Author Topic: Case Study: Sitting On Too Much Cash?  (Read 8618 times)

sunflower_yellow

  • 5 O'Clock Shadow
  • *
  • Posts: 60
Case Study: Sitting On Too Much Cash?
« on: September 04, 2014, 10:28:39 AM »
The Situation:

Life:  Husband and I are in our early thirties.  We both work full time, decent job security.  Excellent health. 

No kids, would like a child in ~2 yrs time.  I would like to reduce work hours to care for child, thinking of forming a co-op with friends to keep the lil' 'uns in a creche.  But I do enjoy my job (so does husband).

Generally on the same page when it comes to finances.  Fairly risk tolerant.  I set up budgets and automagic transfers and then forget about them.  Don't really care if investments lose value if I don't need them any time soon.

We are "simple" people.  "Use it up, wear it out, make it do, or do without."  We bike, we bake our bread, we sit in the grass, and we have a happy life.

Income:  pretax, roughly $90k combined.

Expenses:  $24k per year is comfortable and includes housing with maintenance and taxes and extra principle payments, utilities, food, transportation, and general variable expenses.  Fairly confident we could trim this to $20k in a pinch.

Savings habits:  max out Roth IRA for both of us ($11k per year), plus a smaller retirement account through my job.  We each receive a personal allowance = $4800 for both of us per year, neither of us come close to using it, otherwise all income goes into our joint checking account and gets distributed from there.  Currently saving into a virtual envelope for a new car in 5 years ($2100 per year) and a child in 2 years ($1800 per year).

Debt:  mortgage, roughly $70k remaining, roughly $120k in equity in house.  House is in good shape.  No student loans, no car loans, no medical bills, no consumer debt.

Assets:  just shy of $100k in retirement accounts.  $19k in investment accounts, low expense funds at Vanguard.  And nearly $83k in what Mint considers "cash" accounts (money market account, checking accounts, etc).  To be fair, this includes our HSA savings ($6750) and our baby/ car savings.  But we have a money market account with $50k that holds a $20k emergency fund, another $10k in case of I don't even know what (the roof falls in on our fairly new house?!) and an additional $20k because I don't know.

Questions:

(1a) Would you agree that our little green employees sitting in the cash accounts are drastically underemployed?

(1b) How would you put them to work?

(2) Given our situation, how much would you recommend keeping in an "emergency fund," and where would that fund live?  I know this is highly personal question, but I'm imagining anyone would agree that $50k for our situation is WAY WAY TOO MUCH.

I apologize if these questions are too basic or have been addressed elsewhere - I'm having a hard time relating other experiences to my own and figuring out what to do.  Which is probably how we've gotten into this situation...  just saving is only part of the puzzle.

Thank you in advance for your opinions!

bo_knows

  • Pencil Stache
  • ****
  • Posts: 819
  • Age: 38
  • Location: Fairfax, VA, USA
    • The Crowdsourced FIRE simulator
Re: Case Study: Sitting On Too Much Cash?
« Reply #1 on: September 04, 2014, 10:48:46 AM »
First off, you're doing very well.  I would never feel bad that you have "too much cash" when you're saving for a specific short-term goal in which cash is needed (for you it's a car and a baby). Don't fret about that, in my opinion.

As for your emergency fund, I personally like a "tiered" approach. I have 3 months of expenses in straight cash ($6k for you) and 3 months of expenses invested in an after-tax brokerage using my standard allocation (80% general stock fund, 20% general bond fund).  I see this as a compromise to keeping it all in cash, as my own personal risk assessment thinks that I have a very very low chance of ever needing more than 3 months expenses immediately.

Another note:  Have you talked about what your work life is going to be like when you have a child? Daycare? Is someone going to stay home part-time or 100% of the time?   Just things to think about when it comes to savings.

ZiziPB

  • Magnum Stache
  • ******
  • Posts: 3274
  • Location: The Other Side
Re: Case Study: Sitting On Too Much Cash?
« Reply #2 on: September 04, 2014, 10:49:53 AM »
Decide what size emergency fund you would be comfortable with (something that lets you sleep at night and not worry - I keep 6 months of expenses in my EF) and put that in an account you can access easily (high yield savings account would good for that).  You should also keep the short term savings (car, baby, etc.) in a high yield savings account or CDs as the last thing you want is to find that your savings are down by 50% in 2 or 3 years.  And then invest the rest in accordance with your asset allocation policy - if you don't have one, now would be a good time to come up with one. 

cko

  • 5 O'Clock Shadow
  • *
  • Posts: 14
Re: Case Study: Sitting On Too Much Cash?
« Reply #3 on: September 04, 2014, 10:58:04 AM »
It would depend - I have well over that sitting around but that's because I'm planning to put 20-30% down on a rental property. And I need to have a 50k+ emergency fund because rental properties can go horribly wrong - the real estate market can crash, I can lose my job and break my leg. Cash reserves are necessary in my case.

mxt0133

  • Handlebar Stache
  • *****
  • Posts: 1559
  • Location: San Francisco
Re: Case Study: Sitting On Too Much Cash?
« Reply #4 on: September 04, 2014, 11:12:16 AM »
Generally on the same page when it comes to finances.  Fairly risk tolerant.  I set up budgets and automagic transfers and then forget about them.  Don't really care if investments lose value if I don't need them any time soon.

You say your are fairy risk tolerant but have so much in cash which is contradictory.  You basically have two years worth of expenses as an emergency fund.  I would max out both of your retirement contributions to lower your taxes to start with.  From there start to invest your remaining excess cash that you are comfortable with into low expense funds.

skunkfunk

  • Handlebar Stache
  • *****
  • Posts: 1057
  • Age: 33
  • Location: Oklahoma City
Re: Case Study: Sitting On Too Much Cash?
« Reply #5 on: September 04, 2014, 11:21:18 AM »
2 things I like to hear about emergency funds.

1 - you can withdraw and re-input contributions to a Roth IRA at any time. Works as an emergency fund in a pinch; a pinch is the only time you'll be using it anyway, so just re-max it next month.

2 - HELOC. Just open one and never touch it until you have an emergency. Pay off quickly as possible afterward.

For my part, so far I've been able to work every "emergency" into my normal monthly income. The only thing that might make me withdraw is losing my job, in which case a roth ira or heloc balance are the least of my concerns.

Bank

  • Stubble
  • **
  • Posts: 224
Re: Case Study: Sitting On Too Much Cash?
« Reply #6 on: September 04, 2014, 11:21:55 AM »
I operate with almost no cash reserves.  My emergency fund is an untapped home equity line of credit (HELOC).  If anything happened I would draw down on the HELOC, and then divert monthly investments to pay it off. 

Doesn't work for everyone from a comfort standpoint, but if you are relatively high income, carry appropriate insurance, and your work is stable you are unlikely to find too many problems you can't earn your way out of.

Debt Free in Alabama

  • 5 O'Clock Shadow
  • *
  • Posts: 20
Re: Case Study: Sitting On Too Much Cash?
« Reply #7 on: September 04, 2014, 12:29:39 PM »
I would slaughter the mortgage.  The grass feels better under your feet when you own it.
Then start saving personal money in index funds and/or dividend growth stocks of mega caps like Unilever, Exxon, Disney, etc and enjoy an almost tax free dividend stream to reinvest and/or provide a third paycheck.

MrMathMustache

  • 5 O'Clock Shadow
  • *
  • Posts: 54
  • Age: 41
  • Location: Florida
Re: Case Study: Sitting On Too Much Cash?
« Reply #8 on: September 04, 2014, 03:45:07 PM »
I was in an almost identical situation about a 18 months ago, having amassed over $100k cash in checking/savings in my case.  I decided to keep one year's worth of expenses in cash and invested all the rest in a Vanguard dividend appreciation ETF.  So long as your mortgage rate is south of 4%, you might as well invest it rather than pay down the debt, especially if you're not going to need the money for years.

Eric

  • Magnum Stache
  • ******
  • Posts: 4061
  • Location: On my bike
Re: Case Study: Sitting On Too Much Cash?
« Reply #9 on: September 04, 2014, 04:39:08 PM »
2 things I like to hear about emergency funds.

1 - you can withdraw and re-input contributions to a Roth IRA at any time. Works as an emergency fund in a pinch; a pinch is the only time you'll be using it anyway, so just re-max it next month.

For clarification, that's only applicable within the same contribution year.  So if you've contributed $5500 to your Roth over the last three years, you have the option to withdrawal $16,500 penalty free, but you'd only be able to re-contribute $5500, as that's the total yearly limit.

sunflower_yellow

  • 5 O'Clock Shadow
  • *
  • Posts: 60
Re: Case Study: Sitting On Too Much Cash?
« Reply #10 on: September 04, 2014, 08:49:03 PM »
Thank you all for the responses.

A few more details:

(1) Mortgage rate is fixed at 3.375% for 15 years.  We are on track to pay it off in about 10.  We are fine with this - mortgage is held at a socially responsible local credit union.

(2) Childcare decision will have to wait until after birth.  Yes, I know.  But neither of us have been parents before - how could we possibly make a decision like this in advance?!  I have no idea if I'll be sick of diapers and itching to get back to my work, or sobbing at the thought of leaving baby, or both.  I love the idea of cutting back on work hours and sharing childcare responsibilities with friends who also have kids (e.g. I take all of the kids on Mondays, friend takes all of the kids on Fridays, we pay for 3 days of childcare and work 4 days per week).

A few more questions:

(1) High yield savings account?  Where could I find one of those?  As far as I'm concerned, they no longer exist.  :-/

(2) Asset allocation policy.  We probably need one of those.  I just chuck it all in a Vanguard Target Retirement account.  How does one go about creating one of those?  Any "start here" articles?

(3) How "relatively high income" would you recommend one be in order to use the HELOC approach?  This seems like a good idea - you have access to funds should you need them, but you don't have funds just sitting around, doing nothing.  For what it's worth, I never realized that one could tap a Roth IRA in a pinch.

An observation:

I have read so many "this is what I do with my cash/ EF" posts, and my difficulty has always been applying someone else's logic to my situation.  It's funny that I posted this thread asking for advice specific to my situation, not more examples of what other people are doing, most of which are completely inapplicable to our situation - not that I don't appreciate the responses deeply (I absolutely do!).  I just think this illustrates that there are 6 billion different ways of managing one's finances, as many as there are people on the planet.  Some are surely better than others, but each is unique to its situation.

And an update:

I talked with the husband tonight about the cash question.  As it turns out, he wants to invest most of it, as do I.  I'm not sure why we haven't done this sooner. 

Well, I do:  we are risk tolerant but lazy and generally "hands off" with our finances (so, mxt0133, this is hardly a contradiction!).  We have gotten much better about this since getting married, since we have to verbally discuss and find consensus and make decisions.

We analyzed the most likely reasons we would need to tap into "savings":
  • To cover monthly expenses - this isn't really savings, but we are thinking of keeping ~1 - 1.5 month of expenses ($2k-$3k) in our checking account to cover cash flow.
  • If something happens to our car - We could go days or even weeks while shopping for a car, so having funds somewhat tied up and not totally liquid is not a problem.  Plus we already have some in (liquid) savings.
  • If one of us loses a job - we can live on one income without adjusting anything.  We would lose the wiggle room in our budget and might want to cut back on variable expenses, but it wouldn't be a crisis, or even a stretch.

I came up with a bunch more scenarios, like what if a meteor plows through our roof, but none of them seemed plausible, and many of them could be covered through our regular budgeting process.  Having an additional 3 months of living expenses ($6k) in a savings account should be more than enough, particularly if we also open a HELOC at some point and/or don't mind using a credit card for a month or two and/or tap into one of our Roth IRAs.

So...

...I guess I need to learn how to invest now, eh?

hexdexorex

  • Stubble
  • **
  • Posts: 159
Re: Case Study: Sitting On Too Much Cash?
« Reply #11 on: September 04, 2014, 10:30:07 PM »
Yes I would put 50k into the market. It might drop by half next year or double next year...no one knows...but over 30 years it will be fine. I personally like VOO...just tracks the S&P 500

Gf and I are same age as you...we keep about 30k in cash and invest the rest (this represents 1 year of expenses). We mostly hold Berkshire but I believe index funds are great investments as well.
« Last Edit: September 04, 2014, 10:33:11 PM by hexdexorex »

Prepube

  • Stubble
  • **
  • Posts: 245
Re: Case Study: Sitting On Too Much Cash?
« Reply #12 on: September 04, 2014, 11:09:18 PM »
Thank you all for the responses.

An observation:

I have read so many "this is what I do with my cash/ EF" posts, and my difficulty has always been applying someone else's logic to my situation.  It's funny that I posted this thread asking for advice specific to my situation, not more examples of what other people are doing, most of which are completely inapplicable to our situation - not that I don't appreciate the responses deeply (I absolutely do!).  I just think this illustrates that there are 6 billion different ways of managing one's finances, as many as there are people on the planet.  Some are surely better than others, but each is unique to its situation.

Yes.  There are 6 billion ways to approach money.  Why did you post a request for investment advice if you believe that no one can understand your particular circumstance?  Am I missing something about your particular circumstances that makes you immune from the FacePunch?  Applying "other people's logic" is exactly what you need to do, then give yourself a facepunch when you see that your situation is not unique and that there are basic money management principles that you are missing the boat on.  Then, get on the correct boat, invest that extra cash, and listen to hexdexorex when s/he says "Yes I would put 50k into the market. It might drop by half next year or double next year...no one knows...but over 30 years it will be fine."

Start your investment allocation research with something simple, then adjust it as you get more educated.  Understand the investing approaches here: http://www.bogleheads.org/wiki/Lazy_portfolios, and then adjust to make them fit your style and needs.  You have a long time before you need most of that money.  Put it to work ASAP!

Bank

  • Stubble
  • **
  • Posts: 224
Re: Case Study: Sitting On Too Much Cash?
« Reply #13 on: September 05, 2014, 06:50:03 AM »

(3) How "relatively high income" would you recommend one be in order to use the HELOC approach?  This seems like a good idea - you have access to funds should you need them, but you don't have funds just sitting around, doing nothing.  For what it's worth, I never realized that one could tap a Roth IRA in a pinch.

An observation:

I have read so many "this is what I do with my cash/ EF" posts, and my difficulty has always been applying someone else's logic to my situation.  It's funny that I posted this thread asking for advice specific to my situation, not more examples of what other people are doing, most of which are completely inapplicable to our situation - not that I don't appreciate the responses deeply (I absolutely do!).  I just think this illustrates that there are 6 billion different ways of managing one's finances, as many as there are people on the planet.  Some are surely better than others, but each is unique to its situation.



You have relatively high income.  Your income is high relative to your expenses (although having a baby may change that).  It would have to be a pretty massive event for you to be unable to pay off a HELOC balance in short order, assuming you carry appropriate insurance on your home, property, life of your spouse etc.

Regarding your second point - the reason I posted my experience on this thread is because I think, based on what you shared, that you are in very much the same boat as me and should be doing what I am doing.  But saying I have the only answer for you a) makes me sound like a jackass, b) ignores the fact that I don't know a crapload about your situation, some of which could change my opinion.  So I tell you what I do and hope you find it useful.

FWIW, I don't judge others decisions generally.  But from a mathematical standpoint I don't believe there are 6 billion equally valid ways of handling financial decisions.  Paying off a mortgage of 4% early is almost certainly suboptimal from a math standpoint.  The same with having massive amounts of cash in an EF if you have stable employment, liquid investments, and low expenses.  But, and it's a biiiiiiigggggg but, you need to be able to sleep at night.  So I fully respect other people's right to make decisions different than my own in this regard.

Sounds like you are well on your way to figuring out a strategy that works for you.  Good luck!

skunkfunk

  • Handlebar Stache
  • *****
  • Posts: 1057
  • Age: 33
  • Location: Oklahoma City
Re: Case Study: Sitting On Too Much Cash?
« Reply #14 on: September 05, 2014, 07:25:00 AM »
Read this article. http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/

Keep in mind that if you invest money that you could have spent paying down a debt, you decrease your expected returns without mitigating any risk. So you go from expected 7% for instance on your own money, to (7-4) = 3% with the same 18% standard deviation. So I suggest keeping a balance - paying into a mortgage can be good diversity for your investment portfolio, essentially. Guaranteed returns. Yes the house may lose value, but that loan isn't changing just for that.

Just something to think about.

ZiziPB

  • Magnum Stache
  • ******
  • Posts: 3274
  • Location: The Other Side
Re: Case Study: Sitting On Too Much Cash?
« Reply #15 on: September 05, 2014, 08:05:50 AM »
Re high yield savings account - check online banks.  I use Ally (.87% savings account and some decent CD rates) but there are others with similar or slightly better rates.  Since you use a credit union for your mortgage, do they offer any high yield saving accounts or CDs?  BTW, "high yield" is a relative term.  Ally is certainly higher than what I can get at my local bank.

As to asset allocation, head over to http://www.bogleheads.org/forum/index.php and start reading the forum and their Wiki pages.  It is a great resource.

frugaliknowit

  • Handlebar Stache
  • *****
  • Posts: 1671
Re: Case Study: Sitting On Too Much Cash?
« Reply #16 on: September 05, 2014, 08:31:56 AM »
First, I am definitely of the more conservative camp, but I am also 1 income, living alone with a job which is hard to replace.  I prefer to have one years expenses, plus a car fund.

In your case, I would not be any higher than me.

That being said, I do not see how your expenses for two can be 24k a year while you both work and own a home with a 70k mortgage.  I tend to think you are not including a contingency fund for your house and car like the roof being repaired or your car needing a new alternator...just slap me back if I am off base.  Maybe you are more like 36k????

sunflower_yellow

  • 5 O'Clock Shadow
  • *
  • Posts: 60
Re: Case Study: Sitting On Too Much Cash?
« Reply #17 on: September 05, 2014, 11:00:57 AM »
Wow, you guys rock.  Thanks.  Let's see if I can address all of your points...

Hex, any reason you aim for 1 year of living expenses?

Prepube, I think you may have missed my point.  I admit that I am great at saving but don't know the first thing about investing!  That's why I'm here!  I do believe that folks here can understand my situation and do have relevant experience - this is why I'm posting, asking for advice, as opposed to reading.  Reading posts, I find so many situations that are NOT similar to my own.  Of course the underlying financial principles are the same, but I learn best by understanding the principles first, then learning how to apply them.  I have had difficult doing this simply by reading about others' experiences, which is why I proactively asked a question.  Did I really deserve a facepunch for asking a question?  I get that the facepunch is a "Mustachian thing," but what I *really* needed was the link that you included at the end, *not* a facepunch.  Just something to keep in mind when you're interacting with strangers on the internet.  So, thank you for the link, that's a great place to start.

Bank, I like the way you approach this.  I agree that your situation *right now* seems similar to ours - though again, baby might change that quite a bit.  So, I appreciate you sharing what you are doing, and also for pointing out the underlying principles that have led you to making the decisions you have made. 

Skunk, that's a really good point.  Plus, our PITI payments are currently MUCH less than what it would be to rent a similar home, but we get the security of knowing we need to live here forever with the same payment (at least for the next 10 years).  As our real estate market here is on the up-and-up, that gives me good peace of mind.

Zizi, thanks for the resources.  I guess "high interest" really is a relative term, eh?

Frugal, ok, let me see if I can be more specific about our expenses.  This is a direct ctrl+c ctrl + v from our budget spreadsheet.

Net Income                    $        5,790  (after taxes & after pre-tax retirement - note that we are expecting to have to pay extra taxes as we are having less withheld from our paychecks for this year.)

Retirement (Roth IRA)            $          846

Housing
Mortgage                    $          517
Taxes (School + Property)    $          355
Home Insurance                    $           44
Internet                    $           15
Utilities                    $          100
Extra principle payments    $          250
Total Housing Budget            $        1,282

Variable Expenses
Food                            $          425
Transportation                    $          375
Variable Expenses            $          300
Home Maintenance                $          185
Home Improvement            $          200
Total Variable Budget            $        1,100

Personal Allowances              $          440

Total "Expenses"                 $        4,053

Income minus expenses            $        1,737

Additional savings "envelopes":   
Baby (in 2 years)            $          150
New car (in 5 years)            $          175

What's left over                  $        1,412


So, when I'm talking about my straight-up living expenses, I'm thinking, "what is the minimum we would need if we were really in a pinch."  This means suspending retirement savings, other savings, personal allowances, improvements for the house, and so on.  Then our expenses would be our mortgage, taxes, insurance, internet, utilities, food, transportation, and "variable expenses" (everything from soap to a pillow to socks).  This works out to $2,131 per month and could totally be trimmed (e.g. we RARELY spend the full $300 on "other," I'd ditch the no contract smart phone which is currently paid out of my personal allowance and would get a basic $20 line, etc).  So, that's where I get the $24k from.

In terms of "contingency funds"...

We are already budgeting for the car repairs as part of our regular transport expenses.  Our actual transport expenses are more on the order of $100-150 per month, so I roll over the un-used funds month-to-month for when we need to buy new tires or something).  $375 is an actual real average from the past 18 months or so and has included some not insignificant repairs.

Our house is relatively new and we aren't anticipating any major repairs in the next 5 years.  When it does need a new roof (which will probably be in about 5 years), we will perform that work ourselves (we've got the skills and the tools, plus our house is pretty small, it's an easy job).

Anyway, my point is that all of the things that could require "contingency funds" are actually planned expenses, not big emergency surprises, for us.  The two big ones right now will be replacing the car in about 5 years and having a baby in 2.  I'll probably add a roof fund in about 2 years, depending on what happens with kids.  Other than the aforementioned meteor going through the house, I can't think of what else we should be planning for.  Simple life = low needs = less stress.  :-)

Bank

  • Stubble
  • **
  • Posts: 224
Re: Case Study: Sitting On Too Much Cash?
« Reply #18 on: September 05, 2014, 11:25:49 AM »
Read this article. http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/

Keep in mind that if you invest money that you could have spent paying down a debt, you decrease your expected returns without mitigating any risk. So you go from expected 7% for instance on your own money, to (7-4) = 3% with the same 18% standard deviation. So I suggest keeping a balance - paying into a mortgage can be good diversity for your investment portfolio, essentially. Guaranteed returns. Yes the house may lose value, but that loan isn't changing just for that.

Just something to think about.

This is a nice writeup.  The one add I have is that if you are itemizing deductions, the spread is even bigger.  Instead of 4% interest is 4% less the tax deduction.

RelaxedGal

  • Bristles
  • ***
  • Posts: 349
  • Age: 41
  • Location: 495 corridor, Massachusetts, USA
Re: Case Study: Sitting On Too Much Cash?
« Reply #19 on: September 05, 2014, 12:32:10 PM »
we are thinking of keeping ~1 - 1.5 month of expenses ($2k-$3k) in our checking account to cover cash flow.
[...]
Having an additional 3 months of living expenses ($6k) in a savings account should be more than enough, particularly if we also open a HELOC at some point and/or don't mind using a credit card for a month or two and/or tap into one of our Roth IRAs.

Perfect!  We just realized we had a gob of cash lying around being unproductive and moved it into an investment account.  Our rationale is similar: 2-3 months in the checking and associated savings account (used as overdraft) at the local credit union.  2-3 months at Capital One 360 in a "high yield" savings account - 0.75% I think.  Anything beyond that was moved into investments.

makinbutter

  • 5 O'Clock Shadow
  • *
  • Posts: 56
Re: Case Study: Sitting On Too Much Cash?
« Reply #20 on: September 05, 2014, 12:44:08 PM »
Read this article. http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/

Keep in mind that if you invest money that you could have spent paying down a debt, you decrease your expected returns without mitigating any risk. So you go from expected 7% for instance on your own money, to (7-4) = 3% with the same 18% standard deviation. So I suggest keeping a balance - paying into a mortgage can be good diversity for your investment portfolio, essentially. Guaranteed returns. Yes the house may lose value, but that loan isn't changing just for that.

Just something to think about.



This is a nice writeup.  The one add I have is that if you are itemizing deductions, the spread is even bigger.  Instead of 4% interest is 4% less the tax deduction.

Actually, respectfully, your expected-return-on-stocks [7%, in your example] doesn't magically subtract out the guaranteed-return-on-mortgage-paydown [3%, in your example], leading to an expected return of 3% if you were to choose the investment path.  That's not how the maths work :)

What you'd get is 7% expected, factoring in whatever standard deviation you'd planned on... VERSUS a guaranteed 3.x% (accounting for the mortgage interest deduction, if any).  These two are apples and oranges and shouldn't be combined together to make the equities' return look more paltry.

Smarter mathletes than I can correct as necessary -


Edited to fix the terrible quoting. It's my first time on the Internet, y'all

Bank

  • Stubble
  • **
  • Posts: 224
Re: Case Study: Sitting On Too Much Cash?
« Reply #21 on: September 05, 2014, 12:54:55 PM »
Actually, respectfully, your expected-return-on-stocks [7%, in your example] doesn't magically subtract out the guaranteed-return-on-mortgage-paydown [3%, in your example], leading to an expected return of 3% if you were to choose the investment path.  That's not how the maths work :)


Not to thread hijack, but I read this differently.  With the 3% being the foregone return of paying down the mortgage rather than investing.

Sunflower - you're doing great.  I dig your approach to this whole business.

skunkfunk

  • Handlebar Stache
  • *****
  • Posts: 1057
  • Age: 33
  • Location: Oklahoma City
Re: Case Study: Sitting On Too Much Cash?
« Reply #22 on: September 05, 2014, 01:16:54 PM »
Read this article. http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/

Keep in mind that if you invest money that you could have spent paying down a debt, you decrease your expected returns without mitigating any risk. So you go from expected 7% for instance on your own money, to (7-4) = 3% with the same 18% standard deviation. So I suggest keeping a balance - paying into a mortgage can be good diversity for your investment portfolio, essentially. Guaranteed returns. Yes the house may lose value, but that loan isn't changing just for that.

Just something to think about.



This is a nice writeup.  The one add I have is that if you are itemizing deductions, the spread is even bigger.  Instead of 4% interest is 4% less the tax deduction.

What you'd get is 7% expected, factoring in whatever standard deviation you'd planned on... VERSUS a guaranteed 3.x% (accounting for the mortgage interest deduction, if any).  These two are apples and oranges and shouldn't be combined together to make the equities' return look more paltry.


Leverage is confusing. @.@

I mean, we could start using historical data to calculate the probability of beating your mortgage, but I think my summary does at least show the kind of volatility you introduce by going straight stocks with all your money. Diversity is king, and the mortgage is about as high as you can get for a guaranteed ROI (assuming you are unwilling to short sale or bankrupt yourself.)

Bank

  • Stubble
  • **
  • Posts: 224
Re: Case Study: Sitting On Too Much Cash?
« Reply #23 on: September 05, 2014, 01:44:23 PM »
Okay, Skunkfunk --- I think you are perhaps advocating the exact opposite of what I thought you were and what the math shows.  Investing in something that pays 3% "guaranteed" after tax (e.g. interest savings) vs. something the pays an expected 7% compounded over the long term, even with short-term volatility, isn't a good deal mathematically --- at least it isn't if you have a long term time horizon.  Plus, you're ignoring that holding a fixed rate mortgage provides diversification in other ways.  It's a nice inflation hedge, for example. 

Thread hijack at an end (at least from my perspective).  Just wanted to clarify my position, which is that I LOVE my 3.875% mortgage and intend to pay it off as slowly as possible.

makinbutter

  • 5 O'Clock Shadow
  • *
  • Posts: 56
Re: Case Study: Sitting On Too Much Cash?
« Reply #24 on: September 05, 2014, 01:55:47 PM »
Okay, Skunkfunk --- I think you are perhaps advocating the exact opposite of what I thought you were and what the math shows.  Investing in something that pays 3% "guaranteed" after tax (e.g. interest savings) vs. something the pays an expected 7% compounded over the long term, even with short-term volatility, isn't a good deal mathematically --- at least it isn't if you have a long term time horizon.  Plus, you're ignoring that holding a fixed rate mortgage provides diversification in other ways.  It's a nice inflation hedge, for example. 

Thread hijack at an end (at least from my perspective).  Just wanted to clarify my position, which is that I LOVE my 3.875% mortgage and intend to pay it off as slowly as possible.

Yep, I think we're all on the same sheet of music here now - thanks for the clarification from both you and SFunk.

OP: I'd say keep the mortgage as long as possible UNLESS you get a lot of personal peace-of-mind out of paying the effer off.  If THAT's the case, slay it with extreme prejudice!

Good luck!

sunflower_yellow

  • 5 O'Clock Shadow
  • *
  • Posts: 60
Re: Case Study: Sitting On Too Much Cash?
« Reply #25 on: September 05, 2014, 01:59:04 PM »
OP: I'd say keep the mortgage as long as possible UNLESS you get a lot of personal peace-of-mind out of paying the effer off.  If THAT's the case, slay it with extreme prejudice!

Nah, I don't mind 3.375%, especially when it's held by the aforementioned socially responsible local credit union.  We'll have it paid off in about 10 years with a bit of extra payments and 14.5 without.  I can sleep well with that.

TomTX

  • Magnum Stache
  • ******
  • Posts: 3598
  • Location: Texas
Re: Case Study: Sitting On Too Much Cash?
« Reply #26 on: September 05, 2014, 02:51:10 PM »
Personally, I would just put 100% into a low cost US stock index fund at Vanguard, such as the Total Stock Market (VTSAX). I won't object if you prefer the S&P500.

If you want some bonds, I think getting some I-bonds are safer than getting into a bond fund, or a target date fund. When there is an interest rate/inflation rise, the bond fund will lose value. The I-bonds will adjust their rate of return upward based on inflation. You can get $5k per person per year in I-bonds directly from the US Treasury. $10k in I-bonds is plenty of bond exposure (20% of your $50k). Additionally, you won't pay any taxes on the bonds until you cash them in - and if you cash them for educational expenses, you pay no federal income taxes.


yandz

  • Stubble
  • **
  • Posts: 122
Re: Case Study: Sitting On Too Much Cash?
« Reply #27 on: September 05, 2014, 03:18:39 PM »
FWIW, husband and I recently realized we probably had a surplus of 50k cash sitting, honest to goodness, in our checking account (what?) and sunk it into the mortgage before getting thoroughly educated.   We totally regret it. Not in an emergency way, just that the better option was to invest way.  Sounds like you are leaning toward investment.