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Mortgage notes vs. Stocks

I want to make it clear that I’m not in favor of mortgage loans replacing traditional investments in an investor’s portfolio. Every investor has a complicated combination of risk tolerance, time horizon, accumulation goals, net worth, and income needs. Therefore, every investor, with the help of a seasoned advisor, needs to find their own appropriate and effective asset mix.

My goal in this section is not to tout mortgage loan investing as a superior option to any other kind of investing, but to help the reader understand how mortgage loan investments stack up against more

investments. Doing this will allow more investors and their advisors to determine the appropriate place for mortgage loans in their portfolio.

I view mortgage loan investing playing a complementary role in a portfolio. These assets help improve diversification and are noncorrelated, meaning they are not affected by swings in the stock market. They add balance for many investors and a source of strong, predictable income for those who need it. But again, I want to stress that mortgage loans are just one component of a diversified, well-balanced portfolio.

Too many financial advisors are discouraged or even prevented from researching alternative investments such as mortgage loans or mortgage loan funds. The pool of what they offer clients is a tiny slice of the investable universe. It often consists only of Wall Street–related investments too volatile for a large stake of client assets and which often don’t address the need for high-yield income generation.

The stigma that alternative investments are “too risky” to recommend makes little sense when you consider that stock investing success relies on a combination of consumer confidence, investor demand, and the willingness of corporations to act in their investors’ best interests. Switch over to high-yield corporate bonds, and you have to rely on the company to make the coupon payments and pay back the principal, something studies show might not be as reliable as you’ve been told.

Let’s take a closer look at some often-promoted investments to see how they stack up against mortgage loan investing. I’ll kick it off with the big one—stocks.


I was first introduced to stocks, which represent shares of ownership in an underlying company, when I was sixteen. My grandfather, who was retired during my entire youth, was an active stock market investor before the internet age. He introduced me to Value Line, an equity research company with a series of hard-bound research and ratings books at the library, very similar to a set of encyclopedias.[1] He taught me what to look for in stocks and how to integrate a stockbroker’s advice. I still remember our experiments of picking stocks, pricing them out per share, and tracking our portfolios.

Trading stocks seemed, to me, overly complicated with no real assurance of success. The whole process seemed more like throwing darts at a board than it did controlled research resulting in successful returns. But my biggest problem with the market was that I didn’t like the stress of having to accept losses.

Take a look at almost any generic asset allocation pie chart and you will see that stocks are pushed as the primary investment for most people during their younger, income-earning years. Why? Because conventional wisdom tells us that stocks grow. And grow. Did you know that if you invested $100 in Amazon back in 1997, it would be worth about $196,635 today?[2] If you invested $100 in Microsoft in 1986, it would be worth about $26,100. That same $100 in Apple in 1980? It would be worth about $106,391 today!

These numbers aren’t untrue, but they are pretty optimistic. Because for every one Wall Street unicorn that’s grown exponentially in forty years, there are thousands of companies that have gone bust. So, sure, $300 spread between Amazon, Microsoft, and Apple between 1980 and 1997 could have given you more than $300,000 today, but $300 in Enron, Compaq, and WorldCom might have given you losses or, worse, nothing at all.

The Problem of Picking Winners

There’s no bright, blinking neon arrow flashing over the stocks that are going to grow over the years, and there’s no specter of doom standing over those that will not. As of 2020, there were roughly 2,800 stocks listed on the New York Stock Exchange and 3,300 on the NASDAQ.[3],[4] Which of the thousands are worth investing in? Probably not many. Just five stocks on the S&P 500, which lists 500 tech stocks, are pulling up the average of the whole index.[5] I don’t know about you, but when it comes to being an individual investor trying to pick winners out of pools that big, I don’t like my odds. And that inclination isn’t just a feeling—it’s backed by facts.

For fifty-five years, the Center for Research in Security Prices (CRSP) has maintained a database tracking historical security prices and returns.[6] Studies analyzing that database have found that between 1926 and 2016, the median length of time securities stayed listed was just seven-and-a-half years before disappearing into obscurity, taking investor cash with them.[7] That’s overwhelming to think about, so let’s go smaller and look at the S&P 500. Between 1980 and 2014, 320 listings had been removed from this list due to “business distress.”[8] And according to J.P. Morgan, a steady stream of these companies faced their distress during times of economic expansion, not recession. The year this book was written, we saw massive volatility thanks to an election, a pandemic, and massive unemployment. Imagine trying to pick a winner with this level of volatility.[9]

All this should help you see that the odds are against you when you try to pick stocks, but I want to throw one research paper quote at you to help drive this point home. When researching whether stocks outperform treasury bills, researchers found that:

“… the best-performing 4% of listed companies explain the net gain for the entire US stock market since 1926, as other stocks collectively matched Treasury bills.”

—“Do Stocks Outperform Treasury Bills?” Department of Finance, W. P. Carey School of Business, Arizona State University, May 2018

It doesn’t take a virus, housing market collapse, or dotcom bubble burst to create losses for individual investors like you and me. Attempting to pick winning stocks is like betting against the house in Vegas. The odds are not in our favor, and most people are going to lose, most of the time. So much so that even highly trained, experienced financial professionals have a poor record of picking stocks that beat the market.[10]

Maybe It’s All In the Timing

Another current stock investors fight against is timing. Let’s look at a portfolio at the tail end of 1997 holding Microsoft, Bank of the Ozarks, and Mattel, all purchased from a broker, using a cell phone with a retractable antenna. But let’s up the ante. Let’s say the investor was fifty-five years old, just ten years away from retirement, and threw $100,000 into those positions. Now, we reach the year 2007, the cell phone has been replaced by a Blackberry, and our investor has a portfolio balance of $366,427 the day they retire.

Almost two years after retiring, in February 2009, just as our investor needed to start liquidating their portfolio to take some income distributions, the market crashed and the value of all their investments fell to $220,841.[11] Now, our investor has to liquidate a higher number of shares early on in their retirement just to get the amount they need for a distribution. This leaves fewer shares in their portfolio, which means less opportunity for recovery and growth when the market rebounds.

The above situation is an example of sequence of returns risk, and it causes lasting damage. Just as compounding interest and returns can drive accumulation, selling a large chunk of shares at a low price (or a loss) early in your retirement can devastate your ability to maintain distributions and live out a comfortable retirement.

Time is touted as a great friend to the stock investor, when it can just as easily be the enemy. Proponents of stock market investing hold out 10 percent as a reasonable expectation for returns, a number that’s often based on growth of an entire index during a historical period.[12] Please tell that to investors who lost their savings with WorldCom,, Enron, and the thousands of delisted stocks removed from the NYSE over the years.

Stocks may have a place in your portfolio. That’s for you and your advisor to determine. For my part, I am uncomfortable with the idea that hardworking Americans can have a large portion of their retirement savings wiped out during one major market correction, and it can take years to regain those losses—if they can at all.

While we do know where the market has been, we don’t know where it’s headed. Of the crashes that have occurred during my lifetime, the one thing they all had in common was that very few of us saw them coming. The stakes are too high to take chances when an investor’s retirement is at risk.

Can we—or should we—expect an average 10 percent stock market return in the future? I don’t know, but if there’s any doubt, I would argue that investors should look at putting a small amount of their portfolio into alternative investments, such as mortgage loans, both to hedge against loss and to provide some steady income security.

Let’s look at yet another not-so-nice gift that time brings to stock investors: volatility.

Volatility and Returns

Most people accept the volatility of the stock market as a natural, unavoidable part of investing. Some even embrace it, under the strategy of dollar-cost averaging. This strategy involves investing a specified amount periodically into a certain stock, ensuring that the investor buys both when the stock price is up and when it’s down. Since the market is impossible to time, dollar-cost averaging ensures the investor buys both during highs and lows, thus averaging out their cost basis and better managing volatility.

Example: Dollar-Cost Averaging

It might sound like a great strategy, but the truth is that the more volatile an investment is, the less successful a portfolio will be over the long term.

Many people don’t realize how seriously volatility can diminish returns. If I asked you whether you’d rather have an investment that had a fixed annual return of 3 percent over six years or a volatile investment with an average annual return of 6 percent over six years, you’d probably choose the more volatile but seemingly higher return. But let’s look at the overall performance of both investments:

As you can see, the more volatile investment earns far less than the slow, steady, lower-return investment. By the end of the six-year period, the volatile position has earned just $76,184, while the steady return has earned $180,000.

Alternative investments like mortgage loans are a great complement to a portfolio because they are not correlated to the stock market and can be effective at strengthening a portfolio by reducing volatility.

A common strategy that I see repeated is investors removing some of their stock market gains during a bull market and placing them into either mortgage loans or mortgage loan funds. Then, during a bear market, they remain confident that a portion of their portfolio that is invested in mortgage loans will continue to provide income.

While I am not condoning an attempt to time markets, which is futile, let’s look at how devastating volatility can be to an investment portfolio over time, and how reducing volatility ultimately means much larger gains.

Issues with Income

Stock market investments are not ideal for income generation; stocks are generally bought for growth and speculation. Worse, you can’t control how the market is doing when you start liquidating stocks for income. That is when sequence of returns risk becomes a very big problem.

In the last section, we talked about the difference between a steady return and a volatile return. Let’s see how that same $1 million investment is impacted when the investor needs to take a $25,000 annual income from it.

You can see that while we still have our $1 million principal in our “steady” investment and we’ve been taking out $25,000 in income, we’ve also been accumulating an additional $5,000 per year. Yet in our volatile investment, we’ve tapped into the principal and our balance has dropped below $900,000, despite an average annual return of 6 percent.

But, you may be thinking, what about stocks that pay a dividend? Wouldn’t those be good for income? Well, that depends.

One of the biggest issues I have with dividends is that companies are not required to pay them and can revoke them at any time. For many years, Microsoft was under fire for deciding not to offer a dividend, despite having a profit.[13] While they reinvested this money into the business and the value of the stock grew, investors who were hoping for a dividend were out of luck. Not only are dividends not guaranteed, but dividend-paying stocks can go bust, or companies can simply suspend dividends, like Dunkin’ Donuts and General Motors did in 2020.[14]

When investors look for dividend stocks to create regular income, they often change the parameters around their assessment of a stock. Instead of measuring risk and potential the same way they would a growth stock, they instead consider only the dividend potential. Worse, evaluating stocks this way can actually hurt overall returns as dividends can reduce stock prices.[15]

The most common way for investors to make money in the stock market is to sell shares for a higher price than the price at purchase. Sounds simple enough, but without the ability to time the market and without any meaningful control over company decisions, we have no way to create a positive environment for stock ownership. Worse, we, just as everyone else, are victims of the whims of the market—which means that even if a company is doing well by all measures, if consumer sentiment is against it, the price of its shares can plummet, just when we most need them to rise.

Stocks have their place in the portfolios of many. They offer opportunities for growth, intermittent income, and—when you’re lucky—meteoric rises, if you’re willing to take on some pretty major risks. Mortgage loan investments, on the other hand, remove the instability and costs of volatility while generating a predictable income/yield, with no exposure to market risks.

[1] [2]Yahoo! Finance. Prices accessed 8/30/2020. [3] [4] [5] [6] [7] [8] [9] [10] [11] [12],since%20its%20inception%20through%202019. [13] [14] [15]

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