Author Topic: How to invest new chunk of cash  (Read 1619 times)

Swamp Chomp

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How to invest new chunk of cash
« on: November 24, 2019, 07:55:57 PM »
We recently refinanced our house from a 4.99% to a 3.75%.  We considered two options:

- Lower our payment by $115/month and invest the difference
- Do a cash-out refi, keep our same payment, and wind up with $30,000

For a few reasons, we went for the latter.  The two biggest reasons were: A) when we project investing the two above scenarios (monthly $115 invested vs. $30K lump sum) over 20 or 30 years into stocks using average stock market returns, you come out ahead investing the lump sum.  B) for one reason or another, had we gone the former route, the concern was that there may be times during those 20 or 30 years when we may not religiously put away the $115/month when life is rocking the boat.

In planning what to do next, here are the options we're considering and wondering what some of you would do:

- Pay off our car loan / About $8,000 at 5.5%
- Open IRA for wifey and max out (already maxed out mine)
- Invest into our brokerage VTSAX stock account

Hopefully, not too many important details missing here...  Looking forward to hearing some input from how you all might make the best use of the funds! Maybe some of you will say put the money back on the mortgage :)

Many thanks.

terran

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Re: How to invest new chunk of cash
« Reply #1 on: November 24, 2019, 08:39:13 PM »

Swamp Chomp

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Re: How to invest new chunk of cash
« Reply #2 on: November 30, 2019, 07:29:22 PM »
Thanks.  I did know about that page but wondered if people would have different suggestions given that this is borrowed money? 

For example, if my next step were to invest into an IRA, does it make sense to use this borrowed money that has a guaranteed interest expense to invest into an IRA?

Steeze

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Re: How to invest new chunk of cash
« Reply #3 on: November 30, 2019, 07:54:09 PM »
Top up the emergency fund, Max the 401k then IRA, kill the car loan, and throw the rest in a taxable. Borrowed money doesnít matter - cash is cash, get it working.

terran

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Re: How to invest new chunk of cash
« Reply #4 on: November 30, 2019, 08:19:47 PM »
Thanks.  I did know about that page but wondered if people would have different suggestions given that this is borrowed money? 

For example, if my next step were to invest into an IRA, does it make sense to use this borrowed money that has a guaranteed interest expense to invest into an IRA?

Money is money, it doesn't matter where it comes from. The investment order will tell you whether you should have borrowed the money in the first place (borrowing money at a certain rate is the same as not paying back borrowed money at that same rate), but as long as there are uses for money earlier in the investment order than paying off debt at the rate of the borrowed money then you should use the borrowed money for those uses.

MTBmustachian

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Re: How to invest new chunk of cash
« Reply #5 on: December 01, 2019, 01:16:11 PM »
The bigger question here is, why do you have a brokerage account but you DONíT have an IRA ( or Roth IRA) in your wifeís name? Crazy talk.

Read through that investment order thread linked above in detail.

Swamp Chomp

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Re: How to invest new chunk of cash
« Reply #6 on: December 01, 2019, 06:38:01 PM »
Appreciate you feedback Steze, terran, and MTBmustachian.  MTBmustacian, you're absolutely correct, no excuse.  Wifey IRA is coming.

To speak to terran and Steze, what is driving some my hesitation is a conversation I'm having with someone else.  Rather than try and paraphrase, here is his latest point.  Curious what you would say to this:

When investing with borrowed money, you must keep this in mind Ė the interest that you are charged is on the full amount, yet should the amount of principal shrink, the amount of return you receive will be only on that reduced amount. For this reason, the timing of any investment losses can have a serious impact on your ability to break even on the investment. This is why the actual returns, and not average returns will be important to you.

For example:

If you borrow $25,000 with a 3.5% interest charge, the cost of that is $875.
To break even the first year, your investment must earn 3.5%. Anything above that is profit.
If, instead the investment loses, letís say 5%, the balance would be $23,750. In this year, you would be charged the $875 with no earnings. Therefore, the burden of the first yearís $875 and the second yearís $875 would fall to the now balance of $23,750.
In order to do this, the $23,750 must earn 7.5% just to cover last yearís and this yearís cost. In order to avoid the same thing happening the third year, year two has got to be a little over 12.6% to recover the lost 5% and get back to a balance of $25,000 - so year 3 can start from scratch. (Not to mention the chance that it could be negative again, or flat.)
This relationship is compounded over the life of the strategy, as there is always the negative movement of the interest charge yet no guarantee of a gain, loss, flat from the investment side.

Can you see why itís particularly difficult to make a profit on speculating with borrowed money? Your strategy would have to be a sure thing without a doubt. This is perhaps why many financial gurus out there start with getting out of debt, because if youíre borrowing money somewhere in your life in order to put some other money to work in an investment. It has the same overall net effect.



MoneyQuirk

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Re: How to invest new chunk of cash
« Reply #7 on: December 01, 2019, 11:16:53 PM »
My general rule of thumb is solid debt over 4% should be paid off first.

Given that the car loan is at 5.5%, I would pay that off first. After that, I would sink it into a tax-advantaged account. If anything is still left, then taxable account is fine.

Obviously, low-cost index funds. VOO/VTI/VTSAX.

Cheers!

MTBmustachian

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Re: How to invest new chunk of cash
« Reply #8 on: December 02, 2019, 12:04:45 AM »

When investing with borrowed money,

Exactly, I personally wouldn't have taken the lump sum cashout when you refinanced in the first place, but it sounds like that's already a done deal. You could theoretically put the money straight back into your loan if you wished, but this general rule of thumb is a good one to go by:

My general rule of thumb is solid debt over 4% should be paid off first.

Since you now have your mortgage down below 4%, you're probably better off investing in the markets since average inflation-adjusted return is 7%.

To respond to your friend's point, yes the markets could lose money in the short term... but that's why you're not investing for the short term. I think what his point misses is that the 7% average return is exactly that--an average. So yes, let's say the market loses ground over the next 5 years. You'll be out money in the short term. But in order for the market to average back out to a 7% gain, that means it will probably come raging back at some point. For instance, so far this year the S&P 500 is up 25% since January 1. But you don't see us all making our retirement calculations on an average return of 25%, do you?

Steeze

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Re: How to invest new chunk of cash
« Reply #9 on: December 04, 2019, 05:19:51 PM »
The sequence of return will have an effect as youíve demonstrated. It could go either way though in the short term. Suppose your up 20% in the first year, then your worry free? The math is simple over a long period. Consider the average return over 30 years - most likely your investment will beat the cost of your loan, not guaranteed, but very likely.

Many people here would borrow an infinite amount of money at <4% fixed for 30 years to dump into the SP500 if they could, the risk reward ratio is favorable. Still some would prefer to keep overhead low and stay debt free by allowing large amounts of equity to accrue.

I have a paid off house, I missed out on $60k this year by not refinancing in January and investing in the S&P. I also am not paying a $1500/mo mortgage payment each month, and sleep soundly knowing my wife and I could both lose our jobs and be fine.

There is no right answer here, just a personal risk tolerance. If investing it makes you uncomfortable then no amount of potential returns are worthwhile. If your FOMO is worse than your fear of losing money, then invest.


Swamp Chomp

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Re: How to invest new chunk of cash
« Reply #10 on: December 16, 2019, 06:58:53 PM »
The sequence of return will have an effect as youíve demonstrated. It could go either way though in the short term. Suppose your up 20% in the first year, then your worry free? The math is simple over a long period. Consider the average return over 30 years - most likely your investment will beat the cost of your loan, not guaranteed, but very likely.

Many people here would borrow an infinite amount of money at <4% fixed for 30 years to dump into the SP500 if they could, the risk reward ratio is favorable. Still some would prefer to keep overhead low and stay debt free by allowing large amounts of equity to accrue.

I have a paid off house, I missed out on $60k this year by not refinancing in January and investing in the S&P. I also am not paying a $1500/mo mortgage payment each month, and sleep soundly knowing my wife and I could both lose our jobs and be fine.

There is no right answer here, just a personal risk tolerance. If investing it makes you uncomfortable then no amount of potential returns are worthwhile. If your FOMO is worse than your fear of losing money, then invest.

Thank you all and thank you especially @Steeze for this perspective.  Following the train of thought it's better to invest early and often (), we're going to pay off the car loan, max out tax-advantaged account, then put into taxable.  Grateful to everyone for sharing their perspectives and taking the time to write.  This group is so great.