The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Cheddar Stacker on July 20, 2014, 09:52:10 PM
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Since this is nearly a daily question on the forum, I'd like to get a barometer as to where the majority lies on this question. Selfishly I'd also like to just provide a link to this poll every single time the question is asked so I can stop answering it. Obviously there are many variables that could effect your decision including:
1) Fixed or variable interest?
2) How high is the interest rate?
3) Is it tax deductible?
4) Do you get a company match on your 401k?
5) Are you maxing out your 401k?
6) What is your tax bracket?
7) How long until you retire?
8) How long until the debt will mature?
9) Is the stock market, AHEM, overvalued (just joking, ignore this one)?
Well I want you to ignore all that crap because there are just too many variables. Just assume it's not a hair on fire credit card type situation, and everything else is within the range where a reasonable person would ask themselves this question.
I'm going to delay my vote a bit so I can see what others think, but if you've been around a while you likely have a good idea where I stand.
So which camp are you in?
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I'm not an expert on these things, but it seems like a simple matter of asking whether the interest you'd get from investing would be more than the interest you would have to pay on the debt. Am I missing something?
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I'm not an expert on these things, but it seems like a simple matter of asking whether the interest you'd get from investing would be more than the interest you would have to pay on the debt. Am I missing something?
The interest on the debt, presuming it's a fixed rate, is a known quantity. The "interest" (read "return on investment" or "ROR") you'd get from the investment is completely unknown. You can use historical averages as a baseline, but you are taking a risk that "past performance is indicative of future results" unless you are talking about buying some bonds or CDs.
Make sense?
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I am okay with having up to two debts, that meet the threshold decision of lower than investment returns. E.g. much less than 4% interest.
After that it is hard to keep focused on you goals... Tendency is to juggle accounts creatively to justify simply not saving each and every day. Too much working the 'angles' while pretending MMM when you have more than a couple of debts.
Everyone on this forum excluded I am sure... This only applies to me and people 'out there'.....LOL
Therefore, I tend to be on the pay off debt side, before investing even when the loan rate is low.
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Thank you!!!
Seriously, chedder..thank you!!!
I go back and forth between the two choices daily...shit, hourly sometimes...ggrrrrr...hoping this helps me decide once and for all ;)
Maybe..
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Pay off as much higher interest debt as you can, as fast as you can, and then snowball the money on investing.
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I have a bit of a debt situation which is unusual and would love to hear your opinions.
I am a uni student in Australia and incur about $5k (usually around $4.6k but $5 k keeps it simple). I save pracicaly the same ever semester by working. My loan is indexed to inflation whilst I'm still at uni and only indexed once a year. Once I finish uni it will be indexed to the government bind rate with a max of 6%, I imagine it will be around the 5% to 6% mark most of the time.
Now for the catch, any lump sum payments I make are given a 5% bonus, so if I were to do a lump sum payment of $1000 I would have $1100 of debt removed. This deal is good for the entire period of the loan.
At the moment I plan to save by investing in index funds and destroy the $40k of debt I will have in the first year and a bit of working (will be a teacher starting on ~65k + superannuation, hopefully a tad more). However I change my mind on my approach often, to the point ihave 4k waiting in a savings account for me to decide what to do.
So what would you all do?
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Thank you!!!
Seriously, chedder..thank you!!!
I go back and forth between the two choices daily...shit, hourly sometimes...ggrrrrr...hoping this helps me decide once and for all ;)
Maybe..
You're welcome!!!
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Now for the catch, any lump sum payments I make are given a 5% bonus, so if I were to do a lump sum payment of $1000 I would have $1100 of debt removed. This deal is good for the entire period of the loan.
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So what would you all do?
The way you explained it there is around a 15% swing if you don't pay lump sum. Pay off as much as you can at that rate.
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I'm not an expert on these things, but it seems like a simple matter of asking whether the interest you'd get from investing would be more than the interest you would have to pay on the debt. Am I missing something?
Plus the tax you'd pay on the investment income. Which is why for me and hubby, I choose pay down debt. I could be wrong but it's what I'm comfortable with given our situation.
If it's a tax deductible debt this is misleading. You should compare your after tax income to your after tax expense. So assuming 4% debt (tax deductible), 4% ROR, and a 25% tax bracket, both of them net to 3%.
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Folks mean two different things when they ask this question: 1) How do I think about the math and opportunity cost? OR 2) I understand the math, but is it okay if my gut prefers prioritizing one over the other?
The answer to #2 is always "Sure, why not?" as long as you really understand the math. If I had debt with a reasonable interest rate and zero assets, I would need to invest before I could really hit the debt hard. I understand the opportunity cost, but I would need to feel like I had upward momentum before I could throw my money into the debt pit. If I incurred debt today, I could go right into pay off mode because I already have investing success under my belt.
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I think that there is no valuable answer to this question that doesn't rely on the variables that you're excluding.
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I am okay with having up to two debts, that meet the threshold decision of lower than investment returns. E.g. much less than 4% interest.
This.
My general rule is to maximize the guaranteed return (i.e., debt payoff) before investing in something uncertain like equities (even though I know that the market always goes up (http://jlcollinsnh.com/2012/04/19/stocks-part-ii-the-market-always-goes-up/)). Since the beta/volatility on personal debt will always be zero, my rule of thumb is to pay that off first before making investments. Keep in mind though--as Cheddar Stacker mentions in point #4 of the OP--a company match on the 401k is also a guaranteed return. So unless you're only getting something like a 20% match while carrying CC debt at 25%, you should max the 401k company match first.
That said, as goldielocks mentions I do have an investment threshold where I'll prioritize investing over debt payments. My mortgage is fixed at 3.25% and is tax deductible to boot. Plus, I do consider the house to be an investment. It's not a high yield investment, and considering that I lost money on my house when I moved out of Cleveland in 2008, it's certainly not a risk-free investment either. So when I weigh the <3.25% return on extra house payments against an average return of 8% from the S&P500 I'm happy to stick to the mortgage's 15 year payment plan.
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Small sample size so far with 36 votes in, but I'm very surprised to see 2:1 debt to invest.
For those of you who would elect to pay down debt I have some genuine questions for you:
-What is your stock/bond ratio if you are holding investments?
-Do you see a major difference between paying down a fixed interest debt or investing in a bond?
-If you are an aggressive investor with a mix of at least 75% stocks, why would you take a conservative approach with your debts?
The only answer I can come up with is one I was faced with myself a few years ago: When your current cash flow can't service your debt load, it's clearly time to get rid of some of the monthly payments somehow. Does anyone else have another solid, logical reason for paying off debts other than the standard "it's a psychological win"? When I hear that, I think of a car warranty. It makes you feel warm and fuzzy, but it doesn't really do much for you.
Obviously there is no wrong answer here and it's a personal choice, I just thought this forum would be closer to 50/50 based on previous answers I've read.
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I think that there is no valuable answer to this question that doesn't rely on the variables that you're excluding.
Fair point. It's a case by case basis, but there are too many variables to hone it in any further. I will find value in the poll as written, otherwise I wouldn't have written it the way I did. Hopefully others will as well.
What I'm asking is for you to fill in your own variables that fit within a range where you are considering both sides, then vote. If you choose not to participate I will not be offended.
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I think investing is more important than debt paydown (given a reasonable level of aggregate debt). Why?
1) Pay yourself first. Investing is truly paying yourself, while debt paydown is paying for past (and current) indiscretions (I use that term loosely as most need a roof over their head and wheels to get to work).
2) If you pay yourself first (say 20% of take-home), then you are still obligated to make your debt payments which are amortizing your principal outstanding. So your debt is being reduced, however very slowly.
3) I believe it is good to be "hungry", meaning having as little extra disposable income as possible makes one more efficient and a harder worker. This ensures you show up for work, make sensible spending decisions, and such. I appraise businesses for a living and I can tell you that managers/owners that are flush with cash tend to waste it, while those with a manageable amount of debt are lean, efficient operating machines.
4) For those who believe in MMM, if we invest first, we will still have a burning desire to paydown our debt, and will/should strive for it.
5) Generally, the market has significantly outperformed most debt prices in the last decade (generally anything less than 5% interest is a pretty cheap borrowing cost).
While I am against debt, and believe it should be reduced/paid-off, I do believe paying yourself first is more important.
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I can't vote on this question without factoring interest rates! I can't!
It matters!
If you have $100,000 of student loans at 2% interest, then screw paying it off. Let that debt ride into the sunset!
My mortgage is at 4%. I'd love to have a paid off house. But I had an average of 30% gains last year in my investments. It would have been foolish to pay off my house. And yet I have a 10 year mortgage - I didn't go out and refi to a 30 year just so I could invest more.
How could I vote on this?! Ahhh! My brain is exploding!
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I voted invest, particularly since someone with appreciable debt likely isn't maxing out registered accounts.
But it does really come down to the details.
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I can't vote on this question without factoring interest rates! I can't!
It matters!
If you have $100,000 of student loans at 2% interest, then screw paying it off. Let that debt ride into the sunset!
My mortgage is at 4%. I'd love to have a paid off house. But I had an average of 30% gains last year in my investments. It would have been foolish to pay off my house. And yet I have a 10 year mortgage - I didn't go out and refi to a 30 year just so I could invest more.
How could I vote on this?! Ahhh! My brain is exploding!
Hah! Understood. I feel your pain.
I voted invest, particularly since someone with appreciable debt likely isn't maxing out registered accounts.
But it does really come down to the details.
Agreed.
Ok, for those that want details, my general thoughts when writing this in the opening post:
Just assume it's not a hair on fire credit card type situation, and everything else is within the range where a reasonable person would ask themselves this question.
were this is a reasonable, likely tax deductible debt somewhere in the 3.5-5.0% range. Given today's interest rate environment I think that's a solid range where people might swing one way or the other.
For the record, I would (and do) invest any surplus rather than pay down any additional debts, and I have debts within this range.
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I would vote both, if I could. I'm a hedger by nature. In the absence of an all-of-the-above option, I vote to invest.
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I vote max out tax-preferred options for investing, then pay down debt with the leftovers if any. That's what I've done and I'm happy with it.
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I can't vote on this question without factoring interest rates! I can't!
It matters!
If you have $100,000 of student loans at 2% interest, then screw paying it off. Let that debt ride into the sunset!
My mortgage is at 4%. I'd love to have a paid off house. But I had an average of 30% gains last year in my investments. It would have been foolish to pay off my house. And yet I have a 10 year mortgage - I didn't go out and refi to a 30 year just so I could invest more.
How could I vote on this?! Ahhh! My brain is exploding!
This isn't an either/or option. We also do both. Rather than have every extra dime going to investments or paying off the mortgages we have about half going to investments and half going to rental and home mortgage. With healthy 401K balances we still reaped the benefits of the market last year. Had this been 2008-9 instead, and had I followed the same logic as above, I could have very likely had all the eggs in the wrong basket.
Every wealth manager stresses having a diversified portfolio, and I think the "correct" (for whatever that is worth) answer for a great number of people would be to do both.
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Small sample size so far with 36 votes in, but I'm very surprised to see 2:1 debt to invest.
For those of you who would elect to pay down debt I have some genuine questions for you:
-What is your stock/bond ratio if you are holding investments?
-Do you see a major difference between paying down a fixed interest debt or investing in a bond?
-If you are an aggressive investor with a mix of at least 75% stocks, why would you take a conservative approach with your debts?
The only answer I can come up with is one I was faced with myself a few years ago: When your current cash flow can't service your debt load, it's clearly time to get rid of some of the monthly payments somehow. Does anyone else have another solid, logical reason for paying off debts other than the standard "it's a psychological win"? When I hear that, I think of a car warranty. It makes you feel warm and fuzzy, but it doesn't really do much for you.
I'll answer the second paragraph first. For me it's a little bit academic anymore since I don't really have any debt to speak of (mortgage excepted), but I suppose I see it as a risk mitigation strategy. There's any number of reasons that my cashflow could be interrupted such as a job loss, injury, lawsuit, and so on. The debt payments aren't optional, so if my cashflow were to be disrupted for some reason, I'd have to either drawdown my investments early (which could mean paying penalties/short term taxes/etc) or default on the debts.
Regarding your first three questions:
1. Without going into excruciating detail, I'm pretty aggressive with about 90/10 equities/bonds
2. The main difference is risk. Let's say I try to service a $1000 debt at 5% by buying a $1000 bond with a 5% coupon rate (I know that math doesn't exactly work out, bear with me). There's always a chance the company issuing the bond could go under and but I'd still be stuck with the debt.
3. Taking a conservative approach on my debts is a way to hedge against my aggressive investment strategy.
But ultimately, the most important thing to do is to minimize spending. There are different risks/rewards to servicing debt vs. increasing investments, but you can't realize the gains from either strategy unless you're generating surplus cash flow.
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I think the answer has some to do with your debt to income ratio. How much money is coming in vs going out to debt.
Unfortunately, I racked up a few student loans and picked up a mortgage before I discovered MMM, so my D/I is much higher than I'm comfortable with. Therefore, any "extra" cash I have from not paying down interest would get eaten up by commissions/fees if I were to buy a pile of stocks. Therefore, I prefer to free up my cash flow first to be able to make more significant purchases in the future to dilute those costs. Someone with a smaller D/I ratio would probably be comfortable enough to send a big chunk to invest.
All that being said, I still contribute to my tax advantaged accounts as much as possible since the benefits of employee match / tax breaks are too good to miss out on.
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Thanks for the response Bert, very good points. I'd like to counter one of them:
There's any number of reasons that my cashflow could be interrupted such as a job loss, injury, lawsuit, and so on. The debt payments aren't optional, so if my cashflow were to be disrupted for some reason, I'd have to either drawdown my investments early (which could mean paying penalties/short term taxes/etc) or default on the debts.
I see your point about paying penalties, taxes, etc. if you had to cash out to service a loan, but at least you'd have that option. If you are 5 years into aggressively paying down a mortgage, you have about 8 more years until it's gone, and you lose your main source of income, you're screwed. How are you going to make your next $1,000 mortgage payment? And the next? The mortgage company does not care that you "pre-paid", they want the next months payment or they will eventually foreclose. The only way the debt payoff strategy mitigates this risk is if you complete it and are left with a $0 balance due.
Investing gives you much more flexibility, liquidity, and the ability to keep making payments and maybe pay off the entire debt at any point after some years of compounding.
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The thing is you are comparing a guaranteed ROR with an unknown ROR.
Last year in the Stock Market was great, 2007/08 you would have lost money.
You are also comparing tax deductible interest with taxable returns.
There is also the fact that once your mortgage is paid off that debt is gone forever. Not having debt is a great thing and no one knows how long they will be able to keep making debt payments. You can stop investing if you don't have the money but you can't stop paying your mortgage.
Besides, I don't see this as an either or situation. No reason that extra money can't be split between debt reduction and investments.
I would opt for the security of paying off the mortgage.
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I agree with those who say I just can't vote without taking variable into account!!! And, I also do both. (or did, until I killed my student loans two weeks ago, yes!!!!) That being said, I lean towards the pay down debt side.
-If you are an aggressive investor with a mix of at least 75% stocks, why would you take a conservative approach with your debts?
The only answer I can come up with is one I was faced with myself a few years ago: When your current cash flow can't service your debt load, it's clearly time to get rid of some of the monthly payments somehow. Does anyone else have another solid, logical reason for paying off debts other than the standard "it's a psychological win"? When I hear that, I think of a car warranty. It makes you feel warm and fuzzy, but it doesn't really do much for you.
My reason is that I'm paranoid about a loss of income and having a sufficient emergency fund. Without debt, my required monthly outflow is lower. I don't really have a reason to be worried about losing my job, but I'm just a worrier by nature. Layoffs I think I would see coming, but in two years at my job I have seen two people on my team fired (ostensibly for cause), one saw it coming, one did not. I think some of our management issues are worked out now, but I'm still paranoid. :)
That being said, I do have a 0% car loan outstanding with a pretty low monthly payment. Even I am not conservative enough to pay that one off early :)
(also re. Bert's comment and your response, I guess this doesn't apply to mortgages you can't really "pre-pay," but it did apply to my student loans, and I know my one friend who got fired did appreciate it when her next student loan payment wasn't really "due" for another year and a half due to her prepayments!)
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I guess it is a continuum but I voted invest in today's environment.
We have a 3% interest rate on a 15 year mortgage. I don't see any purpose in paying that down quickly. The market might not beat 3% over the next 10 years, but that would be a pretty nasty run if it didn't. Plus the yield on the S&P is nearly 2% So just dividends which don't vary as much covers 1/2-2/3 of the interest I am paying.
We recently bought a new (used) car and were going to pay with cash (I had never borrowed money for a car before), but they were offering 2% interest. How can I pass that up? Just the yield on the S&P almost covers the interest.
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In my case I have $1500 of debt at a true 0% (no fee balance transfer with an original balance of $4000). I am paying $40 per month until it is gone (about 3 years).
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I just re-read this MMM post (http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/)on the subject for anyone interested. There are some good points in there, and the basic summary is it's a win-win question. I agree.
Since no one else has mentioned it yet, I'll bring up the obligatory "inflation hedge" argument.
If you currently make $100K and you have a fixed interest mortgage payment of $1,000/month (1%), in 10 years when you make $140K your fixed mortgage payment will still be $1,000/month (0.71%). It automatically becomes easier to meet your debt load as time goes by and your wages increase.
For those saying "you don't have to choose one or the other, you can do both", I agree completely. IRL this is not either or, but my question is specifically either/or for a reason. I want to know which you prefer, I don't have a use for "both" in the poll.
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How do I switch my vote? I fat fingered it on a mobile device.
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i'm quite surprised at the overwhelming side to pay down debt. it would be nice to have a follow up for those people who chose pay down debt to see if that have debt that needs to be paid down. B/c in my mind while a mortgage is debt its a very good kind of debt as cheddar indicated above. (as long as your rate is reasonable) It doesnt really make sense to pay off a mortgage faster esp. if youre sub 5% APR. but i have learned there are ultra risk averse people on these forums since i joined. so to each his own
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How do I switch my vote? I fat fingered it on a mobile device.
I don't think you can. I tried to edit the poll to allow people to change their votes, but I didn't see that option. If someone else has a fix let us know.
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I'm not an expert on these things, but it seems like a simple matter of asking whether the interest you'd get from investing would be more than the interest you would have to pay on the debt. Am I missing something?
Plus the tax you'd pay on the investment income. Which is why for me and hubby, I choose pay down debt. I could be wrong but it's what I'm comfortable with given our situation.
Minus the tax deferral for failing to contribute fully to 401Ks and IRAs, and minus the Saver's Credit...
I think that there is no valuable answer to this question that doesn't rely on the variables that you're excluding.
Exactly. Once you've "corrected" for risk and return, the choices are exactly equal and the question is moot. If everyone answered rationally, the poll results would be 50/50.
At best, all the poll results reveal is what fraction of the MMM readership is "risk-averse" in some general, nebulous sense (corresponding to the extent the "pay off debt" vote exceeds 50%).
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At best, all the poll results reveal is what fraction of the MMM readership is "risk-averse" in some general, nebulous sense (corresponding to the extent the "pay off debt" vote exceeds 50%).
Great observation Jack. This was part of the reason for asking the question in the first place (aside from what I said in the original post). I'm curious how many people are taking a safe, risk averse approach to FI and are relying mostly on their savings rate and badassity. There's nothing specifically wrong with that approach, but it's not really what I'm doing.
I know there are others here who take extreme, calculated risks. That's not really what I'm doing either. I think I'm somewhere in the middle with an aggressive stock/bond mix, and a willingness to take some small calculated risks like carrying debt in an attempt to achieve higher returns to accelerate FIRE.
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I don't think it can be boiled down to one or the other. There are two un-ignorable questions:
- Which one, after all is said and done, has a better return?
- How much does debt weigh on your mind? What is its effect on your mental well-being, feelings of freedom / dependency, etc?
The more iron-willed you are, the more cost of debt you're able to tolerate until you put money there instead of investing. It's a sliding scale. Most people would choose to pay off debt at, say, 90% return of investment. Are you at 90? 70? 30?
The first question puts the numbers in a neat form, the second decides where your sliding scale ends.
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yes carrying debt even car debt isnt bad at today's rates in my mind. why pay off a 3% car loan now if you can invest. now once retired i will be making more cash only purchases to keep my expenses and therefore tax exposure down.(but i guess this could go both ways spending 5k at once for a car will increase burden that year. may have to go back to the drawing board on this) but right now while in the growth stages. you may as well carry low interest debt. you will in all likelihood come out ahead of those who paid down low interest debt.
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Here's another variable: what is the LTV on your mortgage? Right now mine is ~90%. So it makes sense for me to make extra principle payments until it is down to 80% or lower. Right now, if I had to, I probably couldn't sell me house.
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I voted "invest," but I realize me vote was influenced by the phrasing of the question in that it says "extra money" ( I won't start the argument that there is no such thing! ;). )
Coupled with the fact pattern of no hair in fire debt issue (I.e., debt is getting paid) - my thoughts were to start having my money work for me (like someone up thread noted "pay yourself first).
That said, like others have noted, I did both, and recently became 100% debt free, so I do tend to prioritize payoff vs? invest - but I am trying to learn more....
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I'm a SAHM with a very limited earning potential if I went back to work FT - say....30K. So I like to pay off debt so that if for some reason my hubby were laid off or unable to work, (or heck, left me, but he's a great guy, not worried about that!) I could go back to work and not have to worry about bringing in a ton of money because my monthly obligations would be low. We just paid off a car that had low interest rate, but the payment was $400 a month and if I had to be the breadwinner, I didn't want to have to limit myself by being forced to find a job that would pay $4800 more per year. There's no guarantee that the money invested would be there in case Murphy really struck and my husband wasn't working for whatever reason and the market tanked.
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I voted "invest," but I realize me vote was influenced by the phrasing of the question in that it says "extra money" ( I won't start the argument that there is no such thing! ;). )
Sorry for the poor choice of words G-dog. I just meant the money left after all obligations are met. You know that stuff everyone else calls "disposable income" that we all like to call "savings". : )
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At best, all the poll results reveal is what fraction of the MMM readership is "risk-averse" in some general, nebulous sense (corresponding to the extent the "pay off debt" vote exceeds 50%).
Great observation Jack. This was part of the reason for asking the question in the first place (aside from what I said in the original post). I'm curious how many people are taking a safe, risk averse approach to FI and are relying mostly on their savings rate and badassity. There's nothing specifically wrong with that approach, but it's not really what I'm doing.
I know there are others here who take extreme, calculated risks. That's not really what I'm doing either. I think I'm somewhere in the middle with an aggressive stock/bond mix, and a willingness to take some small calculated risks like carrying debt in an attempt to achieve higher returns to accelerate FIRE.
I guess I have debt now that I could be putting more money to (college loans), but it isn't important to me. It is fixed interest rate and I am only aggressively paying down the above 4.5% parts. The rest I will only continue to make the minimum payments until the 10 year window closes it. To me, the important things to get done are maxing out my Roth IRA, which I control and say what is put in it, and throw as much as possible in a Roth 401k and traditional 401 to minimize marginal tax rates, company has good investments but still have record keeping fees, ugh.
I plan on taking my end of the year bonuses and throw them into the market. The market will then decide how quickly I have a down payment to a house. Or if interest rates go through the roof, pay for a house in straight cash homie!
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This is really a corporate finance question. Everyone wants to maximize their returns--in this case, holding debt and investing it in equities or other assets can be a win win situation, we all know that. However, there is risk and uncertainty that go along with this.
--Will holding debt change your behavior--increase your propensity to spend vs invest for instance?
--Are you really heading for ER? In this case, debt makes no sense, unless it is part of a collateralized income producing asset. Why? Reducing risk through your investments (debt being one of them) will be a key to long-term success. Leverage provides very little long term benefit to those IN ER. Prior to ER debt very well may have a place.
--Why did you get into debt? If it was to take advantage of mispricing in the market, this may be ok. If it was to consume, then you probably want to pay it off, as it is not contributing to your goal.
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I would pay off debt first because until you are debt free, any extra money is not yours to spend.
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I voted "invest," but I realize me vote was influenced by the phrasing of the question in that it says "extra money" ( I won't start the argument that there is no such thing! ;). )
Sorry for the poor choice of words G-dog. I just meant the money left after all obligations are met. You know that stuff everyone else calls "disposable income" that we all like to call "savings". : )
Obligations are being met - I stick with invest. I am also biased by my own stash - I can meet the obligation of an unexpected expense. Now back when I graduated college, I focused on getting rid of debt ( but did also start saving/ investing - and wish I had understood my 403(b) options better then!). My risk tolerance has increased over time as my risks decreased.
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I would say pay off emergency debt immediately (i.e. credit card debt).
If the returns are higher than debt interest, then I would invest before debt in tax-sheltered accounts (for the most part 401(k) and Roth IRA).
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I do both, but I lean heavily towards paying down debt. Why? Here's two great reasons.
1) If you have to temporarily stop contributing to your retirement accounts, they don't start charging you extra fees and ruin your credit.
2) My investment plan does not say I should be using leverage to enhance my returns.
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The market will then decide how quickly I have a down payment to a house. Or if interest rates go through the roof, pay for a house in straight cash homie!
I LOVE this! Let the tail wag the dog every now and then. Most people set a deadline then align their cash/investments/debt according to the deadline. You're doing it backwards, which is brilliant. I applaud you.
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Small sample size so far with 36 votes in, but I'm very surprised to see 2:1 debt to invest.
For those of you who would elect to pay down debt I have some genuine questions for you:
-What is your stock/bond ratio if you are holding investments?
-Do you see a major difference between paying down a fixed interest debt or investing in a bond?
-If you are an aggressive investor with a mix of at least 75% stocks, why would you take a conservative approach with your debts?
The only answer I can come up with is one I was faced with myself a few years ago: When your current cash flow can't service your debt load, it's clearly time to get rid of some of the monthly payments somehow. Does anyone else have another solid, logical reason for paying off debts other than the standard "it's a psychological win"? When I hear that, I think of a car warranty. It makes you feel warm and fuzzy, but it doesn't really do much for you.
Obviously there is no wrong answer here and it's a personal choice, I just thought this forum would be closer to 50/50 based on previous answers I've read.
Wow, stunningly insightful questions. Really made me think through my choices and the why...
I have three types of 'money' locations, like many of you...
Tax sheltered RRSP,
Non sheltered investments ,
Big mortgage debt.
1 - 10% bonds. I don't like bonds, prefer dividend returns when not in growth stocks but forced myself to start to buy bonds when I realized I was in a heavy cash position...and bonds are better than cash. In the RRSP only do I have bonds.
2 - I do not remove $ from the RRSP. Once money is there it is no longer available as FU money. It would not be used if we lost our jobs until about 1yr of no income and even then, I would work as a retail cashier, really flex MMM muscle to reduce costs, before touching it, and in Canada you don't have that 10% withdrawal penalty so it is easy to use RRSP as an income hedge (money in in high income yrs, money out in low income yrs).
3 - conservative, yes to less debt. Two yrs ago I had $500 k mortgage and no FU money. I was stressed at the thought of losing my job or just needing to refinance in 3yrs at slightly higher rates.. I was fully aware that my current 3.7% rate was low and could adjust by 1% and completely wipe out my ability to break even month to month.
What I did was set up a MTG saving investment outside of the RRSP, for future MTG pay off or temp MTG payments until I find employment, or even in case interest rates went up. Although invested, we did not max out RRSP in order to pay down the MTG fund. See my aversion to touching RRSP. Yes, I chose to not receive the large RRSP tax deduction, so it really is a pay debt before investment decision. Just at a MUCH higher rate.
Now, I have refinanced at 2.4%, but was able to choose a variable rate without stress, because that MTG fund is at $50k.
And yes, salary raise went to added RRSP payments, so I am nearing maxing out RRSP too, with a year or so.
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Since no one else has mentioned it yet, I'll bring up the obligatory "inflation hedge" argument.
The inflation hedge argument is just smoke and mirrors math to justify a decision. It is working the angles. I lost. a lot of money a few years ago due to a perfectly logical inflation hedge argument that swayed the way I looked at underlying principles.
These principles are, listed in rough priority for me..:
Save money.
Pay cash.
Live a good life, less than your income.
Work on marriage and spend quality time in relationships before divorce or spending on guilt presents.
Put short term money into safe investments or keep as cash.
Max out employer match
Max out tax advantaged funds, such as RRSP, RESP.
Note that no debt is higher than investments....
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Since no one else has mentioned it yet, I'll bring up the obligatory "inflation hedge" argument.
The inflation hedge argument is just smoke and mirrors math to justify a decision. It is working the angles. I lost. a lot of money a few years ago due to a perfectly logical inflation hedge argument....
Can you elaborate? I'm unsure how you can lose money on this. Maybe it's different in Canada? I know our mortgages tend to be fixed and I've heard here before that Canada's renew every 5 years or so with a new rate and new payments. Is that what you're talking about/how you lost money?
This article (http://financialmentor.com/financial-advice/pay-off-mortgage-early-or-invest/7478) is another great resource on this subject for anyone with a little spare reading time. IMO, there are a lot of great points on both sides of this argument. Very well thought out.
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Since no one else has mentioned it yet, I'll bring up the obligatory "inflation hedge" argument.
The inflation hedge argument is just smoke and mirrors math to justify a decision. It is working the angles. I lost. a lot of money a few years ago due to a perfectly logical inflation hedge argument....
Can you elaborate? I'm unsure how you can lose money on this. Maybe it's different in Canada? I know our mortgages tend to be fixed and I've heard here before that Canada's renew every 5 years or so with a new rate and new payments. Is that what you're talking about/how you lost money?
This article (http://financialmentor.com/financial-advice/pay-off-mortgage-early-or-invest/7478) is another great resource on this subject for anyone with a little spare reading time. IMO, there are a lot of great points on both sides of this argument. Very well thought out.
OK. In the spirit of too much information.
We sold our home and moved to California and started to rent while looking to buy. Our company relocation package had a heavy money incentives to "step into" a mortgage, but it was insane. This was 2006 and 2007. We did not bite even after looking at over 100 homes.
My husband was well versed in financial trading and investments, and gave very logical and sound rationale about investing our house money in the stock market as we would likely be renting for several years, and the value in cash or bonds was totally eroding vs increasing home prices. We needed our house money to increase with home prices, or at least at half the rates. Invest as a hedge against inflation
Well, I was prepared to lose 10%, or even 15% of the money as a risk choice for better returns and we had time to replace that. He was actively researching the investments for this and other income generating funds on a daily basis. Highly up to date and financially educated.
I was not prepared to lose well over 30%.
How did it happen? When we decided to move back to Canada, we had two weeks to get it done. We talked just before moving in late Aug 2008, about capturing our 10% losses in case we could use it in future- unlikely as that was- and selling all - remember, the market dropped a bit in the couple of months leading up the the crash?- but decided to hold on as the money was likely to recover or at least not lose more in two weeks and we did not really have much time to think about it now. All solid blue chip players too.. Hand selected, etc.
Guess what? In the 1 week we were out of internet access due to the move, 2008 crash hit.
We managed to keep $ in until 2009, when we needed a down payment, and in 2010 we needed money for the renovations.
Although the markets have recovered now, we had to get out early and lost over $100 k, a big percentage of our net worth at the time.
It is a lesson learned that we as humans are very good at justifying our decisions.
The more complex the justification, the more likely we are not based on our true principals and it is just smoke and mirrors. ( see the thread on buying a handbag for a great example)
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Since no one else has mentioned it yet, I'll bring up the obligatory "inflation hedge" argument.
The inflation hedge argument is just smoke and mirrors math to justify a decision. It is working the angles. I lost. a lot of money a few years ago due to a perfectly logical inflation hedge argument....
Can you elaborate? I'm unsure how you can lose money on this. Maybe it's different in Canada? I know our mortgages tend to be fixed and I've heard here before that Canada's renew every 5 years or so with a new rate and new payments. Is that what you're talking about/how you lost money?
This article (http://financialmentor.com/financial-advice/pay-off-mortgage-early-or-invest/7478) is another great resource on this subject for anyone with a little spare reading time. IMO, there are a lot of great points on both sides of this argument. Very well thought out.
...Long story...
That sucks, but thanks for sharing. I appreciate it, and hope to learn from it.
I guess with any strategy you need to be aware of the short-term and long-term implications. In your scenario, it is likely only an issue if you are forced to make it a short-term decision. Whether you are forced by life circumstances or your own fears/emotions, a short-term need forced your hand.
Your story involves stock investing as an inflation hedge. While that is a smart decision and had a great, logical purpose, I do think it differs slightly from using a leveraged loan on real estate as an inflation hedge. The stock market is volatile, and while real estate can be volatile (and certainly would've been if you purchased in 2007) the beta is much lower.
Here's a quote from the article I linked above that explains it better than I can:
Lost Diversification: This one is “the biggie” so pay close attention… Most investor portfolios are denominated in their domestic currency and thus carry the risk that inflationary government policies will depreciate their investment purchasing power over time. A residential real estate mortgage is the only practical way for most people to short their domestic currency and hedge against inflationary economic policy. In other words, the way mortgage financing works is you borrow (short) your currency and use the proceeds to buy an inflation adjusting asset (real estate). Few people understand how conventionally financed real estate is little more than a leveraged play on inflation. That is why it’s such a powerful wealth building tool more than 90% of the time, and it blows up horribly when the rare deflationary event strikes (i.e. 2008).
So even this author, who is promoting this as the most important reason to consider investing while holding a mortgage, is stating that when deflation hits this strategy backfires. As long as that deflation is temporary though and can be leveraged by utilizing this as a long-term strategy, you should come out ahead.
Too bad you didn't pull out after the 10% loss, but I guess we can all look back with 20/20 hindsight.
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The market will then decide how quickly I have a down payment to a house. Or if interest rates go through the roof, pay for a house in straight cash homie!
I LOVE this! Let the tail wag the dog every now and then. Most people set a deadline then align their cash/investments/debt according to the deadline. You're doing it backwards, which is brilliant. I applaud you.
I realize more and more that as a single guy without roommates anymore my aggression and abscessation go unchecked for long periods of time. No one relies on me and "risk" is simply a number.
We shall see what time and possible companionship end up providing.
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I picked pay off debts, but oddly, I have no debts. However I want to actually start investing, but I do not know where to start and a lot of the terminologies in this thread escape me. Currently, I have way too much money saved up and it needs to go somewhere. I am interested in long term and short term investments. Although, after reading this thread, I would change my answer to investing or half/half if that was an option. If your return on your investments out weights your debts, then it only makes sense to go the investing route. Although, knowledge can help protect you from bad decision making in investing, but it is not absolute...
No debts
Active in 401k [just started though]
No Roth IRA [want & don't know where to start]
No Portfolio [same as the above]
And a bank account bursting at the seams
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I don't know if it is possible, but I would change the poll to more directly ask the question that is at the root of the debt payoff vs. investment decision: How risk averse are you? To answer that question, what about this polling question?
At what difference between current interest rate of debt and expected ROI (whatever you base your investment decisions on) in the market would you decide to payoff debt?
a.) debt rate is greater than ROI
b.) debt rate is 0 to 1% lower than ROI
c.) debt rate is 1 to 2% lower than ROI
d.) debt rate is 2 to 4% lower than ROI
e.) debt rate is 4 to 6% lower than ROI
f.) always pay down debt! always!
For example, if you expect an investment to have a ROI of 7%, and you would only start to pay off debt before investing if your interest rate on debt is greater than 4%, then you would fill out "d."
Hopefully that makes sense to folks.
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Debt reduction is a passive, very easy fix - write a check - pay a bill - plus the gain is not variable, it's locked in and permanent assuming you aren't a compulsive crediholic.
Investing on the other hand is almost the exact opposite - it can sometimes be cumbersome, scary, frustrating and even expensive if you don't know what you're doing.
I would suggest every iota of credit except for the mortgage take precedent over investing. Bad investing is probably WORSE than bad credit, if you do it badly for a period of time you tend to give up and shuck the whole concept. While you are paying down your debt you can start to read every GD book you can find on investing, ask questions, open a Vanguard account w a minimum balance or figure out which trading company you want to use (Ameritrade, etc). Between life and debt reduction it should take you at least a year to accomplish all this and by then you're ready to start investing.
The mortgage issue is more complicated - more variables to account for, but generally if my rate was above 5% I would put 50% of my discretionary savings towards the mortgage. If my rate was between 3 and 5% I would pay down anytime I got a chunk of extra cash and if I'm at 2-3% I'm letting it ride using the extra cash to max out all my investments.
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I would vote both, if I could. I'm a hedger by nature. In the absence of an all-of-the-above option, I vote to invest.
Ditto.
I used to be firmly in the pay down debts camp. In 2008, 2009, and 2010 I put 50K (extra) toward my mortgages (my primary house and my rental house at 4.875 & 5.25) (both tax deductable) now that I have lerned more about investing and refied down to 3.125 on my primary I am doing more investing. (I added 8% to 401k and invested 24k in the past 2 years, but I also put about 6k toward my mortgage to hedge my bets. I have plenty in savings and investments that liquidity is not an issue. Besides, I'm pretty close to paying off the rental, and that will be a great feeling.
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I picked pay off debts, but oddly, I have no debts. However I want to actually start investing, but I do not know where to start and a lot of the terminologies in this thread escape me. Currently, I have way too much money saved up and it needs to go somewhere. I am interested in long term and short term investments. Although, after reading this thread, I would change my answer to investing or half/half if that was an option. If your return on your investments out weights your debts, then it only makes sense to go the investing route. Although, knowledge can help protect you from bad decision making in investing, but it is not absolute...
No debts
Active in 401k [just started though]
No Roth IRA [want & don't know where to start]
No Portfolio [same as the above]
And a bank account bursting at the seams
The short answer is vanguard and index funds like vtsax. Set it and forget it. The long answer is to go read the jlcollins stock series. Then come back and ask questions in the investor alley here.
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I picked pay off debts, but oddly, I have no debts. However I want to actually start investing, but I do not know where to start and a lot of the terminologies in this thread escape me. Currently, I have way too much money saved up and it needs to go somewhere. I am interested in long term and short term investments. Although, after reading this thread, I would change my answer to investing or half/half if that was an option. If your return on your investments out weights your debts, then it only makes sense to go the investing route. Although, knowledge can help protect you from bad decision making in investing, but it is not absolute...
No debts
Active in 401k [just started though]
No Roth IRA [want & don't know where to start]
No Portfolio [same as the above]
And a bank account bursting at the seams
The short answer is vanguard and index funds like vtsax. Set it and forget it. The long answer is to go read the jlcollins stock series. Then come back and ask questions in the investor alley here.
Exactly this. The jlcollins stock series is simple and straightforward - they are a non-intimidating easy read. Check the expense ratios on the funds you are interested in, try to invest at the Admiral fund level if you can to get even lower expense ratio (ER).
You really cannot screw this up. The mistake is waiting/or not acting. And yes- it is intimidating.
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I don't think it's about the math, but about how debt averse you are (or not). I was on my own at 17 and grew up with parents barely making it paycheck to paycheck. I vowed never to have debt. I've always paid cash for everything, cars, home, etc other than short term credit card debt paid in full each month.
I could not invest knowing I owed money even if mathematically I would come out ahead. Besides there's always the risk my investments could lose money.
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Note to DSiee - You are missing out here! Pay your fees upfront to get 10% discount, paying lump sum later you only get a 5% discount / bonus. (according to Hecs/Help website I just checked, but I think there has always been a bigger discount for up front compared with later lump sum payments - just that back in the day it was something like 25% compared with 20%.)
My strategy in your position would be, use what you have saved to pay next semester's fees, next semester save for the one after, etc. Yes you miss out on interest / investment returns but you are unlikely to get more than 10% + CPI + tax rate level returns on any investment (not reliably). You should then end up with just the semesters already incurred to pay off when you start work.
(Also FTR, 5% on $1000 would be $50 not the $100 you have noted)
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I know the % game leans to investing. I have recently thought about it this way if I put inflows toward debt then when and if a correction happens I will have more money to invest and then benefit form the recovery.
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Note to DSiee - You are missing out here! Pay your fees upfront to get 10% discount, paying lump sum later you only get a 5% discount / bonus. (according to Hecs/Help website I just checked, but I think there has always been a bigger discount for up front compared with later lump sum payments - just that back in the day it was something like 25% compared with 20%.)
My strategy in your position would be, use what you have saved to pay next semester's fees, next semester save for the one after, etc. Yes you miss out on interest / investment returns but you are unlikely to get more than 10% + CPI + tax rate level returns on any investment (not reliably). You should then end up with just the semesters already incurred to pay off when you start work.
(Also FTR, 5% on $1000 would be $50 not the $100 you have noted)
Thanks! I didn't realize the discount was 10%, I thought they cut it but you are correct! Well I will defiantly be paying my fees as I go now. Thanks heaps.
(Yeah, I don't know how I stuffed that up. Lucky I'm not studying math, just physics :P)
Thanks again for pointing that out!
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I don't vote because I think it does a dis service to a pretty important question that can't be answered with a yes or no question.
I think there is a three step process involved.
- Figure out the after tax interest rate. For most people this means getting out a Turbo Tax and figuring out your taxes with and without paying of the debt
- Assess your expected investment returns based on your risk tolerance. The pay off answer is much different for the person who finds investing in Vanguard Wellesley nerve wracking vs the person who is 100% equities with a strong weighting of small cap funds and emerging markest.
- Factor in the intangibles. For some the Dave Ramsey shout out of "I'm debt free" provides great joy, for others having hundreds of thousand trapped in home equity making nothing creates great stress
The benefit of having the discussion on the forum is getting a wide perspective of opinion and figuring out which ones make the most sense to you.
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I voted for Invest even though I strongly dislike most debt. Chunk some money to a rainy day fund and the future no matter what budget disaster you might have going. Naturally, that means cutting out stuff that might really matter now.
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For me the answer was obvious. Pay off debt.
As another poster put it, your investment funds don't start charging you late fees or sending collection agencies after you if your income drops unexpectedly.
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What I did was set up a MTG saving investment for future MTG pay off or temp MTG payments until I find employment, or even in case interest rates went up.
I wanted to emphasize this idea. I think it could be the best of both worlds in cases where the interest on debt is low enough to make the question worth considering: by making a post-tax investment that is accessible when you need it, with the intention of it being used to cover the debt if income changed, I think you cover a lot of bases! You take advantage of the higher returns from the investment side, and you have no fear of running into problems with the debt should situations change. It becomes a purely mathematical question about the debt interest rate vs the expected earn on the investment, and removes a lot of the other emotional components that push for debt pay down. Nice!
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Small sample size so far with 36 votes in, but I'm very surprised to see 2:1 debt to invest.
For those of you who would elect to pay down debt I have some genuine questions for you:
-What is your stock/bond ratio if you are holding investments?
-Do you see a major difference between paying down a fixed interest debt or investing in a bond?
-If you are an aggressive investor with a mix of at least 75% stocks, why would you take a conservative approach with your debts?
The only answer I can come up with is one I was faced with myself a few years ago: When your current cash flow can't service your debt load, it's clearly time to get rid of some of the monthly payments somehow. Does anyone else have another solid, logical reason for paying off debts other than the standard "it's a psychological win"? When I hear that, I think of a car warranty. It makes you feel warm and fuzzy, but it doesn't really do much for you.
Obviously there is no wrong answer here and it's a personal choice, I just thought this forum would be closer to 50/50 based on previous answers I've read.
I have no debt but did vote to pay it down first, and that is exactly what I did to get to this point.
60/40 equity/fixed income.
"Your creditors can call in your debt at any time for any reason" is what separates it from a bond.
When the SHTF, everything is likely to go at the same time.
Imagine this scenario:
MAJOR environmental/industrial/other disaster.
Your house is destroyed, fortunately no major injuries to you or your family.
This disaster puts economic stress on not only you but your employer, and your creditors.
Your employer goes under, putting you out of work.
Your creditors need cash flow and they call in your debt.
You just got a triple whammy.
It's NOT just a psychological win to pay off debt. You are removing a liability that could tip you over the brink. Being appropriately insured and having an emergency fund only go so far.
I understand the scenario and the justification, but imagine this scenario:
You are aggressively paying down debts. You've gotten them down from $100,000 to $30,000, and your minimum monthly payments have dropped from $1,000 to $600. Now the same facts as yours cjottawa. You still owe $600 next month, what do you do?
Now imagine instead of aggressively paying down debts you've invested your surplus and paid according to standard debt amortization. Your debts have dropped from $100,000/$1,000 to $75,000/$1,000, but you've invested about $40,000 principal and earned $10K int/div/cap gains in a taxable brokerage account. Now the same facts as yours cjottawa. You still owe $1000 next month, what do you do? Well you have 40+ months of debt service payments saved in investments, so you begin liquidating them monthly.
How is this not safer? I guess your investments could lose money right, so let's assume you lost 25% of your portfolio. That still leaves you with the ability to service that debt for over 2 years until you're back on your feet.
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Not sure how it works in the US, but here in Canada the RRSP deduction complicates the issue.
I'll describe the situation I was faced with this Spring to illuminate.
We had a credit card debt carried over from a lot of bad financial thinking combined with an unexpected period of much higher costs and lower income. $10K @ 10% interest, yes I know. Mortgage $250K locked into a <3.5%, with accelerated biweekly payments. No other debts.
I have a mandatory pension contribution, and we both have set up automated RSP contributions every paycheck. My reasoning will follow shortly.
I had been hurling cash at the credit card constantly to bring it down to $10K. In the early part of this year my side business had a great month and I had an extra $7K all of a sudden. I was faced with eliminating a hefty chunk of the credit card debt, or putting some or all of the cash into an RSP.
Putting the cash into an RSP shelters it from being taxed, which matters (~25% of it stays mine, at least for now). It also provided a nice (~25%) refund on this year's taxes, which I then put onto the debt.
So, a 25% 'return' on the investment, plus whatever the investments return over the next 20 years. But that leaves me with the remainder of the debt at 10%.
Ultimately I have been able to hack and claw the CC debt down to almost zero, and will likely have it paid off for good by October, this while continuing to increase our RSP savings as well.
Not sure how clear the example is, but the tax benefits of an RSP need to be considered in choosing whether to invest or pay down debt. Having an almost immediate cash benefit to investing helped reduce the debt significantly.
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Not sure how it works in the US, but here in Canada the RRSP deduction complicates the issue.
Putting the cash into an RSP shelters it from being taxed, which matters (~25% of it stays mine, at least for now). It also provided a nice (~25%) refund on this year's taxes, which I then put onto the debt.
This is similar to how a 401k functions in the US. The (potential) difference is that the money in a 401k will still be taxed when you take it out in retirement - people save by contributing to the 401k when they are earning a high income (and thus the money would be taxed more heavily) and then withdrawing it when they are earning little to no other income (and thus, potentially, taxed much less).
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The short answer is vanguard and index funds like vtsax. Set it and forget it. The long answer is to go read the jlcollins stock series. Then come back and ask questions in the investor alley here.
Thanks Mr. Cheddar for the reply. I keep hearing about this Total Stock Market Index Fund Admiral Shares and how good it is. I would like to start a Roth IRA as soon as possible. I was thinking of decreasing my 401k and dropping extra money into a Roth IRA, because I do not get that high of a match from my company nor do they match it that high either or keep contributing to my 401k and start a Roth IRA to hit that 5.5k amount.
I have read a little from JL Collins. I did start the Four Pillars of Investment, but I lost interest in it. Thanks for the suggestions.
Exactly this. The jlcollins stock series is simple and straightforward - they are a non-intimidating easy read. Check the expense ratios on the funds you are interested in, try to invest at the Admiral fund level if you can to get even lower expense ratio (ER).
You really cannot screw this up. The mistake is waiting/or not acting. And yes- it is intimidating.
G-dog, Thanks for the advise as well. This really means a lot. I am going through stock series right now and looking up terminologies as we speak. Sadly, I have waited on Roth IRAs and investing for almost a year now. :/ But it is time to start now!
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When a house is bank owned sometimes they will only sell to cash buyers. If you have the $ to pay cash you can get a great deal which is what we did 2 years ago. Of course we could have turned around & gotten a mortgage to free up our $ if we wanted but not on your life. Paid for home-priceless!!!
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When a house is bank owned sometimes they will only sell to cash buyers.
How ironic, right? I mean, they are in the business of lending money. What a strange policy.
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You are so right! The house sale kept falling through for 6 months because once people got the inspection they withdrew their offer. The realtor knew we wanted the house if the price came down. One day she calls & said they lowered the price by $22,000K and they were taking the cleanest offer & all bids had to be submitted within 24 hours-cash only. Since hubby is a civil engineer we did not need an inspection-he did it himself & he is very handy so would do the work himself too. WE also offered about 8k more then they asked to beat out the other bidders of which there were many. Long story short we got the house for 60k & put 40 into it. Now 2 years later it is worth 200,000k. It is in a great neighborhood, etc. Overall, prices have risen slowly in our area but between the house originally being priced under market & the price reduction we really made out.
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I chose to pay off debts, but that's just me and my limited knowledge coming through. I have a little over $11k left in my student loan (originally $20k) at a whopping 6.75% (was 7% but lowered with autodebit) with a minimum payment of $325, though I typically put between $500-$600 a month towards it. I am saving through my company's 401k (measly 5%, but getting the full match), and "paying myself" about 10% of my income a month. Right now I'm building up my emergency fund, but once that's complete I'll be saving towards opening a Roth IRA. Still, anytime I get more money than normal (overtime, hoping I'll be getting some extra back when I switch auto insurance providers), I never know if I should throw that at my loans or not.
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I put invest in to the poll, but I can understand where paying down debts will ease the burden on the shoulders, and whatever is an acceptable risk that will let you sleep at night is the choice that's good enough.
What I am sure of is that people will take on the risk today,
but when it comes down to a pinch in the future,
gut feelings will usually override the initial bravado as everything starts to slide downhill.
If you're caught in the situation where your primary income is gone,
And you have a huge mortgage hanging over your head,
AND your investments are in the downturn
then all of the justified percentages,
all the math
and all of the advice feels worthless in that moment.
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Small sample size so far with 36 votes in, but I'm very surprised to see 2:1 debt to invest.
For those of you who would elect to pay down debt I have some genuine questions for you:
-What is your stock/bond ratio if you are holding investments?
-Do you see a major difference between paying down a fixed interest debt or investing in a bond?
-If you are an aggressive investor with a mix of at least 75% stocks, why would you take a conservative approach with your debts?
The only answer I can come up with is one I was faced with myself a few years ago: When your current cash flow can't service your debt load, it's clearly time to get rid of some of the monthly payments somehow. Does anyone else have another solid, logical reason for paying off debts other than the standard "it's a psychological win"? When I hear that, I think of a car warranty. It makes you feel warm and fuzzy, but it doesn't really do much for you.
Obviously there is no wrong answer here and it's a personal choice, I just thought this forum would be closer to 50/50 based on previous answers I've read.
I have no debt but did vote to pay it down first, and that is exactly what I did to get to this point.
60/40 equity/fixed income.
"Your creditors can call in your debt at any time for any reason" is what separates it from a bond.
When the SHTF, everything is likely to go at the same time.
Imagine this scenario:
MAJOR environmental/industrial/other disaster.
Your house is destroyed, fortunately no major injuries to you or your family.
This disaster puts economic stress on not only you but your employer, and your creditors.
Your employer goes under, putting you out of work.
Your creditors need cash flow and they call in your debt.
You just got a triple whammy.
It's NOT just a psychological win to pay off debt. You are removing a liability that could tip you over the brink. Being appropriately insured and having an emergency fund only go so far.
I personally think you are in a better situation with debt in that scenario because you can always stick it to your creditors. Hand them the keys to your now worthless assets that secure the loan and move on.
Also I don't think most secured debt is callable, mortgages aren't.
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I voted pay off debts because I'm thinking about it from a cash flow perspective. I have variable income and breathe a lot easier having eliminated about $1000/mo in debt payments.
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I put invest in to the poll, but I can understand where paying down debts will ease the burden on the shoulders, and whatever is an acceptable risk that will let you sleep at night is the choice that's good enough.
What I am sure of is that people will take on the risk today,
but when it comes down to a pinch in the future,
gut feelings will usually override the initial bravado as everything starts to slide downhill.
If you're caught in the situation where your primary income is gone,
And you have a huge mortgage hanging over your head,
AND your investments are in the downturn
then all of the justified percentages,
all the math
and all of the advice feels worthless in that moment.
As I said in my earlier post, every situation is unique. But it isn't clear which situation mortgage or no mortgage will create more sleepless nights.
Imagine two couple in their mid 50s, one person has already quit work and the other was planning on quitting in the next 5 years. Great Recession II hits and lose their job.
One started the recession with $1 million and 300K house and no debt
The other has 1.25 million in investments and 250K mortgage at 3.5% interest and 300K house. Payments are 1122/month.
Now if everything house and investment both drop 30% while the debt free couple has more assets 700K +210K house, the couple with a mortgage has a lot more flexibility. They have $875K in investments a 210K house -250K mortgage. The additional $175K in investment makes a lot of $1122 payments. If say the market stabilize at -30% but housing prices continue to drop in their area to say 50% like happened (and worse) in many parts of the country. The couple with mortgage actually has the option to walk away from their mortgage and sufficient cash to buy a $300K house for $150K and would come out slightly ahead.
Now plenty of people would prefer being in the situation with no debt, but there is a fair number would rather have more liquidity. Both are valid viewpoints. Financially in certain circumstance either could be superior.
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This article (http://financialmentor.com/financial-advice/pay-off-mortgage-early-or-invest/7478) is another great resource on this subject for anyone with a little spare reading time. IMO, there are a lot of great points on both sides of this argument. Very well thought out.
That was an excellent article to read, just for my own education. I have a mortgage that I'm not prepaying on, and it was great to read the article and understand the pros and cons. Very detailed and well-explained.
Anyway, I would agree with you that I'd invest before prepaying a mortgage. But I'm not nearly as convinced that investing is superior if its another form of debt, especially if the debt is smaller. I think a major point that I've heard made many times is very applicable to this discussion: the benefit from paying off debt (typically) isn't realized until the debt is completely paid off and you have an increase in cash flow each month. So if it will take many years to pay off a loan, like a mortgage, than you are likely in a worse financial position until the debt is paid and the monthly payment is freed up. But if it's a smaller debt, it may make more sense to pay it off and remove the monthly obligation.
I guess the logical solution to a larger debt would then be to invest money until you have enough to pay off the debt. Then you are in the position to either a) pay it off immediately and lower your exposure to risk or b) let it ride until you have a need to pay off the debt, with the understanding that you could lose some of your profits if you are forced to sell at a low point in the market. But most people would likely let their money ride if they were in that situation with a mortgage, at least in today's rate environment. If rates start to climb, the scale might tip the other way.
On the flip side though, I think the best point made in the article against investing was at the end:
For every 10 people who claim to be making the minimum mortgage payment and investing the difference I would hazard a conservative guess that more than half fail to follow through on the investment part of the equation. The road to financial mediocrity is paved with the best intentions. In other words, an optional savings program that requires self-discipline is frequently no savings program at all. Contrast this with someone who places a 15 year, biweekly mortgage on their home thus creating enforced discipline. One happens with certainty regardless of life’s wrinkles… the other is optional.
Sticking to an investment plan is very hard, and riding investments through a down market is also hard. Just because I think I'd be able to stick with a plan like this doesn't mean everyone would or that it's the best choice for everyone.
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The short answer is vanguard and index funds like vtsax. Set it and forget it. The long answer is to go read the jlcollins stock series. Then come back and ask questions in the investor alley here.
Thanks Mr. Cheddar for the reply. I keep hearing about this Total Stock Market Index Fund Admiral Shares and how good it is. I would like to start a Roth IRA as soon as possible. I was thinking of decreasing my 401k and dropping extra money into a Roth IRA, because I do not get that high of a match from my company nor do they match it that high either or keep contributing to my 401k and start a Roth IRA to hit that 5.5k amount.
I have read a little from JL Collins. I did start the Four Pillars of Investment, but I lost interest in it. Thanks for the suggestions.
Exactly this. The jlcollins stock series is simple and straightforward - they are a non-intimidating easy read. Check the expense ratios on the funds you are interested in, try to invest at the Admiral fund level if you can to get even lower expense ratio (ER).
You really cannot screw this up. The mistake is waiting/or not acting. And yes- it is intimidating.
G-dog, Thanks for the advise as well. This really means a lot. I am going through stock series right now and looking up terminologies as we speak. Sadly, I have waited on Roth IRAs and investing for almost a year now. :/ But it is time to start now!
It takes 5 years for the Roth to vest, which is another reason why earlier is better. But, the urgency in my note is because I was (am) in the exact same situation as you, cash heavy. I had to force myself to take the plunge, it is easy to procrastinate and hours become days, which become weeks, then months... You are paying yourself (future you), no need to wait. And, the market fluctuates, but you are in for the long term. Try not to get nervous and trust that time is on your side.
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It takes 5 years for the Roth to vest, which is another reason why earlier is better. But, the urgency in my note is because I was (am) in the exact same situation as you, cash heavy. I had to force myself to take the plunge, it is easy to procrastinate and hours become days, which become weeks, then months... You are paying yourself (future you), no need to wait. And, the market fluctuates, but you are in for the long term. Try not to get nervous and trust that time is on your side.
G-dog, what do you mean by 5 years for the Roth to vest. To invest? To increase its amount or 5 years for you to withdraw. However, I can only assume you are younger than 59 1/2, I am 28. I can't withdraw that money without penalty without a home purchase or serious disability or something else terrible happening. Could you please explain this?
When should I invest in a Roth IRA? As in tonight? Tomorrow? Next Week? Next Month? How long is too long? But what do I need to know before investing in Total Stock Market fund, VTSAX? I like Vanguard at this moment, but I think they are best because they are cheaper. I don't really know why they are better than other options. I think I understand why VTSAX is good to start out with, but I don't know why others funds isn't as good as VTSAX. I haven't created an account with Vanguard or done anything else other than researching Vanguard and VTSAX again.
What should I know first? And where should I start before diving into Roth IRA & VTSAX?
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It takes 5 years for the Roth to vest, which is another reason why earlier is better. But, the urgency in my note is because I was (am) in the exact same situation as you, cash heavy. I had to force myself to take the plunge, it is easy to procrastinate and hours become days, which become weeks, then months... You are paying yourself (future you), no need to wait. And, the market fluctuates, but you are in for the long term. Try not to get nervous and trust that time is on your side.
G-dog, what do you mean by 5 years for the Roth to vest. To invest? To increase its amount or 5 years for you to withdraw. However, I can only assume you are younger than 59 1/2, I am 28. I can't withdraw that money without penalty without a home purchase or serious disability or something else terrible happening. Could you please explain this?
When should I invest in a Roth IRA? As in tonight? Tomorrow? Next Week? Next Month? How long is too long? But what do I need to know before investing in Total Stock Market fund, VTSAX? I like Vanguard at this moment, but I think they are best because they are cheaper. I don't really know why they are better than other options. I think I understand why VTSAX is good to start out with, but I don't know why others funds isn't as good as VTSAX. I haven't created an account with Vanguard or done anything else other than researching Vanguard and VTSAX again.
What should I know first? And where should I start before diving into Roth IRA & VTSAX?
If you invest directly into a Roth IRA you can withdraw the principal at any time and any age without penalty or tax. If you withdraw earnings before 59.5 you will pay a penalty.
If you convert 401k/IRA funds into a Roth IRA you have to wait 5 years before you take the funds out (maybe not if you're over 59.5 - not sure on that).
You should invest in a ROTH IRA/401K/Traditional IRA/Taxable account as soon as you can so you don't miss out on potential gains. You might also lose money, but overall it should go up long-term.
VTSAX is great. It's invested in many companies, and it has a low cost. There are plenty of other funds out there, and this one will get you a diverse group of companies but not a proper diversification among all the asset classes so you should look at others as well.
None of us will be able to tell you if you should do a 401k, a roth ira, a traditional ira, or a taxable account unless you provide details about your situation like age, income, goals, etc.
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Both! One for me, one for you, one for me, one for you...
If I can pay my debt off in 1yr or less, I'd focus on the debt, but if it's going to be a while, I need to invest in me, and the longer I put it off, the longer I have to wait until I'm FI.
There are so many considerations that I see why people get into "analysis paralysis". High interest CC debt should definitely be a priority, as well as tax advantage investments that can't be raided by creditors.
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To dsiee, tyd450, and anyone else who wants to pay down debt but is worried about leaving too small a cushion for emergencies in the short term:
Consider using a sinking fund strategy. The idea is you set aside the amount you want to pay toward the mortgage/other debt into a low risk taxable investment account (probably bonds or income funds) and do not touch it. When you’ve accumulated an amount equal to the remaining principal of the debt, you cash out the investments and pay off the debt in a lump sum. If a super serious emergency comes up – and it has to be serious enough that you would basically be willing to take out a home equity loan for it – you’re covered without incurring further debt or falling behind.
The added risk for this strategy, besides the obvious risk of depreciation of investments, is this account is relatively unprotected if you are ever found liable in a lawsuit. Retirement accounts and primary housing are very hard to take away from an individual but taxable investments are pretty much fair game. If protecting this account is vital to your long-term financial viability, you might consider additional umbrella insurance.
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retirement accounts are protected... how sweet is that... all my monies are tied up in houses or retirement accounts... good information to have ... incase i get sued for some reason... i look like a broke ass dude. networth 250k... monies you can take 3k. saweeet!!!
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Just assume it's not a hair on fire credit card type situation, and everything else is within the range where a reasonable person would ask themselves this question.
I like this simple way to look at it. If a reasonable person is asking this question then the interest rate on the debt is relatively low, the person can afford to carry it, and their investment time horizon is decently long. Invest! In my opinion.
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Just assume it's not a hair on fire credit card type situation, and everything else is within the range where a reasonable person would ask themselves this question.
Funny, I was going to answer but decided there were so many variables that I'd skip voting and just read the comments until I saw this.
As a fifty something who's happily FIRE, I have to shout (based on the above clarification), "INVEST, dammit!".
The more you invest early in life, the less you need to save to fund your retirement. Let compound interest work its effortless magic while you work your butt off to pay off your "stupid" debt. Please note I said INVEST, not save. Saving in a virtually zero interest bank account won't get you there. It will help you buy a house, if that's a goal, but it must be invested for the long term in order to flee the rat race early.
If I had understood this earlier in life (and I've never had anything but mortgage debt and two small, cheap car loans on used vehicles), I could have retired at least a decade earlier.
I'm kind of a financial blog junkie and this point is not covered enough, IMHO. For example, my 22yo stepson just inherited about 80k. I am trying to convince him to that if he invests this money well, he will never have to save another penny for retirement. He just can't think that far ahead and I can't find much in the blogosphere that addresses this issue.
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Consider using a sinking fund strategy. The idea is you set aside the amount you want to pay toward the mortgage/other debt into a low risk taxable investment account (probably bonds or income funds) and do not touch it. When you’ve accumulated an amount equal to the remaining principal of the debt, you cash out the investments and pay off the debt in a lump sum. If a super serious emergency comes up – and it has to be serious enough that you would basically be willing to take out a home equity loan for it – you’re covered without incurring further debt or falling behind.
Thanks Dezrah. I didn't know here was a name for my strategy. My spreadsheets tell me that if everything stays the same in my life (very unlikely) to include same job at same pay, that I could pay off my primary home in 8 years. However, as I see the balance on the sinking fun grow, I realize how much money it's earning each month, I think I may rethink the strategy as time goes on. I'm okay with that too. I like having the option.
I'm a bit older than most on this forum. How many people plan to carry mortgages beyond retirement?
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I just read that most people carry mortgages in retirement but actually that is a big mistake because paying it off leaves you with a much lower amount of money you need in retirement for your other expenses. I think it was in US Today I read that.
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I don't view a paid off mortgage a necessity for pulling the trigger on retirement. If I still have one then that just requires me to be able to sustain the higher level of expenses. My specific plans allow for the mortgage to stay and I use this as a bit of margin of safety. It's an expense that could always be reduced in a downsize or it could be paid off if market returns allow it at some point after retirement.
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I just read that most people carry mortgages in retirement but actually that is a big mistake because paying it off leaves you with a much lower amount of money you need in retirement for your other expenses. I think it was in US Today I read that.
Paying it off also leaves you with a much lower amount of money available to cover your expenses. If we assume the mortgage rate is low (reasonable to assume in the current housing market; eventually this will likely become untrue), then the difference in what you don't have in $$$ is greater than the difference in what you are not forced to pay out.
So, from a sheer $$$ vs $$$ view, keeping the mortgage seems to be the best option. This does raise an interesting followup question (http://forum.mrmoneymustache.com/ask-a-mustachian/invest-vs-payoff-debts-swr-effects-of-mortgage-payoff/), however, on how paying off a mortgage would affect your SWR...
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I'm bumping this.
I'm 23 years old and in May had $21k or so in student debt that prior to finding MMM I tried to push off as much as possible, saving for a house down payment instead.
Then I found MMM and since then I only have my last student loan of $5,400 at 3.4% left. I'm an engineer so I over analyze the shit out of everything. I'm at 21% contribution to my 401k, not the max but well above employer match, and haven't done any work on IRA yet.
Paying down these loans has brought me down WAY below my comfortable "emergency fund" and as I plan on paying off my last loan next month it's going to drop me significantly below that number.
But who cares, I'm going to FEEL better about being debt free. Sure that $5,400 can make some decent coin over 10 years, and I expect that it would rather than wouldn't, but I want to be debt free so that's what I'm going to do.
My decision is not one based on risk, my 401k is in a 100% stock vanguard fund, when I get my IRA set up through Vanguard I'm going for stocks not bonds, and it's big risk to go under that emergency fund.
But who cares I'll be debt free and if a true emergency happens, well it's time to get creative. ;)
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I'm bumping this.
I'm 23 years old and in May had $21k or so in student debt that prior to finding MMM I tried to push off as much as possible, saving for a house down payment instead.
Then I found MMM and since then I only have my last student loan of $5,400 at 3.4% left. I'm an engineer so I over analyze the shit out of everything. I'm at 21% contribution to my 401k, not the max but well above employer match, and haven't done any work on IRA yet.
Paying down these loans has brought me down WAY below my comfortable "emergency fund" and as I plan on paying off my last loan next month it's going to drop me significantly below that number.
But who cares, I'm going to FEEL better about being debt free. Sure that $5,400 can make some decent coin over 10 years, and I expect that it would rather than wouldn't, but I want to be debt free so that's what I'm going to do.
My decision is not one based on risk, my 401k is in a 100% stock vanguard fund, when I get my IRA set up through Vanguard I'm going for stocks not bonds, and it's big risk to go under that emergency fund.
But who cares I'll be debt free and if a true emergency happens, well it's time to get creative. ;)
I love everything about this. You're going to do well!
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Let me give a different perspective.
As mentioned elsewhere we had a ton of debt to get rid of and now being debt free and getting (too) fast to retirement (55 this year!!!!!) I realize that I focused too much on paying debt off. I should have applied the rule of paying myself first. In this case sending off a quarterly cheque for my DRIP stocks. It was so much that I could have made great money but that I never developed the habit of saving. Now I'm struggling to save and it's not easy if you've never ever saved money.
So while I vote of paying debt off I'd say get in the habit of paying yourself first even if it's not much
Edit: reminded myself and just sent off a cheque for a 100 dollars to Emera!
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As I was reading all the replies, I kept waffling back and forth. Like other posters, my choice would depend on the details, and in the past I have definitely leaned towards eliminating debt. BUT, our student loans were at 8%, and our mortgage was at 9.75%, so those were no-brainers to payoff. As soon as they disappeared, I shifted to investing all the freed up money, and more, to make up for lost time. I was also learning more subtle financial ideas thruout the period, and so it has been a stepwise refinement as we went along.
Now we are debt free, so for us there is no choice to be made, it is all "invest". If I had the ability to go back 10 or 12 years and decide again, with my current financial knowledge set, and yet ignorant of the market gyrations to come, I am not sure what I would choose. I wasn't aware of the concept of FIRE then, so wasn't really aimed that way at the time, but if I'd known about it I THINK that I would have leaned more to the invest side. It definitely would have been a balancing act, though. No maxing out 401k or Roths prior to mortgage free.
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Interesting reading the reasoning for both sides.
But there's something I'm a bit confused about, I believe Mr. Cheddar (or Mr. Stacker) pointed out too; I don't totally see paying of mortgage as the "safe" or risk-averse option. In my opinion I view that as pretty risky. You're dumping your liquid assets into a non-liquid (or at least less liquid) asset. People mention wanting to pay off mortgage in case they loose their job etc. But what if you pay off a 30 year loan aggressively for 5-10 years. You monthly bill is still the same! You have gained no safety net at all. I guess you could sell your house and pocket the equity if you need, but that does not sound optimal. Or you could refinance and extract equity, but good luck doing that right after loosing your job. (I realize HELOC is an option). The pay-down-mortgage strategy only gain you safety the moment you finish it, up until that point it is way riskier (IMO).
Personally I like seeing the cash in my taxable investment account, because it is liquid and I could get it at any time. I considered paying extra on my mortgage for a while, but in the end found that I don't like the risk of tying up my money that way. I'd rather invest it, have it accessible in an emergency, and then pay of the mortgage in one lump sum at some point if I feel like it. Even splitting the difference I decided wasn't worth it for these reasons.
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Personally I like seeing the cash in my taxable investment account, because it is liquid and I could get it at any time. I considered paying extra on my mortgage for a while, but in the end found that I don't like the risk of tying up my money that way. I'd rather invest it, have it accessible in an emergency, and then pay of the mortgage in one lump sum at some point if I feel like it. Even splitting the difference I decided wasn't worth it for these reasons.
It's totally emotional. My husband and I decided to fast-track our mortgage because we decided it would have made us feel better if our house had been paid off during the recession - when we were staring down our 30% portfolio losses. I'm a tax accountant. I can write you a detailed argument as to why we should not pay down our house - with math and stuff.
But feeeeeelings.
That said, I agree with you on the "What if I lose my job" angle. Emotionally, the savings are going to make you more secure than your half-paid-off mortgage.
We have plenty enough in investments to pay off our home. The math still doesn't support withdrawing it and paying the mortgage. The smart money is locking in a low interest rate now, for as long as possible. A ten year mortgage was a compromise between keeping a mortgage payment and paying it with a lump sum - but it's still a compromise between feelings and math.
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I have about $90k in equity in my home and this idle amount of capital makes me uncomfortable. This thread motivated me to get on the ball and open a $40k HELOC. Still in underwriting and will close in a couple weeks, but I look forward to having this available as an optional life buffer.
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Having posted here before as a proponent of the pay off the mortgage camp, I felt I should clarify a few points.
- I am a massive supporter of Pay Yourself First. I have been doing this for so long I tend to forget that I am doing it. As a start, I recommend adjusting your pre tax or tax deferred investments (401k or equivalent) to be maxed out near the end of each year. NOT just maxing out the employer match but the maximum allowed contribution.
- Pay off all high interest debt, again this is something I rarely even think about because I have been paying off my cards every month for decades. Credit cards are handy, I use them all the time. BUT if you cannot pay them off when they are due, don't buy that crap.
- Keep an "emergency reserve". I put this is quotes because I treat that money as my operating capital and spend it as necessary but I always replace it right away.
- Get into a habit of making regular after tax investments. This comes out of paying yourself first. If you get a raise, redirect some of the money (25% or more) to your investment accounts. Direct deposit to multiple accounts is a great way to do this if your employer offers this feature.
Only after these items are running on auto pilot should you consider paying off your mortgage. For years, I only paid a few dollars more than my minimum mortgage payment. Once the first four items were completely under control did I even consider paying off my mortgage.
Once I decided to do it, I liquidated and consolidated assets, saved even more than usual and bumped up my operating capital to the point where I could pay off my mortgage in a single payment. This is what I meant when I voted for payoff debts. Not pay down, but PAY OFF debts.
This approach worked for me. Of course YMMV
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I only just found this thread, and it blows my mind that 3/4ths of Mustachians voted to pay off debts.
Just assume it's not a hair on fire credit card type situation, and everything else is within the range where a reasonable person would ask themselves this question.
Right. I'm assuming if one is in the situation where they're asking this question, invest vs pay off debt, they've run the math and it works out in favor of investing* (or would have, historically), but they're deciding between the mathematical and emotional.
(*Obviously if paying off the debt works out better mathematically AND emotionally, EVERYONE would pick that option, so we're assuming it doesn't work out better mathematically, thus why you have to ask the question.)
And it appears 3/4ths of the voters voted "Emotions" over "Math."
I disagree.
:)
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@Rebs, surprised me as well which I'm sure you picked up on. I knew which way you'd vote. Had you chimed in ealier with your convincing arguments maybe it would've swayed the vote a bit more.
To each their own, but with the sophisticated group of minds here I did not expect 3 times as many debt averse people. Oh well, more capital for us I guess.
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I think there should be an extra option in this poll - it depends on the variables.
I really can't vote one way or another without knowing the expected interest rates on the debts or investments at the very least.
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Well, I just took another $8.5k that was purposefully saved for the house, and put it into the RRSP instead of mtg. Yep,and I voted pay debts first.
What gives? A feeling of security and FU money to ride out any job loss or rate hike.. Together with, a new 2.4% variable MTG rate versus 41% tax back on the RRSP. Even keeping it in govt bonds inside the RRSP would be better.
And of course reading this blog and really thinking about early retirement strategies, and the fact that I can pull from RRSP at any time without penalties; it's actually to my benefit if I do so in lower income years. (Such as early retirement or sudden job loss).
So maybe we vote conservatively, but invest logically?
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Well, we just got rid of two debts. I suppose we technically got rid of two liabilities and their payments. We had a 0% loan on a tractor and a 0% loan on a classic corvette.
Obviously, investing makes way more sense. However, keeping those assets no longer fit in with our lifestyle. So, we cut the dead weight and paid off the debts. With what was left, plus what we were paying monthly, we have been investing at a higher rate than before.
Our mortgage is at 4% interest and we are not paying it down faster. Though we are trying to sell and downsize. :)
Now, the tricky question is to pay cash for a smaller house (that would also make the 1% rule in our area for a rental, should we ever move, etc) or get a loan. I'm on the loan side and DH is not convinced yet. He needs to see the real math advantage played out and I don't have the excel skills to prove him otherwise. And, yes, I've read the thread in investor alley, but he hasn't.
So, in the end, I voted pay off debts. But I wonder if that was a misrepresentation of my actual goals and intentions?
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It always comes down to the math. So, I'm sorry, but that makes this long.
Canadian situation: RRSP's are done with before-tax dollars, money (and whatever it made) is taxed as income when withdrawn.
TFSA (Tax Free Savings Account) - done with after-tax dollars, money (and whatever it made) is withdrawn tax free.
Both have maximums, RRSP is income based, TFSA is flat rate but must be "of age", both can have withdrawals repaid (but there are rules about that).
Mortgage interest is not tax-deductible, there is no capital gain (or loss) on sale of primary residence.
There is capital gains tax when investments are sold, there is income tax on dividend and interest income.
So from a tax viewpoint it does not make sense to save for a mortgage in an account that is not a TFSA, since there will be a big tax hit when the account is cashed.
So again re taxes, where is the person relative to brackets? If at the low end of a bracket, there is lots of room to increase income without penalty - invest. If close to the top of a tax bracket, more investment income will be taxed at the next bracket (not a big deal if the next bracket is not a lot more, but if there is a big jump - ouch - so watch Provincial as well as Federal brackets) - so pay down debt with that money instead. Income has not changed but debt payment is less, so more money is available. Of course this assumes the debt is not overwhelming, in which case it should always be paid down first.
If passive income is high enough (investments, pensions, whatever) then disasters are not disasters. Disaster to your house? Your house insurance should be replacement cost (not original cost, labour and materials have gone up), so you don't find yourself paying costs your insurance company should have. And will your insurance company let you take the money instead? You might not want to rebuild - there may be very negative emotions involved with the disaster. This does not mean you can't have high deductible for less than disastrous situations, to keep premiums reasonable.
Just my $.05 worth (no pennies any more).
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It always comes down to the math.
You would think it would, but it doesn't.
For many people when the math falls on the side of invest, they pay debt anyways.
That's okay, but suboptimal.
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I wrote "Of course this assumes the debt is not overwhelming, in which case it should always be paid down first." For some people anything >0 may be overwhelming, emotionally, in which case the answer is, pay down debt. I used to be more in that camp (except for the mortgage and car loans), now I am a bit more flexible. After all, I am retired and still have a mortgage and a tiny car loan. The car loan is at 0%, why would I pay it down early? My emotions want me to, logic says otherwise.
Mind you, we make a lot of decisions (and not just financial) for emotional reasons that could be improved by a bit of cold hard logic. I can think of more than a few that I have made!
It always comes down to the math.
You would think it would, but it doesn't.
For many people when the math falls on the side of invest, they pay debt anyways.
That's okay, but suboptimal.
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The "math" we're discussing here makes assumptions about the future. Nobody has a crystal ball.
Paying off debt relegates it to the past instead of pushing it into an uncertain future.
Assumptions based on history are not crystal ball territory. Having a mortgage at a low rate is an excellent hedge against inflation. You also have leverage with a mortgage because you put a small amount into it initially, but get the value of a larger amount of money i.e. a place to live that you would otherwise pay rent for.
The more money you have saved and under your control, assuming no CC or SL debt, the less uncertain the future feels.
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Interesting thread. I'm been reading another forum for a few years catering to property investors and I'm sure their responses would be completely the other way! I think that way too, I consider myself an investor but then again, I don't have consumer debt except for a home loan and that debt isn't very big, and the house value basically has almost doubled the 7 years we have lived here. So not a bad investment at all. I say invest!! Damn partner is very cautious. Not an investor. He's cost me big bucks... :(
You have to invest to make the big bucks. Use other people's money (OPM). Invest, leverage, take the equity increases when property prices go up. And even if they don't, you still have regular money coming in from rents.
Agree though, anybody with revolving credit card debt at typical credit card interest rates is stupid. I currently work for Australia's biggest bank, (It's the highest value company on the Australian Stock Exchange btw, extremely profitable) and previously worked at Amex for 6 years. Don't borrow money for consumer goods. Don't finance them.
If you don't understand the power of investing, play Robert Kyosaki 's cashflow 101 a couple of times. The take home message i get from the game is, it's ok to borrow money, have debt, but do it to make you money in the long run.
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Holy old thread
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I had to vote for "invest" since I don't understand this "debt" thing you speak of. Never did debt, never will. So invest instead.
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Old thread, but relevant topic.
I get stressed out by debt. When I'm stressed, I do stupid stuff, like eating a lot of chocolate or crashing cars. Therefore it makes economical sense for me to pay down debt rather than investing.
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I suppose this becomes more interesting if you switch your way of thinking about work.
Considering the requirement to work as a debt of sorts, making investing itself paying off a debt.
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Since this thread has been resurrected I'll add my 2 cents.
...For many people when the math falls on the side of invest, they pay debt anyways.
That's okay, but suboptimal.
That depends entirely on what someone is trying to optimize. I think everyone seems to agree that it is suboptimal if someone's goal is to maximize net worth. However, depending on what an individual values, it may or may not be suboptimal if they are trying to optimize happiness. I think it's safe to say that generally everyone's goal is to optimize happiness; for some this is achieved by investing and maximizing net worth, while for others it is achieved by paying off a mortgage early. When viewed from the perspective of optimizing happiness, it's like arguing about whether chocolate or vanilla tastes better - the answer is based completely on the individual.
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Since this thread has been resurrected I'll add my 2 cents.
...For many people when the math falls on the side of invest, they pay debt anyways.
That's okay, but suboptimal.
That depends entirely on what someone is trying to optimize. I think everyone seems to agree that it is suboptimal if someone's goal is to maximize net worth. However, depending on what an individual values, it may or may not be suboptimal if they are trying to optimize happiness. I think it's safe to say that generally everyone's goal is to optimize happiness; for some this is achieved by investing and maximizing net worth, while for others it is achieved by paying off a mortgage early. When viewed from the perspective of optimizing happiness, it's like arguing about whether chocolate or vanilla tastes better - the answer is based completely on the individual.
I agree with this, but I also think it matters just how strongly the math favors investing.
We use a 5% or 6% growth rate for long term investing of stocks, right? Even though it's really closer to 7%?
So technically, if you have a 4.5% or even 5% debt, the math still works out in favor of investing. However, investing over paying down a 5% debt is a lot riskier than investing over paying down a 0%-3% debt. I'd probably pay down anything over 3.5% and invest if I only had 0-3% debts.
Another variable is what the market's doing -- if it's really low and you could stand to make a ton in the next upswing, maybe it'd be smarter to divert some debt-paying money into investing.
I didn't even answer the poll because I feel like there are way too many variables for this to be boiled down into a yes/no type answer.
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Since this thread has been resurrected I'll add my 2 cents.
...For many people when the math falls on the side of invest, they pay debt anyways.
That's okay, but suboptimal.
That depends entirely on what someone is trying to optimize. I think everyone seems to agree that it is suboptimal if someone's goal is to maximize net worth. However, depending on what an individual values, it may or may not be suboptimal if they are trying to optimize happiness. I think it's safe to say that generally everyone's goal is to optimize happiness; for some this is achieved by investing and maximizing net worth, while for others it is achieved by paying off a mortgage early. When viewed from the perspective of optimizing happiness, it's like arguing about whether chocolate or vanilla tastes better - the answer is based completely on the individual.
I would suggest that if your happiness is dependent on yournet worth, or debts, or investments, you're approaching happiness suboptimally.
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It depends on the interest rate of the debt. I paid off my student loans rapidly because I had a crappy interest rate. Also, because I travel a lot for work, I charge a lot of hotel and taxi fares to my CCs that get reimbursed. The work reimbursements helped me keep $5-$12k on 0% CCs instead of in 6.25% student loans. The reimbursement cash infusions make it easy to shift capital between cards based on when the 0% period will end. I make sure the amount I have loaned at 0% is low enough relative to the end of the 0% period that I can still pay it off in time even if I was out of work for a while for some reason.
Obviously, not everyone will be comfortable with this approach. Ultimately it depends on what you're comfortable with. At the same, if the interest rate is 4% or less,be aware that you could be paying with opportunity cost to pay the loan off earlier.
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I would suggest that if your happiness is dependent on yournet worth, or debts, or investments, you're approaching happiness suboptimally.
While I wholeheartedly agree with you (and arguably so would MMM - see http://www.mrmoneymustache.com/2014/11/23/not-extreme-frugality/) I can not think of a way to argue that what makes one person happy is any more or less valid than what makes another happy. I'm not suggesting that one's entire sense of happiness is dependent on a single thing, though I am suggesting that when given a choice there is generally an option that contributes more to their overall happiness than the other available options. My argument is that happiness is very personal and therefore entirely up to the individual. If someone truly derives some sort of happiness from things such as net worth, debts or investments then I think that's entirely their prerogative whether or not I agree with it. Happiness is entirely subjective and I do not know of a way to logically prove that what makes one person happy is any more valid than what makes another person happy.
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I'm lucky right now - the math and my feelings currently agree. Pay off debt first. In about a year, I won't have that alignment.
Emotionally - I really want to be able to say that I'm debt free.
Math - It will be advantageous of me to invest.
What will probably happen - I'll max out 401k and possibly IRA of some sort, then use remainder to kill all debt, then direct all funds to savings/investments for 1) house and 2) FI. So do both, which should appease many here, and will appease my logical and emotional brains.