabilities at 17 trillion. The Fed publishes this once a quarter. The last one they have is through March.

Total assets in this country is like 141 trillion. - Crazy, right? Giant, absolutely, absolutely giant. I'll find this. Just look for it on Fred. Discretionary income to debt, and it's just been falling. It's ticked up a little bit since post-pandemic, but it's so far below where it was pre-2010.

It's a different world. - And I don't mean to make judgments on a big group of people, but if you have a high student loan balance, you probably haven't been a huge part of the economy anyway in terms of spending, right? And most of the people who have student loan debt are young, so they probably aren't really steering the economy as it is in terms of spending.

So those people aren't going to have a really big impact either way. - Except on, I'd say a lot of independent coffee shops around big cities are about to have a real tough time. - They're just there for free Wi-Fi anyway. Let's talk-- - Yeah, it's true. No, that's what I'm saying.

Someone sits there for three hours, they bought a $5 coffee, and now they're not going to be able to pay that. - That's true. - People will find a way to manage that. I'm pretty confident of that. - Okay, no show next week because of the holiday. We're taking the week off.

I think we do have Animal Spirits next week. Maybe, is that the only thing on the compound next week? - Oh, no, no, no. We've got TCAF. We've got a special release on Monday, actually, for July 4th. - Okay, so we got other stuff going on. - So yeah, we got a lot.

Yeah, that's why we're not doing this, though. We're not doing this, the compound. - Yeah, good thing. Thank you to Barry, as always. - Yeah, thanks, Barry. - Check out Barry at The Big Picture and at Bloomberg. You can email us, askthecompoundshow@gmail.com. If you have a question, always, again, feel free to send us a voicemail.

That was kind of fun last week. Leave us a review, subscribe, all that good stuff. Leave us a comment on YouTube, and we'll see you next time. - Thanks, everyone. (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) (upbeat music) you