Case Study: Too much cash

[Hondo]

I'm married with two young children. My salary is $125K, I typically receive a bonus of $12K to $20K per year. My wife doesn't work.

Debt:
Our only debt is a mortgage of $303K on a home with a market value of around $405K. The mortgage rate is 3.4%

Assets:
$295K in cash, earning an average of .4% interest
  $36K in a portfolio of about a dozen individual stocks. 
$400K in 401ks and IRAs, invested in total stock market and S&P 500 index funds.

Question(s):
What to do with the cash? US stock markets are at record highs, which makes me highly skeptical about putting it all to work in the market at these levels. Bond funds look weak, and will remain weak with the possibility of interest rate hikes by the Fed next year. CDs and money market funds pay next to nothing.

I could pay off my mortgage by selling about $10K worth of stock and using all my cash, but then I'd have no reserves for a while. I could pay off a portion of the mortgage.

What I'd really like to do is put all the cash to work to generate growth or income, but I'm highly risk-averse. Should I wait for interest rates to rise and then start building a CD ladder? I know someone is going to tell me to punch myself in the face for not paying off all or a portion of my mortgage. What would you do?

[Future Lazy]

Paying off as much mortgage as you're comfortable paying would be a good idea - less liability later in trade for less liquid assets now - but quick to build it back up, if you're saving most of your income.

To really help you decide where you want to invest, though, I think it would be helpful for everyone to know your current age, your projected age of retirement, and any financial goals you might have for the nearish or farish future (more expensive house, travel the world, put kiddos through college?).

PS. Except for recessions, stocks are practically always at record highs...
http://www.mrmoneymustache.com/2014/08/25/indexview/

[Icecreamarsenal]

If you're highly risk averse you could look at paying off a big portion of your mortgage as a ROI of 3.4%.

[mxt0133]

I would look at my possible alternative and weight my options.

Stocks - You say that you are hesitant to invest at these levels, well how long have you had that cash?  Did you say that a year ago when the market was at high levels as well?  What is your investment horizon?  If it is longer than 5-10 years then stocks will more than likely outperform all your other options.

Pay off mortgage - You are paying 3.4% right now and only getting .4% interest.  You are going to end up paying $170,459.73 in interest vs earning $38K over thirty years, you do however get a tax deduction if you itemize on the mortgage interest.  With regard to no reserves for a while, do you have credit cards?  You can also open up a HELOC with the equity you have.


Before you rush into anything I would analyze all my options and no matter how things turn out you have to comfortable with yourself knowing you made the best decision you can with the information you had at the time.  The worse thing you can do is do something you are not sure of, not have it workout and abandon it and make an even worse decision.
 

[index]

Triple the size of your after tax investment account (60K). Invest in a 60/40 split of stocks and bonds. Maybe buy individual muni-bonds. You should be able to find 7-yr to expiration bonds for 3% and pay no taxes on the interest.

Put 100K at Ally Bank 5-yr CDs @ 2% - Early withdraw penalty is 6 months interest
Put 50K in a High Yield Savings @ .9% - Liquid EF

Buy some rental property. 85K could be leveraged to 340K which could buy several duplex's or a couple of single family homes. You could even pay a property manager and have minimal work. 15-yr mortgages and the houses could cash flow your kids education expenses when they are college aged.

[BaldingStoic]

Yes, you have way too much cash in my opinion; It makes zero sense to earn .4% on interest when you pay 3.4% on your mortgage.  (Unless of course you need cash for a future home purchase, rental property etc.).  Looks like you are already leveraging all the right tax sheltered accounts, but you might want to start 529 Plans for the kids.  I'd recommend putting between 50-80% toward your mortgage and the rest into stock funds.  If you worried about the high US stock prices, put more into bond funds, European stock funds, and emerging market funds. 

[UnleashHell]

What to do with the cash? US stock markets are at record highs,

yeah.. as they were at the previous record, and the one before that and that and that.....

at they at a high compared to the next ten years? what does your crystal ball tell you.


The only time I made money with a crystal ball was selling it at a yard sale....



you can't time the market. you don't know what will happen.


If it were me I'd be setting up a portfolio with a bond/stock mix - and I'd be heavy on the dividend paying stocks as they could easily pay the mortgage if anything was to happen. plus they generally keep paying even if the market goes down.

I'd also start putting that cash to work in Roths - as much as possible so that you have an tax free income stream in the future.

The mortgage - its not a bad rate. you might be able to lower the amount with cash at the same time as a refi to a lower rate.. that would cut that expense down - or even the same expense with a far lower term.

Its a good problem to have.

[index]

I think paying of a mortgage at 3.4% is a bad idea. You are paying ~2.5% interest after tax write-offs. Even with the current low inflation of 1.7% this comes down to 0.8%. If inflation ticks above 2.5%, the bank is paying you to keep their money.

You essentially have 40% of your liquid net worth hedged against inflation right now.

[webguy]

Do you have any international exposure in your stock portfolio? If not, I'd definitely consider putting a good chunk of it into that.

[Hondo]

I appreciate all the responses. I'm in my mid-40's (an "older dad") and my wife is 6 years younger than me.

Here is the explanation for my risk aversion: From the mid 1990s to the early 2000s, I worked for a high-tech company that experienced exponential growth. It went from a small startup to a world-wide company with over 10,000 employees. I had approximately 120,000 shares of stock in this company. The all-time high price of that stock was $60, while my cost ranged from about $3 to $20 per share. I was ready to retire in my early 30s, but all my eggs were in one basket. The market crashed, the economy entered a recession, and the company collapsed. I didn't sell a single share the entire time - I was confident that the only direction it could go was "up."

So, I'm a prime example of how human emotions can lead to irrational financial decisions. I was irrational then (I should have harvested the money and diversified), and I'm irrational now (I'm afraid of crashing and burning again). That's why I've been reading MMM, jlcollinsnh, and other FI/ER blogs for years, but only now am I reaching out to like-minded people.

[opnfld]

Do you have any international exposure in your stock portfolio? If not, I'd definitely consider putting a good chunk of it into that.

I agree with this.  Internationals are down ~5% for the year versus S&P up ~11%.  In a taxable account, you'd benefit from foreign tax credit.

[juuustin]

Holy hell.  Over $7 million and you didn't see a penny?  I know there are a lot of robots that would say an experience like that shouldn't affect your future decisions, but that is definitely a lot to swallow.  Good luck man!  You have done well to accumulate the cash you have.

[NewStachian]

I can tell you if I was in your situation I would dump all the money into 6 ETFs: large cap, mid cap, small cap, 2 international, and a bond. But, that's me.

[RichMoose]

I appreciate all the responses. I'm in my mid-40's (an "older dad") and my wife is 6 years younger than me.

Here is the explanation for my risk aversion: From the mid 1990s to the early 2000s, I worked for a high-tech company that experienced exponential growth. It went from a small startup to a world-wide company with over 10,000 employees. I had approximately 120,000 shares of stock in this company. The all-time high price of that stock was $60, while my cost ranged from about $3 to $20 per share. I was ready to retire in my early 30s, but all my eggs were in one basket. The market crashed, the economy entered a recession, and the company collapsed. I didn't sell a single share the entire time - I was confident that the only direction it could go was "up."

So, I'm a prime example of how human emotions can lead to irrational financial decisions. I was irrational then (I should have harvested the money and diversified), and I'm irrational now (I'm afraid of crashing and burning again). That's why I've been reading MMM, jlcollinsnh, and other FI/ER blogs for years, but only now am I reaching out to like-minded people.

While I sympathize your situation and understand why you are risk-averse, the only lesson to learn from this is: Don't put all your eggs in one basket.

Instead, be smart and buy index funds. Even the S&P 500 means you are putting your eggs in 500 baskets. Diversify!

This means, be tax-smart with your investments and maximize your tax advantaged accounts. With you earnings you should probably go with a Traditional IRA (see MadFientist for reasons why). In those accounts buy index funds. Anywhere from 60/40 to 90/10 stock bond split will do, but for you maybe 60/40 is a better bet. In your regular investment account buy international index funds first and take advantage of those tax credits.

[hodedofome]

Consider the permanent portfolio, you should get at least inflation returns with very little volatility. I don't personally use it but for someone who is risk averse, it should allow you to keep what you have. I think it was down 15-20% at the worst of 2008, which I wouldn't expect to happen again for a long time.

[Hondo]

Holy hell.  Over $7 million and you didn't see a penny?  I know there are a lot of robots that would say an experience like that shouldn't affect your future decisions, but that is definitely a lot to swallow.  Good luck man!  You have done well to accumulate the cash you have.

I hope my experience can provide a good example of how *NOT* to manage one's personal finances. Thanks for your response.

[frugaliknowit]

You definitely need to put that cash to work.  I have no problem with your paying off the mortgage, then building cash, given that you are pretty risk averse and the market is on the high side.  Once it is paid, average into the market with index funds or etf's.

[jamal utah]

Another thing to think about is adjusting your investing strategy so that you don't continue to accumulate more cash. I can understand your hesitation about dropping all of your cash into the stock market, but you should make sure that you are maxing your 401k and roth ira contributions and then look at increasing your automatic deposits into your separate investment account.  Of course this advice is moot if your cash was the result of a windfall.  Just my 2 cents.

[Ricky]

Wait, how is OP risk averse with $36k in individual stocks?

How is drawing .4% on ~40% of your net worth being risk adverse? You're losing money with inflation alone which sounds risky to me!

Do yourself a favor and pay half of the cash on the mortgage and invest the rest in an index at Vanguard or Betterment. Problem solved!

[Hondo]

Wait, how is OP risk averse with $36k in individual stocks?

How is drawing .4% on ~40% of your net worth being risk adverse? You're losing money with inflation alone which sounds risky to me!

Do yourself a favor and pay half of the cash on the mortgage and invest the rest in an index at Vanguard or Betterment. Problem solved!

My cost basis for the individual stocks is substantially lower than 36K.  I am risk-averse, but watching their value rise over the past decade compelled me to hold them.

I agree with what Index said above:

"I think paying of a mortgage at 3.4% is a bad idea. You are paying ~2.5% interest after tax write-offs. Even with the current low inflation of 1.7% this comes down to 0.8%. If inflation ticks above 2.5%, the bank is paying you to keep their money.

You essentially have 40% of your liquid net worth hedged against inflation right now."

[Malaysia41]

My cost basis for the individual stocks is substantially lower than 36K.  I am risk-averse, but watching their value rise over the past decade compelled me to hold them.

Isn't that the thinking that got you into trouble when the tech bubble burst?

With that much cash I would consider buying a rental property.  Or, if landlording ain't for you, spread it out over assets over time - DCA into international funds, VTI fund, bond funds, even a small amount into LendingClub.  And then, consider buying a few shares of VXX (or equiv) as insurance against a downturn.

[Davids]

The quick answer is yes you have a lot of cash. You have a low mortgage rate so I do not think you should look to pay it off quickly but I will not fault you if that is a goal. Do not be concerned that the market is at a record high. I would though take it slow and not dump all your cash in the market right away. I would do dollar cost average, open up a brokerage account with Vanguard and over the course of 12 months move $22K per month into there to purchase ETFs. My approach would be 50% Total Stock Market, 25% Dividend Appreciation, 15% REIT, 10% Total Bond Market. After 12 months the difference of $30K is a reasonable cash balance to have (Though I am sure some will say still too high).

Do you max out your 401K and your Roth IRA and wife Roth IRA (You can have Roth IRA for your wife if she does not work since you work)? If not then definitely do that as well. Do you invest in 529 plan for your kids, are you on a HDP health insurance plan so you can have HSA?

I understand your cash concern from your earlier life experience but time to move on and learn and diversify.

[GoCubsGo]

Assuming your market supports it, yours is the PERFECT situation to diversify into a rental property.  You can lock in fairly consistent returns and potentially gain on appreciation.   Buy a property in excellent shape and have a property manager handle it from there and you've at least used some of that cash and have it diversified away from stocks should you choose to buy some (which you should and I second buying solid dividend stocks).