Author Topic: Proper Ratio of Paying down the mortgage vs. saving for FI  (Read 7533 times)

nyxst

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Proper Ratio of Paying down the mortgage vs. saving for FI
« on: January 16, 2014, 11:17:48 AM »
Ok. I know that this is probably already a topic somewhere in here, but I couldn't find it :)  I have been working hard the last couple of months and really feel like I have a lot of the check marks filled in to be a budding Mustachian.  I have a couple debts that will be taken care of completely within the first quarter of this year.  And, when it is done, I want to have a good plan in place to get this savings growing.

Basic Background: I have 3 kids age 15, 8 and 4. I am divorced and we work with one income of $45,000/yr.  Extra cash coming in isn't reliable, so I work within that $45k.  I own my home and owe about $55k on it (house is worth $200,000+).  I don't plan to move until the youngest starts college, if I ever decide to move.  I am 33 years old.  I have $15,000ish in a Simple IRA through work with a match.  I put 7% in and they match 3% (might be going up to a 6% match.. we will see though..).  I am building my emergency fund within this quarter also, so with my tax return and other things I am selling, that should be well established and not of concern.

Question: Should I take the extra monthly cash after the first quarter and put it against my mortgage (3.75% interest rate.  Its a 30 year mortgage, so my payments are really pretty low), or should I dump that money into my Roth ( a measly $1,200 in there now).  Or should I split it between the two?  I want to take advantage of time for the Roth to grow, but hate having monthly payment at all, so the mortgage and the interest it incurs really irks me, but its at such a low rate, I would probably make more in an index fund... I just can't decide!  Please, all advise is welcome and appreciated!

Carrie

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #1 on: January 16, 2014, 11:20:04 AM »
I would increase retirement contributions to max out the Roth IRA, and maybe add a little more to the 401k before tackling the mortgage too hard.  If you want a compromise, maybe pay your mortgage as if it were a 15 year (just to see the principal number move down faster), and put the remainder of your extra cash into retirement.

Catbert

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #2 on: January 16, 2014, 12:40:34 PM »
I would be in no rush to pay off a 55K loan at 3.75%.  The monthly payment must be tiny - $250. or so a month principle and interest.
« Last Edit: January 16, 2014, 12:42:32 PM by mary w »

aj_yooper

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #3 on: January 16, 2014, 01:34:16 PM »
I would be in no rush to pay off a 55K loan at 3.75%.  The monthly payment must be tiny - $250. or so a month principle and interest.

+1 on not paying early on the mortgage in your situation.  It is low cost and smaller.  No hurry.  You have a great mortgage interest rate.

You have a lot of responsibility so building up your emergency fund is very important.  The EF is a better use of your current money than paying on the mortgage principal.  The EF protects your family and house. 

Can the 'undependable income' become more dependable, say, by using the court system?  That would help.

I would review your withholding tax with your employer.  A refund of taxes you pay means that you overpaid and gave the US government a zero interest loan for a year.  The refund is also decreased in real spending terms by the inflation rate (about 2%).  If the tax refund is just the Earned Income Credit, then all is fine though.

+1 to OP on no debt and wanting to build up your Roth account for the future. 

You should put extra money into your Roth IRA as you currently are in a 15% marginal tax bracket; I would do it for the 2013 year.  The Roth would also bolster your EF. 

Not related to your post, but I hope you have financially efficient choices for investing with your work money and your Roth.  I like  Fidelity and Vanguard.

Best wishes.


nyxst

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #4 on: January 16, 2014, 08:41:30 PM »
yes, I agree that the emergency fund is top priority. I have been breaking old habits and stopped more bleeding than I could have predicted! That is funneled straight to the EF. I think I will split it between my capital one 360 account and my Roth. I am waiting until i fully understand the Roth before putting all my eggs there. I need to learn more about picking funds. I see everyone saying "index", but there are tons of index funds to choose from. I need to understand what makes them different. As far as my tax return, I claim all the exemptions right, so I'm not exactly sure why I get a big return still.. $3500 on average, but that's not huge. I will look into this more and figure it out.
My mortgage payment is tiny, $585 with my p&i AND house insurance and taxes $3600/yr. Thank you for your info! Do you have a list of funds, maybe by symbol?, that you think I should add to my research list? I have some vanguard in the list.. And one with the symbol SPY that follows s&p 500 that I saw someone mention in these forums...

Wanderer

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #5 on: January 17, 2014, 04:03:23 AM »
I see everyone saying "index", but there are tons of index funds to choose from. I need to understand what makes them different.

The difference is (mostly) the index the fund is based upon.  Indices are groups of stocks sharing some similarity that people track to see how the stock market is doing.  The big one in index funds is the S&P 500.  This is a list of 500 companies with the highest market capitalizations ("cap" in stock terms), meaning the biggest volume of money in the stock market.  If you read a list of these companies you'll see a lot that have been around for decades.  A very different creature is the Russell 2000 index, which is composed of the smallest 2000 companies on the Russell 3000 index, making it a small-cap index.  The Russell 3000 index is pretty close to a total stock market index, since it contains 98% of publicly traded companies.  You can also find mid-cap indices that are usually based off of the bottom 800 of the Russell 1000 (top 1000 companies).  There are a variety of other indices, but in general if you don't recognize the index they're using, it's probably a really specific selection of stocks, and could be very volatile.  Look it up before you buy. 

The point of index funds is for the fund manager to just give up trying to do better than the stock market, which is hard and expensive for investors because it increases the amount of buying and selling of stocks in the fund.  Actively managed funds usually perform slightly worse than expected based upon the general market performance because of their higher expenses.  Sometimes they perform much worse than expected because the manager makes a wrong guess about where the market is going.  Index funds say, "We're not even going to try to beat the average," and just invest the fund in a pool of stocks designed to mimic the index. 

Sometimes it's hard for the fund manager to exactly mimic the holdings of an index and the index fund might drift, which would lead the fund to perform differently from the index it's based upon.  It's actually bad if your index fund beats the index!  This means it's not mimicking the index properly and probably has a different composition than you expected when you bought it, and next year it might well underperform the market.  Generally when you buy an index fund you want one that has performance in line with the index it is based upon and lower fees than alternative candidates (if two funds are supposed to mimic the S&P 500 they should perform the same, so you should pick the one with the lowest fees, everything else being equal). 

When people talk about investing in index funds, they're usually talking about either investing in an index fund based upon the S&P 500 (S&P 500 index) or a total stock market fund (Russell 3000 index).  Mid-cap and small-cap indices can have their place, but it's usually not as the foundation of a new portfolio because these smaller companies might have more room to grow than established large cap companies and could take off like blazes, but they can also crash and burn. 

SPY S&P 500 is a similar but different beast.  It's an exchange-traded fund, which is bought and sold on the market like stocks, and is designed to mimic the S&P 500 like an S&P 500 mutual fund.  I won't say much about it because I don't know a lot about ETFs and don't own it, but when I was looking at it before I found it to have low expenses but to be more expensive for me to buy in because of a trading fee (I don't trade in individual stocks so don't have a good account set up at a brokerage for this).  It depends on how cheaply you can buy it, I guess. 

As for paying off the mortgage vs putting it in your Roth, paying down your mortgage last year would have given you an effective return on your money of 3.75%, while the S&P 500 brought in 29.6%.  Of course in 2008 it was down 30.0%.  Investing in the stock market is generally more profitable than paying down a very very low interest rate debt, but you never know what's going to happen. 

Incidentally that's also why I would recommend putting the money into savings and a Roth.  You need to have a lot of flexibility as the sole provider for a family.  You can withdraw your contributions to a Roth if you absolutely must, and having money in cash savings is the ultimate in flexibility.  If you put it in the house, it's stuck there in a single asset and you have to refinance, take out a home equity loan, or sell if you need to get your hands on that money. 

What's your emergency fund target?  You should probably stash at least 6 months of expenses, maybe more. 

Wanderer

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #6 on: January 17, 2014, 04:14:33 AM »
Oh, and who is holding your Roth for you?  You can always move it if you don't like your fund selections.  Lots of people have accounts at Vanguard and Fidelity because of their very low fees.  Mine is at Schwab because at the time I made it Schwab had lower account starting deposits than Vanguard and Fidelity, and also have low fees.  No need to rush, but if you find out that your Roth custodian isn't the best choice, you can transfer it to another company and get better fees and fund options. 

aj_yooper

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #7 on: January 17, 2014, 05:26:18 AM »
+1 to Wanderer's comments.  A very good starting fund index would be the total stock market index or Russell 3000.  We keep our funds at Vanguard.  If you are not at a low cost provider of funds (Vanguard, Fidelity, or Schwab) and you want to move your money, contact the receiving company, say Vanguard, and have them move the money for you.  This is the best way to do things.  When you put money in the Roth, you can start by putting it in a money market account (like a checking account) and decide later what fund to purchase.   

So the next step is to get some library books on investing.  There are a lot of good books to read, like Burton Malkiel's The Elements of Investing or Larry Swedroe's The Only Guide You'll Ever Need for the Right Financial Plan.  You can also read Rick Ferri's articles in Forbes magazine on the web. 

Way to go in repairing old habits!  Keep clarifying your goals and doing your plans.

nyxst

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #8 on: January 17, 2014, 06:10:45 AM »
Wow! To Wanderer: Thank you for that wealth of information!  It really helps me clarify a lot of things.  I set up a Roth because someone told me it was a good idea, but I didn't really know what to do with it.  I ended up just opening a TDAmeritrade account and throwing $1000 in there (mainly so I could say "yes, i have a roth" next time anyone asked.. hahahaha!)  I just took that $1000 and mirrored what my Simple IRA was buying... plus I bought some silly stocks with my "10 free trades" that I got for signing up.  My Simple IRA through my work invests in my choice of American Funds, so that is relatively limiting.  Right now, half of it is in a retirement target date 2045 American Fund, and the other half buys some growth funds. 
My goal for my Emergency fund is $5,000 this year and $5,000 next year.  $10,000 is probably excessive since my expenses are rather low, but I think it is the number that feels most comfortable to me (really, the most expensive thing I could need in an emergency would be a roof, and that should cover it.  Even if I lost my job for some reason, I have never been unemployed and have ALWAYS found work to pay the bills.  I also carry life insurance of about $350,000, which costs me $550 per year.)
I will do my research and move my Roth to somewhere better.  Now that I am serious about funding it, I will start my research and see what i can figure out.
To AJ: I will stop by the library tonight and grow my investing mental muscles :)  I always felt like I needed $10,000 to go to Vanguard or Schwab.  I have no idea where that though comes from, maybe something I overheard along the way, which is just further proof that research is needed!!

Thank you all for helping me get my compass pointing in the right direction!

aj_yooper

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #9 on: January 17, 2014, 06:24:36 AM »
+1 on $10,000 for your emergency fund goal.  BTW, you only need $1,000 for an IRA at Vanguard.


nyxst

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #10 on: January 23, 2014, 07:02:33 AM »
Ok, did lots of research and read a lot of books (believe it or no, I think I am up to 5 books on investing now.. I love the library!).

I decided on a Schwab account.  They have lower minimums to get started and no charge for index funds.  I can buy into each fund with $100 each, so this means I will have enough to get started right away and establish my own little pie :)

Anyone who wants to chime in, please do so!!!  Here is the plan I have made for my "portfolio" percentages:
SWPPX - 20% (Index that tracks S&P500)
SWTSX - 20% (Total Stock Index)
SFSNX - 20% (Small Cap Index)
SWISX - 15% (International Index)
SFENX - 10% (Emerging Market Index)
SWLBX - 10% (Total Bond Index)
SWRSX - 5% (TIPS Index)

What do you think?  It will take me the first half of the year to get the whole pie funded, since I am focusing mostly on building my emergency fund.  But, since these are no fee funds, and they are going into a Roth, at least I can pull them back out if I need to in the meantime.  The plan is to put 90% of my savings into the emergency fund and 10% into this Roth until my emergency fund is at $10,000.

jrhampt

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #11 on: January 23, 2014, 08:51:07 AM »
I would ditch the S&P and small cap funds since you already have total stock index on your list.  Always better to simplify where possible.  Also, does the international index fund already include emerging markets?  If so, maybe you can ditch emerging markets, too.

nyxst

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #12 on: January 23, 2014, 12:30:56 PM »
I would ditch the S&P and small cap funds since you already have total stock index on your list.  Always better to simplify where possible.  Also, does the international index fund already include emerging markets?  If so, maybe you can ditch emerging markets, too.

I'm not really sure... The Emerging Markets Index fund says it tracks the "Russell Fundamental Emergening Markets Large Company Index", while the international index just says it tracks Large Non-US companies.  It doesn't mention emerging in the description anywhere. 
I will look closer at the Total Stock index and see if I can learn the difference compaired to the S&P and Small Cap Funds.  I am just learning, but I'm sure I will get the hang of it :)

JamesAt15

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #13 on: January 23, 2014, 07:07:25 PM »
I agree that this seems overly complicated. You might want to read this link on the Bogleheads wiki about the Three Fund portfolio, for starters.

http://www.bogleheads.org/wiki/Three-fund_portfolio

Towards the bottom they list Schwab funds that would work for this portfolio, as well.

I prefer to keep my portfolio simple, and add elements only where it seems worthwhile and I am clear on why I am doing so.

nyxst

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #14 on: January 24, 2014, 08:04:28 AM »
Thanks James for the link!  I read it and definitely can see the repetitiveness of my choices.  I will par it down a bit :) Thank you!

TomTX

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #15 on: January 24, 2014, 01:46:06 PM »
Ok, did lots of research and read a lot of books (believe it or no, I think I am up to 5 books on investing now.. I love the library!).

I decided on a Schwab account.  They have lower minimums to get started and no charge for index funds.  I can buy into each fund with $100 each, so this means I will have enough to get started right away and establish my own little pie :)

Anyone who wants to chime in, please do so!!!  Here is the plan I have made for my "portfolio" percentages:
SWPPX - 20% (Index that tracks S&P500)
SWTSX - 20% (Total Stock Index)
SFSNX - 20% (Small Cap Index)
SWISX - 15% (International Index)
SFENX - 10% (Emerging Market Index)
SWLBX - 10% (Total Bond Index)
SWRSX - 5% (TIPS Index)

What do you think?  It will take me the first half of the year to get the whole pie funded, since I am focusing mostly on building my emergency fund.  But, since these are no fee funds, and they are going into a Roth, at least I can pull them back out if I need to in the meantime.  The plan is to put 90% of my savings into the emergency fund and 10% into this Roth until my emergency fund is at $10,000.

I think that's a crazy amount of complexity for $1,000.

Pick one, maybe total stock market. Whatever. Put $$ in there until you hit at least $5k. Then start putting $$ in the next one. Max out at 3, maybe 4 choices.

nyxst

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Re: Proper Ratio of Paying down the mortgage vs. saving for FI
« Reply #16 on: January 25, 2014, 08:35:36 AM »
That was more of a long term plan, but I am rethinking it now. I'm down to 5 instead for the long term.  Thanks for the feedback!