Author Topic: Does paying off debt early always lead to an earlier retirement?  (Read 7497 times)

nedwin

  • 5 O'Clock Shadow
  • *
  • Posts: 88
Does paying off debt early always lead to an earlier retirement?
« on: December 16, 2013, 04:20:01 PM »
I know, this is MMM's forum so the answer should be HELL YES, BECAUSE YOUR DAMN HAIR IS ON FIRE!  I began reading MMM and the forum this past summer, and have drank enough of the kool-aid to understand and even embrace a good portion of the philosophy.  Recently I did some rudimentary calculations with Excel, and it seemed that paying off our student loans early rather than putting the extra money to our retirement funds was a wash in our situation.  This is long, bear with me.

My wife and I have just shy of $60,000 of student loan debt together and one motorcycle loan.  The motorcycle loan is from a family member, with no interest.  We are paying $175/month on it.  The motorcycle is for sale now, and we have enough equity in it that we will have some money leftover.  In addition, we owe a mortgage on our residence and a mortgage on our rental.  We do not have c.c. debt.  Our student loan debt is as follows:

Loan 1:  $15,931.28, 5.75%, minimum payment of $271.07
Loan 2:  $13,372.28, 4.25%, minimum payment of $155.00
Loan 3:  $12,924.76, 6.3%, minimum payment of $150.00
Loan 4:  $12,914.41, 6.3%, minimum payment of $119.00
Loan 5:  $5,605.26, 5.00%, minimum payment of $50.21

These student loans are the bane of my existence, every time I see the balances I want to stab these loans in the throat.  Right now we are paying $500 per month extra on loans 3 and 4 (payoff highest interest first, right?).  For retirement savings we have about $91,000 between five accounts (ROTH and Traditional IRA for me, 403(b), 401(a) and Traditional IRA for my wife), all in low cost index funds.  Our goal is to have $1.5M at retirement, not counting any home equity.  For my calculations I used excel's future value function and assumed that the annual interest rate on our investments would be 7%.  The "number of payments" is the number of monthly payments made.  For the last year we have averaged $1085/month of contributions to our retirement funds, including employer contributions.  this varies a little every month, my wife is paid hourly so her income fluctuates.  In the first set of calculations the extra $500/month goes into our loans, and the loans are snowballed as each individual loan is paid off (highest interest rate to lowest).  In the second set of calculations the extra $500/month is put into our savings, and loan payments are snowballed into our retirements savings as they loans are paid off.

Accelerated loan payments of $500 and Retirement as normal   
Annual Interest Rate   7%
Number of Payments   54
Amount of Payment   -1085
Present Value   -91000
Payment is due at the beginning of the period   1
Future Value of the Investment Stream   $193,614.99
   
Annual Interest Rate   7%
Number of Payments   200
Amount of Payment   -2330
Present Value   -193600
Payment is due at the beginning of the period   1
Future Value of the Investment Stream   $1,503,629.41
   
Number of Months   254

Loan Payments as Normal and add $500 extra to retirement   
Annual Interest Rate   7%
Number of Payments   66
Amount of Payment   -1585
Present Value   -91000
Payment is due at the beginning of the period   1
Future Value of the Investment Stream   $261,481.64
   
Annual Interest Rate   7%
Number of Payments   36
Amount of Payment   -1856
Present Value   -261500
Payment is due at the beginning of the period   1
Future Value of the Investment Stream   $396,952.62
   
Annual Interest Rate   7%
Number of Payments   10
Amount of Payment   -2011
Present Value   -396900
Payment is due at the beginning of the period   1
Future Value of the Investment Stream   $441,436.42
   
Annual Interest Rate   7%
Number of Payments   36
Amount of Payment   -2161
Present Value   -441400
Payment is due at the beginning of the period   1
Future Value of the Investment Stream   $631,005.65
   
   
Annual Interest Rate   7%
Number of Payments   105
Amount of Payment   -2330
Present Value   -631000
Payment is due at the beginning of the period   1
Future Value of the Investment Stream   $1,500,332.62
   
Number of Months   253

As you can see the number of months to reach at least $1.5M is only one month apart, and when we're talking over 20 years what does one month matter, anyway?  If I change the annual interest rate to 6%, the result is 274 months for both scenarios.  If it is true that the earlier one pays off debt the earlier they can retire, my calculations must be incorrect.

Here are my questions:
1.  Can it be true that not paying off debt early does not necessarily affect one's retirement date?  Or is it rather that paying off debts allows one to retire with a smaller 'stache?
2.  What mistakes did I make, and which of my assumptions are incorrect?
3.  Is there anything else I missed?

gillstone

  • Bristles
  • ***
  • Posts: 388
  • Age: 37
  • Location: The best state in the Union (MT)
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #1 on: December 16, 2013, 04:49:46 PM »
1. The answer depends on interest rates of debts and assume return rates of investments.  For my own purposes I've found paying off my 3.5% APR mortgage with regular extra paymetns will delay my retirement more than if I just saved up a lump sum and paid the damn thing in one shot.  being debt free does make it easier to retire (less fixed costs) and improves the chances of you staying that way.

2. Nah that looks right more or less

3. I would say you missed one intangible thing - the feeling of being debt free and knowing that if something shitty happened tomorrow you aren't in hock to Sally Mae.

SunshineGirl

  • Pencil Stache
  • ****
  • Posts: 740
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #2 on: December 16, 2013, 05:04:53 PM »
Your assumption that you'll make 7% year in and year out with your investments is where I'd urge caution.

goodlife

  • Stubble
  • **
  • Posts: 188
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #3 on: December 16, 2013, 05:11:35 PM »
Paying off your debt gives you pretty much a risk free return. Investing your money is never risk free and returns can be very uncertain while the interst on your debt is certain. I would just pay off the debt asap and worry about investing later.

frugaldrummer

  • Pencil Stache
  • ****
  • Posts: 655
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #4 on: December 16, 2013, 05:26:27 PM »
Yes, the difference is all about risk.  I would pay the debt off.

Another (small) point - you have two student loans at 6.3% interest that you are throwing your extra money at.  I'd pick the smaller of those two and throw ALL of the extra at it, instead of splitting it between the two.  My reasoning is, that once you have eliminated one of those loan payments, you have about $150/mo less in mandatory payments - a little extra buffer if there are unexpected job losses etc.  If you have only paid off half of both loans, you don't have that extra security yet.

frugaldrummer

  • Pencil Stache
  • ****
  • Posts: 655
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #5 on: December 16, 2013, 05:28:01 PM »
Quote
Loan 3:  $12,924.76, 6.3%, minimum payment of $150.00
Loan 4:  $12,914.41, 6.3%, minimum payment of $119.00

Correction, I would pay off Loan 3 first, since it has the higher minimum payment and the totals are almost the same.

Will

  • Pencil Stache
  • ****
  • Posts: 770
  • Location: Vancouver, WA
  • What the deuce?!?!?
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #6 on: December 16, 2013, 05:44:22 PM »
...and as I always do, I'd recommend running various scenarios over on http://www.whatsthecost.com/snowball.aspx

You can plug in your numbers and try different things easily to get different results (which you may or may not be able to do with your own spreadsheets).

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #7 on: December 16, 2013, 08:23:16 PM »
To answer the question posed in the thread title: no.  Paying off debt often slows down your retirement, where paying the minimums would be much better (and paying interest for 30 years, rather than paying it ASAP) would leave you with more money (and potentially even lower risk).

It's all about the interest rate versus your future returns.  Your risk tolerance is mixed in that too.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

fodder69

  • Stubble
  • **
  • Posts: 166
  • Location: Charlotte, NC
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #8 on: December 17, 2013, 08:32:05 AM »
And it has been addressed other ways, but if you look at straight numbers and rosy scenarios, paying off debt early doesn't always win. But there are two big (to me) benefits, one is mental in that it just feels better to have no debt, and two is the flexibility of less monthly obligations for unforeseen events or what have you.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #9 on: December 17, 2013, 09:10:48 AM »
And it has been addressed other ways, but if you look at straight numbers and rosy scenarios, paying off debt early doesn't always win. But there are two big (to me) benefits, one is mental in that it just feels better to have no debt, and two is the flexibility of less monthly obligations for unforeseen events or what have you.

I'm glad you added the "to me" - I disagree with both of these.  :)

I feel bummed that my student loans are paying off soon (after paying the minimum for years), and I'm constantly trying to find ways to get into more debt.  I feel stressed annoyed when I have a bunch of useless trapped equity and own rentals free and clear (which is partially the case right now).

Regarding two.. yes, maybe, that's one way to look at it. The other way is that paying off debt makes you much less liquid - so if there is an unforeseen event, as you say, I'd rather have 100k in the bank, and a $600/mo mortgage, than a paid off house and no mortgage payment, but have very little in the bank.  The monthly obligation is not nearly as big of an issue as not having liquid funds to deal with the problem.

YMMV, obviously.  ;)
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

nawhite

  • Handlebar Stache
  • *****
  • Posts: 1060
  • Location: An RV somewhere in the West
    • The Reckless Choice
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #10 on: December 17, 2013, 10:10:26 AM »
Paying off your debt gives you pretty much a risk free return. Investing your money is never risk free and returns can be very uncertain while the interst on your debt is certain. I would just pay off the debt asap and worry about investing later.

I definitely side with arebelspy for my student loans but only because my interest rates are <4%. The important thing is the risk of the investment vs the return. Paying off the student loans is a risk-free and inflation-hedged investment. Investing is neither. So your options are:

Pay off 6.3% loan risk free
or
Earn X% interest in a "high" risk investment

Around these parts, we estimate a 5-6% (inflation adjusted) long term return in the stock market. (the 7% you used is in line with that but you need to subtract inflation). So if X% is 6%, then investing in this situation is the WRONG move because the loans pay a higher rate AND have less risk.

The question becomes what is your X%? Arebelspy invests in real estate and he gets a much higher rate than 6%. His X% is probably closer to 10% if not higher. In which case, he makes the choice that investing will be the better move (even despite the higher risk). And he is entirely right!

If you are only going to invest in index funds though, I wouldn't expect more than about 6% inflation adjusted long term in which case paying off the loans is a better move even if you ignore the fact that paying off the loans is risk free. So I'd say pay off the highest interest loans ASAP and then reevaluate when you get to the 5% ones.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #11 on: December 17, 2013, 10:18:29 AM »
Good post, nawhite.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

nedwin

  • 5 O'Clock Shadow
  • *
  • Posts: 88
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #12 on: December 17, 2013, 11:10:49 AM »
Your assumption that you'll make 7% year in and year out with your investments is where I'd urge caution.

Paying off your debt gives you pretty much a risk free return. Investing your money is never risk free and returns can be very uncertain while the interst on your debt is certain. I would just pay off the debt asap and worry about investing later.

I definitely side with arebelspy for my student loans but only because my interest rates are <4%. The important thing is the risk of the investment vs the return. Paying off the student loans is a risk-free and inflation-hedged investment. Investing is neither. So your options are:

Pay off 6.3% loan risk free
or
Earn X% interest in a "high" risk investment

Around these parts, we estimate a 5-6% (inflation adjusted) long term return in the stock market. (the 7% you used is in line with that but you need to subtract inflation). So if X% is 6%, then investing in this situation is the WRONG move because the loans pay a higher rate AND have less risk.

The question becomes what is your X%? Arebelspy invests in real estate and he gets a much higher rate than 6%. His X% is probably closer to 10% if not higher. In which case, he makes the choice that investing will be the better move (even despite the higher risk). And he is entirely right!

If you are only going to invest in index funds though, I wouldn't expect more than about 6% inflation adjusted long term in which case paying off the loans is a better move even if you ignore the fact that paying off the loans is risk free. So I'd say pay off the highest interest loans ASAP and then reevaluate when you get to the 5% ones.

I've ran the calculations with 5% and 6% annual interest rates, and the results that lead to my question are the same (274 months under both scenarios at 6% and 300 months for both at 5%).  I suspect it would be the same at 8% and 9%.  It seems, then, that the annual return on investment does not change the answer to my original question, whether paying debt off early leads directly to an earlier retirement.

I see it repeated a lot on this forum that it is an "instant return" (or guaranteed) to pay off debt.  It seems to me that the instant or guaranteed return is only on the amount that is paid extra, and the return is only made over the remaining term of the loan.  Also loan balances decrease over time, further reducing the guaranteed return.  Is this wrong? 

We very much want to get into real estate like Arebelspy.  We already have one rental property but that was by mistake, not design.  The barriers to entry seem higher though, and unless we have a good amount of cash on hand we may not be able to do it.

My reasoning is, that once you have eliminated one of those loan payments, you have about $150/mo less in mandatory payments - a little extra buffer if there are unexpected job losses etc.  If you have only paid off half of both loans, you don't have that extra security yet.

3. I would say you missed one intangible thing - the feeling of being debt free and knowing that if something shitty happened tomorrow you aren't in hock to Sally Mae.

But there are two big (to me) benefits, one is mental in that it just feels better to have no debt, and two is the flexibility of less monthly obligations for unforeseen events or what have you.

These are all very helpful points, and probably why I am stuck on this question.  I despise these loans, but at the same time I very much want to pay more to savings.  One thing that may reduce risk with regard to the debt is that loans 2, 3 and 4 are federal student loans, and can be put in forbearance under certain circumstances. 

It also seemed to me that the MMM philosophy embodied paying off debt as quickly as possible as dogma.  Do I misunderstand this?  Or does this apply only to high interest consumer debt?

So it seems that the biggest (maybe only?) factor affecting the length of time to FI or retirement is the proportion of income devoted to savings.  Increasing that proportion by increasing income (and devoting the increase to savings), decreasing expenses (but not necessarily debt), or both would lead to earlier FI or retirement.  Right?

Thank you everyone for the good insights.

gimp

  • Handlebar Stache
  • *****
  • Posts: 2348
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #13 on: December 17, 2013, 11:20:00 AM »
I think you misunderstood a little. The best schedule to pay off loans is the one that has the highest ROI. If you're a man/woman of steel, then the highest ROI is purely monetary. If you're a nervous wreck, the highest ROI is mental. Most people fall somewhere in between.

With that said, debt isn't necessarily bad. Debt at 25% interest is pretty bad unless you've found a way to invest and get more than 25% (... and have it not be a pyramid scheme or illegal - good luck!) Debt at 5% is much more manageable and leads to debates of 5% guaranteed vs 7% theoretical. Debt at 0% is essentially free money to invest. Of course, all this works as long as you're smart! Having debt while investing money is investing on margin; if your investments go south, you have a bunch of debt and no money, whereas if you had paid it off you would have had no money and no debt either.

Choose your comfort level. For 6.3%, I'd pay it off. For 5%, I'd probably pay it off. For 0%, I'd milk it as long as possible. For 25%, I'd pay it off and then pick up extra side work to pay it off faster.

SunshineGirl

  • Pencil Stache
  • ****
  • Posts: 740
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #14 on: December 17, 2013, 11:23:16 AM »
Your OP had nothing to do with wanting to be a real estate investor. You also didn't mention you have additional (real estate) debt.

Is there a different question you want to explore, because while this has been an interesting thread to watch, is it really taking you where you want to go? Maybe write something up in case study format.

nedwin

  • 5 O'Clock Shadow
  • *
  • Posts: 88
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #15 on: December 17, 2013, 12:01:10 PM »
Your OP had nothing to do with wanting to be a real estate investor. You also didn't mention you have additional (real estate) debt. 

I didn't think mentioning that I would like to invest in real estate changed the subject of the post, if it did I am sorry.  I did, however, state that we have additional real estate debt in the OP.

In addition, we owe a mortgage on our residence and a mortgage on our rental.


arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #16 on: December 17, 2013, 12:37:30 PM »
I didn't think mentioning that I would like to invest in real estate changed the subject of the post, if it did I am sorry.

Depends if you want a theoretical discussion or practical discussion.

Theory and practice can differ quite a bit, obviously.

"In theory, there is no difference between theory and practice. But, in practice, there is."
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

PeteD01

  • Bristles
  • ***
  • Posts: 413
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #17 on: December 17, 2013, 02:16:04 PM »
With a 20 years investments horizon and a reasonably secure income you could do the following:

Start paying off your debt - the interest rates are too high to do anything else right now (you may find yourself doing this for years - no problem)

With the next market downturn of more than 15 or 20% (you decide) switch to investing in stock index funds (you may find yourself doing this for years - again, no problem)

With the markets recovered to previous highs switch back to accelerated debt service

If you do this in a disciplined manner you will end up having bought stock funds at better valuations then otherwise and have paid down your debt as well. Essentially, you are making volatility work for you with a long term investment plan like this.

That's what I do and the only issue is that you will be paying off debt while everybody is excited about stocks and you will be buying stocks while everyone else is selling them cheap :-)

Peter
« Last Edit: December 17, 2013, 02:18:18 PM by PeteD01 »

nawhite

  • Handlebar Stache
  • *****
  • Posts: 1060
  • Location: An RV somewhere in the West
    • The Reckless Choice
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #18 on: December 17, 2013, 02:52:44 PM »
Pete, I like your idea but I'd like to do it in a way I can define exactly what to do when and look at past results. I'm trying to come up with something like Value Averaging (http://www.bogleheads.org/wiki/Value_averaging). How would you go about defining your cutoffs (when to switch to stocks and when to switch back to debt)?

Hamster

  • Pencil Stache
  • ****
  • Posts: 623
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #19 on: December 17, 2013, 05:16:52 PM »
...
Start paying off your debt - the interest rates are too high to do anything else right now (you may find yourself doing this for years - no problem)

With the next market downturn of more than 15 or 20% (you decide) switch to investing in stock index funds (you may find yourself doing this for years - again, no problem)

With the markets recovered to previous highs switch back to accelerated debt service
...
Except that over the long term market timing doesn't work, and you are making guesses about when to buy and when to change your strategy based on your assumptions about market trends.  Even "trained professionals" would do just as well (or better?) flipping coins in deciding when is the best time to buy, rather than buying based on your assumptions about what will happen next based on what has happened recently.

When will the next 15-20% downturn be? After that, when will it start to recover? or will it continue to fall first? What if you got in a month sooner? a year sooner? waited a year longer?

I'd suggest the OP read Berstein's "The Investor's Manifesto". If you are looking specifically at stocks/bonds investing, it will probably disabuse you of the notion that you can intelligently time the market. And, it will reframe the original question of whether to pay down your loans versus investing in terms of risk-premium.

E.g. you believe you need a 3% risk premium for whatever you choose to invest in instead of paying down your 6.3% loans (at guaranteed rates of return), then you'd need to reasonably expect 9.3% return to justify that risk (taxes and fees aside). Maybe those of you who are wiser than I am about investing will see things differently, but that's how I'd frame the issue.

KingCoin

  • Pencil Stache
  • ****
  • Posts: 783
  • Location: Manhattan
  • Achieved FI @ 30
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #20 on: December 17, 2013, 05:36:45 PM »
3. I would say you missed one intangible thing - the feeling of being debt free and knowing that if something shitty happened tomorrow you aren't in hock to Sally Mae.

I'm a little perplexed by the pervasive notion that paying down debt is somehow a better sleep-at-night choice. If you get laid off, would you rather be in:
Scenario 1: $50k liquid portfolio and $50k debt, or
Scenario 2: $0 in liquid assets and $0 debt.

I'd much rather be in the first position than the second, as you'll have much more time to get back on your feet without facing the pressure of a dwindling emergency fund. Even if a lay-off is accompanied by a 25% portfolio drop, I still like being in scenario 1.

As usual with these tough choices, the best route is often to split the difference. Invest some excess funds in paying down debt and some in a market portfolio to give you a little extra liquidity.

nedwin

  • 5 O'Clock Shadow
  • *
  • Posts: 88
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #21 on: December 17, 2013, 05:40:18 PM »
I didn't think mentioning that I would like to invest in real estate changed the subject of the post, if it did I am sorry.

Depends if you want a theoretical discussion or practical discussion.

Theory and practice can differ quite a bit, obviously.

"In theory, there is no difference between theory and practice. But, in practice, there is."

I was hoping for a theoretical discussion, maybe the personal information muddied the waters.

I guess I was surprised that there was no difference in the time horizon to reach our goal whether we paid off the loans faster or not.  Upon reflection, however, it makes sense.  Essentially we are trying to save about $1,560,000 (retirement goal + loans), so the only way to reach it faster is to increase the actual amount of $$ applied to that goal through increased income, decreased expenses or both.  The difference in interest paid on scheduled or accelerated loan payments is essentially inconsequential to the time reach the goal, given that it is small compared to the goal and that the time horizon is pretty long.  Also probably because these are relatively low interest rate loans, or at least not sky-high interest rates.  I could see where accelerating debt payments would have more impact if one's goal were to retire in a shorter timeframe.  Where one decides between paying loans or adding to savings has to do with their appetite for risk and is more a personal decision.

Pete - that's an interesting idea.  As Hamster points out though, it is difficult to time the market.  I definitely need to learn more about stock/bond investing.  I'll add your suggestion to my reading list.

Maybe my mega millions ticket will hit tonight, then this discussion would definitely be theoretical.  ;)


gimp

  • Handlebar Stache
  • *****
  • Posts: 2348
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #22 on: December 17, 2013, 06:00:06 PM »
Maybe if you have debt you shouldn't be buying lottery tickets :)

PeteD01

  • Bristles
  • ***
  • Posts: 413
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #23 on: December 18, 2013, 11:18:39 AM »

Pete - that's an interesting idea.  As Hamster points out though, it is difficult to time the market.  I definitely need to learn more about stock/bond investing.  I'll add your suggestion to my reading list.


I would not overthink this too much - especially in regards to "market timing".
Redirecting the flow of your investment money is very different from market timing in the strict sense.

With your current interest rates on your loans and the current inflation rate, it is difficult to justify investing in a market that is certainly not at a low.
The whole idea of investing in the stock market is that it will go up in the long run and it is not unreasonable to expect 5-7% long term returns. That is not enough to go for carrying loans at 5%+.

However, you do not have to commit today what you are going to do every day for the next 20 years. Conditions change and if a serious downturn should occur and you continue to have income during the downturn, it may be advisable to switch over and invest in the stock market to take advantage of an opportunity. Do not worry about when to do the switch - it will be front page news. The difficult thing will be to actually do the switch when everybody is freaking out and locking in their losses. It will also be at a time when your own stock market investments will have taken a beating and you may feel bad about throwing ever more money down where the rest disappeared. But bad times is when more money than average can be made. The good thing is that when the downturn occurs you will feel pretty smug about having paid down your debt and consequently have suffered lower "losses" which makes it easier to stick with the plan.
It is also not too difficult to decide when to switch back to accelerated debt service: Just write down the SP500 high before the downturn and switch when it is up there again. If you do that you will never feel that you have missed an opportunity to buy cheap shares.
Again, this is not market timing because you are not trading anything, you simply buy what seems to be the most rational place to put your incoming cash at a particular point in time and then you sit on it.

And what if the market, against all odds, keeps going up relentlessly at 6%/year without tanking ever in the next 20 years? Well, a difference of retiring one month earlier or later wasn't much to talk about anyway - so nothing lost and nothing gained.

Peter

 

PeteD01

  • Bristles
  • ***
  • Posts: 413
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #24 on: December 18, 2013, 11:32:38 AM »
Pete, I like your idea but I'd like to do it in a way I can define exactly what to do when and look at past results. I'm trying to come up with something like Value Averaging (http://www.bogleheads.org/wiki/Value_averaging). How would you go about defining your cutoffs (when to switch to stocks and when to switch back to debt)?

What I suggested really applies to the situation the OP is in. He has an income stream to invest, a long time horizon, and a very good zero risk investment option: high interest loans without prepay penalty. The only thing he should be worried about is missing out on opportunity. His interest rate is so high that it would take a very substantial drop in the market to make switching to stock market investing worthwhile - it is not possible to miss such an event, it will be on the news.

Peter

PeteD01

  • Bristles
  • ***
  • Posts: 413
Re: Does paying off debt early always lead to an earlier retirement?
« Reply #25 on: December 18, 2013, 11:41:23 AM »

...

When will the next 15-20% downturn be? After that, when will it start to recover? or will it continue to fall first? What if you got in a month sooner? a year sooner? waited a year longer?


The OP does not plan to invest a chunk of money but redirect an incoming cash flow. The lower it goes and the longer it lasts, the more cheap shares the OP will buy - good for him, because he's got the appropriate time horizon, at least for the next few years.
If the downturn never happens then there simply was no opportunity to be taken advantage of and no risk was taken.

Peter