Author Topic: Reader Case Study - Invest vs Pay off loans?  (Read 2143 times)

Pixelshot

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Reader Case Study - Invest vs Pay off loans?
« on: November 04, 2016, 05:52:23 PM »
Question 1: We have just been unexpectedly reimbursed by my wife's company for a large chunk of outstanding expenses. This sum (23k) nicely matches up to the amount left on our student loans (21k). The loans are at a low 3%. No other debt. One variable is that there is a possibility we may need to move and will want to buy a second house within the next 6 months (and rent our current). Housing market where we live in Denver seems inflated but still growing. My first instinct is to pay off our loan with the cash and then start saving/investing in earnest. My wife suggested we consider keeping that cash around or invest it to get a return above 3%. I am able to save about 3k a month so I could reimburse the 23k in a year or so. Just wondering what the general consensus is. What would you do?

Question 2: If the answer is "invest" then how do I do so while keeping the option open for using the cash if I want a down payment on a house in the future? (investing newbie)

Question 3: If "invest," then Invest where? (Vanguard total market index?)

Assets: New windfall of cash: $23k; Savings: $10k personal; $10k business-related (self employed)
Liabilities: Student Loan - $21k; Home loan; $200k
Interest rates: Both the student loan and home loans are at 3%
Family Savings Rate: Approx $3k per month

Thank you!


« Last Edit: November 05, 2016, 07:52:39 AM by Pixelshot »

MDM

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Re: Age Old question - Invest vs Pay off loans - advice?
« Reply #1 on: November 04, 2016, 08:25:53 PM »
Listen to your wife.

For more detailed response, seeing more of your details (as in How To Write a "Case Study") would help.

Shockers

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Re: Age Old question - Invest vs Pay off loans - advice?
« Reply #2 on: November 04, 2016, 08:51:19 PM »
Listen to your wife.

For more detailed response, seeing more of your details (as in How To Write a "Case Study") would help.

+1.  You can make more than 3% investing your money.  Keep the money, invest it then use your "extra" money you have coming in each month to pay off the student loan.

Pixelshot

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Re: Age Old question - Invest vs Pay off loans - advice?
« Reply #3 on: November 05, 2016, 07:51:32 AM »
Thanks. I've edited the original post to re-format it per your suggestion.

@Shockers - where do I invest the cash? I have a Vanguard account and have used total stock market index in the past, but only with 401k plans, so never with post-tax cash. I would like to keep the cash somewhat available in case we want a down payment on a house.
« Last Edit: November 05, 2016, 08:25:15 AM by Pixelshot »

Grizzly Dad

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Re: Reader Case Study - Invest vs Pay off loans?
« Reply #4 on: November 05, 2016, 02:05:47 PM »
If your loans are only 1% above the risk-free rate, I'd generally say just let them ride. Once you start getting to +3/+4 (around 5-6% right now) is when I would start paying them off first. So I would invest. Now where to invest.

1. Have you maxed out a 401k/ROTH/Traditional IRA for you and your wife yet this year? This would be my first stop for any excess cash. For the 401k you can simply up your contribution % to something ridiculously high and live off the 23k for a few months.
2. After that, I'd just stick it in a taxable account - buy the SP 500 index. No need to get fancy.

Pixelshot

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Re: Reader Case Study - Invest vs Pay off loans?
« Reply #5 on: November 05, 2016, 03:59:06 PM »
Thanks @Grizzly Dad.

If I put the money into a taxable account, such as Vanguard, can I pull it out easily to, say, put a down payment on a mortgage?

Also, could you please explain what you mean by "risk-free rate"?

marty998

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Re: Reader Case Study - Invest vs Pay off loans?
« Reply #6 on: November 05, 2016, 04:19:17 PM »
A risk free rate is the interest rate you can invest in with absolutely no risk of loss. This is usually a government bond.

To earn a return greater than the risk free rate requires you to take a risk that your capital can go up and down in value.

Basically over the long term, any investment you make in a traditional asset class (stocks, bonds, property) is likely to generate a return greater than the risk free rate.

However paying off loans is certain to give you a return equal to the interest rate you are paying.

Shockers

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Re: Reader Case Study - Invest vs Pay off loans?
« Reply #7 on: November 07, 2016, 09:48:46 PM »
If getting some of the money back for a down payment is a priority, you could take $5500 and place it in a Roth IRA this year and another $5500 two months from now.  You can always take out any money contributed to a Roth tax free at any time.

As far as what to invest in... I like Vanguards total stock market index if I am reducing my risk.  I also like VGPMX for a portion of my portfolio.

Vagabond76

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Re: Reader Case Study - Invest vs Pay off loans?
« Reply #8 on: November 08, 2016, 04:28:52 AM »
Not only is the interest rate low, but it is tax deductible. SL interest is a below the line deduction, and mortgage interest is deductible if you itemize.

Pixelshot

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Re: Reader Case Study - Invest vs Pay off loans?
« Reply #9 on: November 08, 2016, 06:55:57 AM »
good to know about the deduction and Roth options. Thanks to all!

frugaliknowit

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Re: Reader Case Study - Invest vs Pay off loans?
« Reply #10 on: November 08, 2016, 07:43:32 AM »
Question #1:  I would pay off the loan.  I am not a fan of hurdles.  I would think of it as a bond allocation/sleeping aid.

I question the wisdom of buying a second home while keeping your present home.  Unless the cashflow is stellar (which I doubt with a $200K mortgage), I would sell the house before buying another. 

If I were to invest, and wanted to have the money AVAILABLE and probably don't want it to be down 20%+, I would put it in a balanced fund, such as this one:  https://personal.vanguard.com/us/funds/snapshot?FundId=0103&FundIntExt=INT

If you don't need to have the money available and don't want to pay off the loan, I would pump your tax deferred and or roth accounts.


Mother Fussbudget

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Re: Reader Case Study - Invest vs Pay off loans?
« Reply #11 on: November 08, 2016, 10:25:23 AM »
I believe Pixelshot is considering buying an investment property, and keeping the existing $220K home they purchased July 2015 as a primary residence.

BTW:  Congrats on the windfall!  My 2:
1. Invest - this question has been asked multiple times, usually in the form of "Should I pay off my mortgage or invest" - replace 'mortgage' with 'loan' in those questions, and you have your situation exactly.  Shamelessly copy/pasting an answer to one of those 'mortgage vs. invest' questions below... (I believe it bears repeating, and brings up the option to read advice from other contributors)
2. Invest in CD's, or a bond fund like VBTLX - Vanguard Total Bond Fund Admiral Shares.
3. See #2.  You can buy/sell shares in a fund at any time.  Your funds are never more than a few days away from electronic transfer to your checking account.

- - - - -
(shamelessly pasted response that bears repeating)

This has been asked hundreds of times here.  Do yourself a favor, and read through earlier responses first - search "mortgage invest". 
1) A few examples from the first page of results:
Extra mortgage payments vs investing
Pay off mortgage or invest
Mortgage or invest
Pay down 2.75% 15 yr mortgage vs invest in taxable
Pay off mortgage or invest
Pay off mortgage or invest
After refinance what should I do pay off loan, pay off mortgage, or invest
Mortgage paydown vs investment

(hmmm... .I sense a pattern here)

2) See Sensible Bogleheads comments on how to prioritize paying off loans here:
http://www.bogleheads.org/wiki/Paying_down_loans_versus_investing


Consensus:  (look it up - it does NOT mean 'unanimous')

Invest. Investments are liquid. Potential ROI is greater than the 2%-to-4% returns/savings from paying off a loan.
Mortgages are not liquid. Must sell your house or refinance to recapture investment dollars.