Author Topic: Case study: your advice on an important decision + long-term investment strategy  (Read 1350 times)

joelho

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Life Situation: We are a young couple (31 and 28 years old) living in Estonia (EU citizens). Soon to have our first child. We have saved and invested money for already more than 5 years (not very successful investments unfortunately) and we just recently bought our first apartment where we plan to live for a long time.

The new apartment will be ready in a few months (so far we have paid just the first payment of 15%), but now we face an important decision: how much loan (mortgage) should we take? The cost of the apartment is 230 000 eur and we could pay with our own money around 180 000 eur. I assume the bank loan interest would be not more than 2%. So we are considering 3 options:

1) Take the least amount of loan - 50 000 eur. This would mean using all our savings and investments but being able to pay back the loan in 5 years.

2) Take as much loan as they give us (I assume around 200 000 eur for 30 years). Then we could keep our investments and even add a big chunk of the loan money to our investment portfolio. It's easy to think that we could earn better than the 2% by investing this money.

3) Some balance between choice nr 1 and 2 - maybe take 100 000 eur loan and keep our best investments but sell less attractive ones. This would still let us invest some of the loaned money.

Net salary for 2: 7000 eur/monthly

No other liabilities and monthly expenses around 2000 eur.

New money for investing each month: 2000 eur.

Our goal is to have an investment portfolio of 750 000 eur by the time we are 50 years old. Then semi-retire (with a 3% annual take out) and enjoy life even more.

As the decision about the loan (mortgage) is an important first step on the road towards our goal, what would be your advice?

We have also been thinking about our investment strategy and asset allocation:

- Should we invest in individual growth-stocks (following Fool.com's paid growth portfolio)?
- Should we invest in dividend growth stocks?
- Should we invest in ETF's?

Or a combination of all three?

Any advice or ideas much appreciated!

former player

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Hello there, and welcome to the forum.  Congratulations on your past financial prudence and on the pregnancy and apartment.

Regarding the mortgage, a 2% loan sounds pretty awesome, but of course it depends on particular factors both for you personally and in Estonia. 

For you personally, affordability and exposure to risk are the two big issues. 

On affordability the affordability considerations seem to be a joint monthly net salary of 7000eur and monthly expenses of 2000 eur, but on this you need to take into account the effects of childbirth and childrearing on both future income  (this is the point at which sexism kicks in to seriously reduce a woman's lifetime earnings) and future expenses - early years childrearing is generally not cheap in time or money without significant outside support, whether from State or family. 

On risk, I personally would never determine the amount of a loan I took on a lender's maximum, as the bank's considerations and interests in deciding how much to lend are very different from mine in deciding how much to borrow.   On the other hand, spending all your savings down when you have big life changes ahead with the new baby seems a bad idea too: having easily accessible money on hand can save a lot of worry when you have other things to concentrate on.  So on both affordability and risk I would be looking to borrow somewhere between your two extremes.

How much to borrow between those two extremes then becomes a finance question, depending on inflation rates, savings interest rates and investment conditions and returns on the one hand and borrowing costs on the other, and the answer will be particular to Estonia, so it will be difficult for anyone here to help with detailed advice (I suspect this is why no other replies yet).  I'm not sure if there is anyone else from Estonia on the boards - the nearest might be Finland.

As to investments generally, the same problem applies as to lack of local knowledge on conditions in Estonia.  I think the principles of MMM should hold good wherever you are, though: 1) spread your risk as wide as possible through index investing, or the nearest thing to it that is available,  2) pay as little as you can in investment costs, 3) buy early and hold as long as you can.


Good luck.

jeroly

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Hello there, and welcome to the forum.  Congratulations on your past financial prudence and on the pregnancy and apartment.

Regarding the mortgage, a 2% loan sounds pretty awesome, but of course it depends on particular factors both for you personally and in Estonia. 

For you personally, affordability and exposure to risk are the two big issues. 

On affordability the affordability considerations seem to be a joint monthly net salary of 7000eur and monthly expenses of 2000 eur, but on this you need to take into account the effects of childbirth and childrearing on both future income  (this is the point at which sexism kicks in to seriously reduce a woman's lifetime earnings) and future expenses - early years childrearing is generally not cheap in time or money without significant outside support, whether from State or family. 

On risk, I personally would never determine the amount of a loan I took on a lender's maximum, as the bank's considerations and interests in deciding how much to lend are very different from mine in deciding how much to borrow.   On the other hand, spending all your savings down when you have big life changes ahead with the new baby seems a bad idea too: having easily accessible money on hand can save a lot of worry when you have other things to concentrate on.  So on both affordability and risk I would be looking to borrow somewhere between your two extremes.

How much to borrow between those two extremes then becomes a finance question, depending on inflation rates, savings interest rates and investment conditions and returns on the one hand and borrowing costs on the other, and the answer will be particular to Estonia, so it will be difficult for anyone here to help with detailed advice (I suspect this is why no other replies yet).  I'm not sure if there is anyone else from Estonia on the boards - the nearest might be Finland.

As to investments generally, the same problem applies as to lack of local knowledge on conditions in Estonia.  I think the principles of MMM should hold good wherever you are, though: 1) spread your risk as wide as possible through index investing, or the nearest thing to it that is available,  2) pay as little as you can in investment costs, 3) buy early and hold as long as you can.


Good luck.

1. One of the big underlying principles behind index investing is diversification of risk. This is a big argument in favor of borrowing a larger sum.  If you put most or all of your investable assets into the apartment you become highly reliant on the Estonian condominium market, and even more specifically on the market for your individual condo (which may appreciate more, or less, than the market overall). If you take out a loan that's a larger LTV (loan-to-value) ratio, you retain funds that you can put into other asset classes like Estonian stocks and bonds and non-Estonian assets as well.

2. There's a standard in the US for "conventional" loans which dictates that the total amount of the loan payments on ALL loans including your mortgage payment but also your credit cards, personal loans, etc., be no more than 33% of your income, and that the amount of your mortgage payment alone (including  principal, interest, taxes, and insurance) be under 28% of your income.  While not perfect, it's a reasonable standard to compare against when considering whether you're taking on too large of a loan.  I'm guessing that with a 2% interest rate, the payments for a 180,000 loan will be considerably under that level for you.

joelho

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Thanks a lot for the answers!

Yes, I didn't expect a lot of replies as I can imagine it's difficult to give advice about those things without knowing how things are in this part of the world. However, I got some useful ideas already but I would really appreciate any more ideas and advice from somebody who has ever faced a similar decision, being it in the US or any other country.

If you have access to a cheap loan (2% interest) for 30 years, would you take as much of it as you can get and invest it in ETF's (that must surely bring in more than the loan costs)?

jeroly

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If you have access to a cheap loan (2% interest) for 30 years, would you take as much of it as you can get and invest it in ETF's (that must surely bring in more than the loan costs)?

While past performance is no guarantee of future results, there's good reason to hope/believe/expect that a diversified portfolio of stocks would return more than 2%.

Regarding ETFs - ETFs include lots of investments, some of which are very far from index funds.  You can get both mutual fund and ETF versions of low-expense-ratio index funds.  In the US there are some tax advantages to how many ETFs are structured (they may not spin off undesired/unexpected capital gains while you still hold them), and they do give one the ability to make transactions during the day, but they are not always better than conventional mutual funds.  [In other words, index funds YES! - ETFs, maybe ;-)   ]

reeshau

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@joelho , do you really get 30 years fixed at 2%?  Those terms won't raise an eyebrow in the US, but while I can get a rate similar to that in Ireland, I can't get anything like a fixed period that long.  The US sees it because there are government bonds of similar term, so there is a basis for hedging risk.  But in Ireland, the longest choice I would have is 10 years fixed.  And of course, with ECB rates negative now, they are much more likely to go up in the next decade than further down.  Another difference here that would shock a US borrower is that there is a prepayment penalty during the fixed term.  While prepayment doesn't seem likely with a rate this low, it could be an issue if you want to sell.  Would you face a similar clause?

Fortunately, Estonia uses the euro; another issue that caught many borrowers in Hungary during the 2008 downturn was low rates tied to Euro payments, but the local currency, the forint, lost a lot of value in exchange, causing huge inflation in payments.

joelho

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@reeshau  2% is guaranteed bank interest, however what can change is Euribor (ECB interest rate) which can increase the total bank interest.

@jeroly  yep, I meant index funds with as low costs as possible.

Linea_Norway

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In your first post, you write that you assume a 2% interest rate loan. I would get some real numbers for it. In Norway you could until very recently get a 2% mortage, but only a as flexible loan. Anything for a fixed period had a higher interest rate.

A financial advisor here advised people to invest their loan into the stock market only after having 60% mortgage left on their home. Maybe you can use that as an example. Not taking investing more than 40% of the value of your home into the stock market.

You should be able to find some international low cost index funds. I wouldn't take the chance of individual stocks. They might score better than the index, but might just as well do much worse. You won't be able to tell which ones will do well. Indexing just takes an average of many companies. Boring, but usually just as good as other, more expensive funds.

Keep in mind that as you are getting children, you might after some time want to move into a bigger home.

BicycleB

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Definitely a big decision!

Like others, I don't know the investment options available to you, or fully understand the terms of this proposed mortgage. Learn the mortgage terms in detail. Please consider posting more specific details of the expected mortgage. In particular, please explain the long term interest more fully...explaining is for us to advise better, but make sure for yourself that you know ALL the details!!

Do you have ready access to international index funds with low reliable fee structures and trustworthy management/regulation?

Is that 2% loan interest nominal, or after projected inflation? 

I read that euro inflation is around 1.2% right now. A loan rate that is only .8% above inflation sounds advantageous if it lasts 30 years, but is that really guaranteed? Or is it a "teaser" rate - short period at low interest, followed by later period at a higher rate? Who provides the loan? Are terms determined by a private bank, or guaranteed by a government? Are such loans regulated in Estonia, and if so, by who?

In USA, the answers to these questions are common knowledge to most forum members. They could be different in your loan. 2% sounds very low and wonderful. In USA, typical interest right now is 4% nominal, fixed for 30 years, provided by private lender under some national regulation, usually with a federal guarantee (in effect, security subsidy) to the lender; inflation currently around 1.7%, targeted at 2% by the currency's central bank.

So we have a fairly reliable cost of 2% to 2.3% above inflation. Meanwhile our typical return from investment is likely to generate real returns of 3% to 5%, nominal returns 4.5% to 7%. Despite the advantage of investment in terms expected return, forum members divide widely on whether it is better to borrow little or much for a mortgage. What are your expected investment returns, and what instruments would be used to get them?

The above are considerations that I would study before deciding whether to borrow a small amount vs a large amount. Curious about any further information you wish to provide.

PS. The investment options 1 and 2 may not be the best. As other posters suggested, most of us prefer index funds rather than investing in specific stocks, because diversification reduces some forms of risk while maintaining roughly equal expected returns. Do please consider index investments of some sort.

I am not sure which is best between index funds or ETFs. In USA, ETFs and mutual funds are similar investments in some respects but different in detail. Some of the differences involve tax considerations that could be different in Estonia. Please research in detail and let us know the significant details from Estonian perspective.
« Last Edit: June 05, 2019, 09:48:18 AM by BicycleB »

Imma

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I am not shocked by the low interest rate - in NL you pay 2,5% now for a 30-year fixed term mortgage. I assume the interest % gets lower, the better your LTV is for the bank. You would need to calculate what the sweet spot is for you.

If your net salary is about 7000, then you are likely making more than 100k gross. This is massive for Europe (much more unusual than it would be in the US) and especially for Estonia where, according to Google, the average worker makes about 1000 after taxes. So your household income is very high.

Are you and your spouse both high earners or is there a significant difference? If there's a big difference in income I think you need to make sure that the lower earner can also pay the mortgage in case something happens to the higher earner.

sisto

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I'm surprised nobody mentioned the glaring fact that you state you net 7K with expenses of 2K and investments of 2K. That leaves 3K completely unaccounted for per month. Did I miss something? As someone pointed out that's huge for the geo. Personally I would leverage that interest rate and invest as much as possible, but that's me.

efree

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I'm from Latvia (which is right next to Estonia) and my eyes popped out when you said you make a total of 7000 net a month. That's so huge I don't even have words for it. Why do you need 20 years to become FI? You could easily do it in 7-8 years. Spending 3000 a month will buy you a very lavish lifestyle.

For those who asked about whether the 2% is fixed or not - it's not. In our part of the world, mortgage rates usually have two parts. The first part is fixed and it depends on the income, LTV, and other factors like you would expect. That's the 2%. The second part is the Euribor rate - either 3 month, 6 month, or 12 month. Right now all of them are negative so they don't apply but this variable rate may become significant in 5 or 10 years.

@joelho , I would recommend you to take out (close to) the maximum amount that the bank is willing to loan you at the lowest rate. Maybe around 150 000 ?

As for investing, index funds are obviously good but I also recommend crowdlending and P2P lending platforms. Have you heard of them? I can name several that are registered right in Estonia - Crowdestate, Crowdestor, Bondora, Envestio, Iuvo Group, Kuetzal, Bulkestate... I have a significant part of my money in this asset class but it's not popular on this forum because most of these platforms don't accept US citizens.

BicycleB

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I'm from Latvia (which is right next to Estonia) and my eyes popped out when you said you make a total of 7000 net a month. That's so huge I don't even have words for it. Why do you need 20 years to become FI? You could easily do it in 7-8 years. Spending 3000 a month will buy you a very lavish lifestyle.

For those who asked about whether the 2% is fixed or not - it's not. In our part of the world, mortgage rates usually have two parts. The first part is fixed and it depends on the income, LTV, and other factors like you would expect. That's the 2%. The second part is the Euribor rate - either 3 month, 6 month, or 12 month. Right now all of them are negative so they don't apply but this variable rate may become significant in 5 or 10 years.

@joelho , I would recommend you to take out (close to) the maximum amount that the bank is willing to loan you at the lowest rate. Maybe around 150 000 ?

As for investing, index funds are obviously good but I also recommend crowdlending and P2P lending platforms. Have you heard of them? I can name several that are registered right in Estonia - Crowdestate, Crowdestor, Bondora, Envestio, Iuvo Group, Kuetzal, Bulkestate... I have a significant part of my money in this asset class but it's not popular on this forum because most of these platforms don't accept US citizens.

Thanks for the 2% explanation! That helps.

Re peer to peer lending, there are other reasons it is not as popular as stock index funds, stock ETFs and bond funds: shorter history, structural questions about reliability, and so on. Mr. Money Mustache himself had some enthusiastic articles in the early to middle 2010s, but later revised his opinion.  One of the USA's major P2P lenders, Lending Club, already produced significant problems (sample links below).  Financial history more generally includes many investment experiments that look good for a few years before falling down. I hope that Estonia's will be more reliable but suggest that you investigate carefully.

Recent comments; leading off with user Chasesfish because he is a recently FIREd banker:
https://forum.mrmoneymustache.com/investor-alley/lending-club-time-to-panic/msg2153708/#msg2153708

Same thread from the beginning; many posts by forum members struggling to get their money out:
https://forum.mrmoneymustache.com/investor-alley/lending-club-time-to-panic/

MMM's own article, including revisions over time that show decreasing enthusiasm based on increasing experience:
https://www.mrmoneymustache.com/the-lending-club-experiment/

Statement from USA's securities regulator, explaining that Lending Club was charged with fraud:
https://www.sec.gov/news/press-release/2018-223
« Last Edit: June 05, 2019, 01:50:45 PM by BicycleB »

efree

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Thanks for the 2% explanation! That helps.

Re peer to peer lending, there are other reasons it is not as popular as stock index funds, stock ETFs and bond funds: shorter history, structural questions about reliability, and so on. Mr. Money Mustache himself had some enthusiastic articles in the early to middle 2010s, but later revised his opinion.  One of the USA's major P2P lenders, Lending Club, already produced significant problems (sample links below).  Financial history more generally includes many investment experiments that look good for a few years before falling down. I hope that Estonia's will be more reliable but suggest that you investigate carefully.

Recent comments; leading off with user Chasesfish because he is a recently FIREd banker:
https://forum.mrmoneymustache.com/investor-alley/lending-club-time-to-panic/msg2153708/#msg2153708

Same thread from the beginning; many posts by forum members struggling to get their money out:
https://forum.mrmoneymustache.com/investor-alley/lending-club-time-to-panic/

MMM's own article, including revisions over time that show decreasing enthusiasm based on increasing experience:
https://www.mrmoneymustache.com/the-lending-club-experiment/

Statement from USA's securities regulator, explaining that Lending Club was charged with fraud:
https://www.sec.gov/news/press-release/2018-223
You're right that the lending platforms have a much shorter history and that is a risk. That's why the interest rates are higher; 10% up to 18-20%. I think such rates deserve a spot in my portfolio.

Also, you are doing a disservice to everyone by parading Lending Club around as the best example. Most platforms registered in Estonia are offering real estate loans, not personal loans, which means that the loan is secured. Some platforms offer business loans as well. And platforms registered in Latvia offer consumer loans with a buy-back guarantee. If the borrower is more than 60 days late, the loan originator rebuys the loan. So the risk is that the loan originator may become insolvent, but that's why you diversify and choose the platforms carefully. But in any case, these platforms have nothing in common with Lending Club.