Author Topic: Reader Case Study - Should I stop paying off debt in favour of investing  (Read 6267 times)

Geert_Dutch

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I life in the netherlands. Thus all figures are in Euro. As the cost of living is different I have decided to keep all my figures in Euro's.

Income:
Two salaries for which we receive net 4.700 (after tax and pension)
Annual bonus expected 10.000 per year
This salary is after deductions for a company car (small family cas which is only halve of my car budget) and after contributions to pension (roughly comparable to US plans where I get a 1 on 1 match from my employer.
460 is roughly added to our pensions every month.

We are both 31 and are both on a fast track in big 4 auditing firms. Both have university and post-university degrees,
We have 1 boy of 2 and the next boy is expected in December

Current expenses:
My question does not relate to my expenses, so a breakdown of my expenses is exluded. I can add this later when required.
We are currently paying a lot for childcare +- 600 euro a month for only two days per week. Both of us work 4 days.
We are able to save 200 euro's every month.
As of September We can save 700 per month (I currently pay morgage on a house being build and rent on where I live)
going up to 1400 euro's after a couple of years (when daycare stops).
This excludes any pay raises and bonusses. On average my pay raises 9% per year.


Assets:
Cash emergency fund: 5.000 Eur
Pension: 30.000 Eur

Liabilities:
Student loan at the government 17.000 Eur @ 1,5%
Student loan at the government 3.000 Eur @ 0,81%
Mortgage: 380.000 @ 3,35% (after tax deductions)
( My mortgagepayment wil repay my mortgage in 30 years for 80%)

Specific Question(s): I have a hard time deciding what to do with my savings. I consider two possibilities:
1. repay mortgage and student loans ASAP
2. Invest

Motivated by a MMM post on a 10 year net asset prediction used to get your significant other on board I have been making some calculations. Based on my calculation I expect that If I do option 1 Our net worth will be roughly 300.000 in 10 years time. However, if we would invest our net worth is expected to be close to 460.000 after 10 years.

Our mutual goal is to retire (active retirement) at age 50. We will need approximatly 900.000 Euro's based on current spending. When our savings grow I see some additional budget cuts which can be made (insurance, medical etc.).

So why did I post this on the forum? Up to yesterday I have been making additional payments to my student debt. I have been able to repay this balance almost completely. But after doing the math I was shocked by the diference in net worth which can be acheived when I don't repay my debts but invest instead. I think this difference is mainly due to country difference. In the Netherlands student loans are provided by the government at the same rate for which the governement borrows (AAA rated up to last year). Also due to interest deduction my net interest on my mortgage is very low.

So investing seems the way to go on the long term. This is opposite of what I feel is the general financial advice: repay debts. So what would you do?



viper155

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I would go full force to pay off the debts first. Sacrifice that time. Once you are debt free, and stay that way, the investing will be easy. The peace of mind is a big factor. The mortgage is different. Pay off all those other debts right away, start investing then concentrate on the mortgage.

MHO
« Last Edit: August 07, 2014, 05:33:05 AM by viper155 »

Bart1ma3u5

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As your interest rates are extremely low, I would invest any extra money and pay off the debts as scheduled. On average investing should have much better returns than  the 1,5% or ,81% returns you would gain by paying off your student loans early.

bo_knows

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As your interest rates are extremely low, I would invest any extra money and pay off the debts as scheduled. On average investing should have much better returns than  the 1,5% or ,81% returns you would gain by paying off your student loans early.

I'd second this.  I don't have any student loans anymore, but I do have a mortgage and roughly the same rate as OP.  We occasionally will throw extra money at the mortgage, even though over time it might not be the mathematical winner (paying the mortgage off is a large psychological feat, and there are plenty of threads devoted to it. Ha!).

TeresaB

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From a numbers point of view, it makes more sense to invest. But if having the debt will stress you out, then pay it off faster. I would pay off the debt. But I hate debt. Thinking about it makes me feel stressed out and sick. I think my husband would do the math and invest.

Which will keep you up at night: Stressing about the debt, or stressing about the 160.000E you could have had?

Dicey

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Most of the answers you will receive will be along the lines of "Debt is bad, kill it." Another approach is to say "Assets are good, grow them." You are not adding to your debt to support your current lifestyle and your interest rates are extremely reasonable. You are correct in your thinking and I strongly advise you to pursue this route. Money invested early is worth much more than money saved later in your career, particularly if you desire to retire early. This concept is much more nuanced than the "kill all debt" approach and in the long run (assuming low-cost, balanced investments) should get you to your goals much faster.

Kudos to the Dutch government for handling student loans in such an enlightened manner.

Scandium

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I have a similar student loan from a European government, although my rate is just over 2% (unfair!). I've been doing just the minimum for now. I might increase it if the rate goes up, which sounds like might be late next year according to the central banks. But 2% is so low it makes little sense to pay it off. Looking at the payment schedule the "total interest paid" column is so small that I decide I'd rather invest it.

Geert_Dutch

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Thank you all for your replies, Following the route I think I will focus on growing my assets. Also I do have a intermediate option which I haven't considered before which might be a good option. In the my Mortgage I have the possibility to pay on a locked account which pays the same interest rate as my mortgage gross tax 5% while not affecting my tax deductable interest payments. In such a way I can invest at 5% relative risk free. this might be a good option for part of my funds.

As a small explanaition. Up to last year it was possible in the Netherlands to open a mortgage without any repayments in combination with a blocked deposits account. The money on the deposit accounts is not taxed nor is the interest income on the account taxed. The account can only be used to repay the mortgage. The total interest payable is however tax deductable. In this way I can have 30 year tax deductable interest while economicly my net interest decreases over time. It is like stealing from the government and although 100% of the mortgages where like this has been banned as of this year for new mortgages.

I think I will go for some asset allocation where I maximise my return on my deposit account as it is a relative risk free return of 5% while simulatiously maximise my investment account. I will stop repaying on my student debt other than the required minimal payments.

It is still my goal to have the same amount of cash available to be able to repay my debts when I want to.

Geert_Dutch

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i like your summary:

You are not adding to your debt to support your current lifestyle and your interest rates are extremely reasonable.

i think I shoul'd be very happy indeed that we are not adding to our debt and continue to increase our net worth.

I also agree that the Dutch Governemnts handles student debt this way. It also has some negative effects though, like very long study periods and also very large balance. I know students who used the easy financing to finance as I would like to call them non economical feasable studies such as art history. It is hard to repay 90.000 euro of debt on such studies. But in general it creates access to university degree for everybody who can study.

bdc

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What is your tax rate on investment returns (dividends and capital gains)?

Why are you paying down student loans (unsecured debt at a lower interest rate) before you pay down the mortgage?

TomTX

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #10 on: August 08, 2014, 01:50:19 AM »
I would go full force to pay off the debts first. Sacrifice that time. Once you are debt free, and stay that way, the investing will be easy. The peace of mind is a big factor. The mortgage is different. Pay off all those other debts right away, start investing then concentrate on the mortgage.

MHO
What the hell?

Really?

You would have him accelerate payments on a loan that is LESS THAN 1% INTEREST?!?!?

"Debt Free" is a Dave Ramesy thing, and excellent for financial disasters who have run up the credit cards and bought cars (and plenty of crap) they cannot afford. When you have money at a rate below inflation and you're not going to blow money on stupid stuff, why would you not take advantage of it?

I can maybe see paying down the house loan - but even that's iffy, as the rate is still pretty low.

taekvideo

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #11 on: August 08, 2014, 02:08:01 AM »
Yeah if the rate is below inflation it costs you MORE to pay it early than to just pay the minimums, so definitely invest the money instead.

Rienk

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #12 on: August 08, 2014, 02:30:36 AM »
What is your tax rate on investment returns (dividends and capital gains)?
This is a good question and something Geert_Dutch should take into account in calculations. Since I'm also from the Netherlands, capital gains tax is 1.2% of the total value of your savings and investments per year, minus any loans (except mortgage). Only the amount in excess of 21k per person is taxed. This tax is regardless of actual capital gains/losses, which are not taxed separately. I believe this tax on assets also replaces dividend tax but I'm not 100% sure of that. In any case, this tax makes it more attractive to pay down the mortgage once your net savings are over 42k for the two of you.

I would first grow investments to 60k or so, and from there split your money between mortgage and investments since they are somewhat equivalent in terms of risk-reward and splitting the money allows you the psychological benefit of seeing both balances improve. Leave the student loans on minimum payments.
Actually once you do reach that 60k you should probably look into the details of your mortgage and find out how early payments work exactly because there are some mortgages in NL with very complex terms in order to optimize the mortgage interest tax deduction.

Finally, at least be aware of the possibility of building additional pension through the third pillar "aanvullend pensioen" regulations. I'm not sure if putting money there is beneficial to you, but it's worth looking into, although it will make the calculations really complex. For what it's worth, for my own situation I've decided to use 'aanvullend pensioen' to cover my needs in old-age retirement only, and separate investments would finance the time between early retirement and social security eligibility.

Geert_Dutch

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #13 on: August 08, 2014, 05:54:46 AM »
What is your tax rate on investment returns (dividends and capital gains)?

Why are you paying down student loans (unsecured debt at a lower interest rate) before you pay down the mortgage?

My tax rate on investment return works as follows. Independend of actual return I pay 30% tax over expected revenue of 4% for all investments above 21.000. So effectively 1,2% every year over outstanding balance.

I'm obligated to repay the loans on a 30 year period (student loans) with a minimum payment of 45 ear per month.

Geert_Dutch

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #14 on: August 08, 2014, 06:01:05 AM »
What is your tax rate on investment returns (dividends and capital gains)?
Finally, at least be aware of the possibility of building additional pension through the third pillar "aanvullend pensioen" regulations. I'm not sure if putting money there is beneficial to you, but it's worth looking into, although it will make the calculations really complex. For what it's worth, for my own situation I've decided to use 'aanvullend pensioen' to cover my needs in old-age retirement only, and separate investments would finance the time between early retirement and social security eligibility.

Good explanation of our tax regime on investment returns. I think you can get a deduction based on dividend tax withheld on your investments, This does not work in the index funds though.

As for the aanvullend pension. I think this is similar to 401K (not sure) or other plans mentioned in US blogs. I do not like to that my money will be locked up. Also I expect that any tax savings will be deminished because I expect that the current lower tax rates for 65 year olds will be raised before I'm that age. ALso I can't use it for early pension as the payout period is blocked to either as of 65 year at a minimum in 5 years or when repaid early at a minimum of 20 years after 65. So if I would let it repay at age 60 the plan will be paid to me over 25 years.

Cheddar Stacker

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #15 on: August 08, 2014, 09:15:38 AM »
http://forum.mrmoneymustache.com/ask-a-mustachian/let's-settle-this-with-a-vote-invest-or-payoff-debts/

I like debt. My investments are barely more than my debts at this point (counting mortgage for debts, not counting house for "investments"). In 2013 I paid ~$8,000 in interest on debts, and made ~$35k+ on investments. In 2014 I will pay around $7,500 in interest on debts and I have no idea how much investment income will be. Through yesterday after a 3-4% drop in the markets, investment earnings are still up about $4-4.5k for the year. I realize this could backfire and I might lose $20K in investments this year or next, but I don't care. I like math, statistics, and probabilities, and I'll take my chances with my low interest debts.

Dicey

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #16 on: August 08, 2014, 05:17:43 PM »
I like debt... I like math, statistics, and probabilities, and I'll take my chances with my low interest debts.

I like your style, CS. So many people scream "no debt" who are talking out of their proverbial hats. Debt is a powerful tool for creating wealth. When these historically low rates are gone, a lot of folks are going to be kicking themselves that they paid off their low-interest loans at the expense of investment/retirement savings.

Cheddar Stacker

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #17 on: August 08, 2014, 05:56:01 PM »
I like debt... I like math, statistics, and probabilities, and I'll take my chances with my low interest debts.

I like your style, CS. So many people scream "no debt" who are talking out of their proverbial hats. Debt is a powerful tool for creating wealth. When these historically low rates are gone, a lot of folks are going to be kicking themselves that they paid off their low-interest loans at the expense of investment/retirement savings.

Thanks Diane C. I mean no disrespect to the debt paydown approach, I just like to bang the drum for the less popular approach. I see the risks as very low and the potential upside to be well worth the risks.

Dicey

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #18 on: August 08, 2014, 10:40:44 PM »
...I mean no disrespect to the debt paydown approach, I just like to bang the drum for the less popular approach. I see the risks as very low and the potential upside to be well worth the risks.
CS - I'm not sure about "less popular". It's less understood. I agree with your risk/reward assessment 100%. I just wish more people would listen to the logic of it.

Cheddar Stacker

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #19 on: August 09, 2014, 06:30:30 AM »
...I mean no disrespect to the debt paydown approach, I just like to bang the drum for the less popular approach. I see the risks as very low and the potential upside to be well worth the risks.
CS - I'm not sure about "less popular". It's less understood. I agree with your risk/reward assessment 100%. I just wish more people would listen to the logic of it.

Click the link I provided a few replies up. We are the majority by 3 to 1. I was shocked it wasn't closer tp 50/50 here.

Dicey

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #20 on: August 09, 2014, 06:27:22 PM »
CS - I enjoyed that thread and did throw my two cents in. Problem is I can't see any results, even when I click "View Results". It's most likely operator error, but there you have it. If it's really 50/50 then I am gobsmacked. I always feel like I'm playing the "Don't Pass" line whenever I bring the subject up, particularly in reference to paying off the mortgage early.

Cheddar Stacker

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #21 on: August 09, 2014, 08:09:05 PM »
Sorry DC that was a major typo. I said majority but meant minority. Weird you can't see the results.

The result was 75% pay down debts, 25% invest. I really thought it would be close to 50/50. Seems like that result doesn't surprise you though.

rmendpara

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #22 on: August 10, 2014, 12:47:41 PM »
Student loans - no. Not now. Do you expect the interest to go to 3-4-5% in a few years? If they were fixed rate, I would say never pay them off. Since they are variable, then maybe take advantage of the low interest now to reduce the balance?

Mortgage - I think this is fixed rate? Maybe pay a little bit extra to this now, and shift to the student loans if the rate goes higher than the mortgage.

Besides that, absolutely invest. You will likely do very well with such low interest rates.

I envy you! I own my condo outright, but wish I had kept the mortgage and invested instead since it was at 3.5%. It was a small loan anyway, so I paid it off, and now just invest all my free cash each month.

It's really up to you. Paying off debt is not optimal, but it's not a bad thing. Invest as long as you are comfortable with the debt.

Dicey

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Re: Reader Case Study - Should I stop paying off debt in favour of investing
« Reply #23 on: August 10, 2014, 01:18:56 PM »
Sorry DC that was a major typo. I said majority but meant minority. Weird you can't see the results.

The result was 75% pay down debts, 25% invest. I really thought it would be close to 50/50. Seems like that result doesn't surprise you though.

If you read my comment, you'll see that I did not vote, as I was sure the results were predictable. I just went back and voted and voila, there were the expected results. I was just figuring out that was probably a typo. Thanks for the clarification, CS.

Here's what gets me about these numbers. This is not a get out of debt blog, it's a grow your 'stache, do what you want with the rest of your life blog. Sure, getting out of debt is an important step, but those who don't have consumer debt are being underserved, IMHO. Tools to build wealth are vitally important to FI. The earlier you "buy" them, the less they cost. That's the message that's missed on the majority of PF blogs.

Finally, if I mention that I'm FIRE, it ain't bragging around here. (I was comparatively old when I left the rat race at 54, so I don't think I'm all that.) I'm saying hey, it can be done and it's not as hard as you think. Pete's awesome, but he's not an outlier. Anyone with focus, determination and perseverance can do it. Yet even after FIRE, there's still plenty to learn, which is why I keep coming back.

I love the thought that my experience might make it a little easier for someone else, particularly for single women who aren't huge wage earners. I enjoy the positive reinforcement and the variety of viewpoints here. Just not the one-note screamers.