Author Topic: What to do with the savings: kill debt or invest  (Read 2123 times)

Bjorn

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What to do with the savings: kill debt or invest
« on: March 17, 2015, 06:08:57 AM »
I can't seem to agree with myself on which is the better option:

1) Pay down all debt, then invest
2) Pay down parts of the debt, then invest
3) Pay down debt and invest simultaneously
4) Invest, then pay down debt
(5) Should I leverage the investments?)

Which option do/did you choose and how are you justifying it?

nereo

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Re: What to do with the savings: kill debt or invest
« Reply #1 on: March 17, 2015, 06:12:22 AM »
there are thousands of variations of this thread if you use the "search" function.

However, in order to give sound advice we need to know
a) what kind of debt you hold and what the interest rates are
b) what kind of monthly 'surplus' you have to put towards either debt or investments
c) whether you are contributing to tax-advantaged accounts and if you have a company match on a 401(k) or similar
d) your tax bracket

all of these matter to answer your question.  You might also want to include
i) age (even approximate)
ii) retirement goals
iii) stability of your current job.  Single earner?  Married with two incomes?

Bjorn

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Re: What to do with the savings: kill debt or invest
« Reply #2 on: March 17, 2015, 06:41:39 AM »
Thanks and I've found lots of information too, but my mind is still conflicted. Maybe I just need some face to face (forum)advice:)

a) what kind of debt you hold and what the interest rates are
Student loans: 10k at 2.7%
Mortage on a rental unit: 88k at 2.85%*

*The rental unit gives a yearly cash surplus of 1k, which includes paying down about 3k on the mortage with current interest. Unit is valued at 125k.

b) what kind of monthly 'surplus' you have to put towards either debt or investments
On average about $1,400, but will get it to $1,800 next year after getting rid of some liabilities.

c) whether you are contributing to tax-advantaged accounts and if you have a company match on a 401(k) or similar
There is one "must-have" contribution in my country, which is putting a yearly 2.5k into a tax-advantaged account. It has 4.5% interest, 20% cash-back on your tax returns and must be spent on real estate or you will get a tax penalty. Valid until you are 33 yrs old. I have 8k in it.

d) your tax bracket
I am taxed according to level of salary (~35% tax currently) and certain high living expenses will yield certain tax deductions. I don't live in the US.

i) age (even approximate)
30

ii) retirement goals
To own 2 fully paid down rental units (like the one I have now) + maybe a cash cushion and then retire. Realistic maybe 7-8 years from now?

iii) stability of your current job.  Single earner?  Married with two incomes?
Very stable average paying job. Currently single earner supporting my wife, but that is one of the "liabilities" that will go away within the next year when she finds work. No plans of having kids. We rent and want to stay flexible, maybe (temporarily) move to a low COL area in 10 years time.

nereo

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Re: What to do with the savings: kill debt or invest
« Reply #3 on: March 17, 2015, 06:48:46 AM »
You have very low interest rates.  For that reason I would put 100% of your monthly surplus towards investments.  Make sure you top off your tax-advantaged accounts first (don't entirely understand your country's system) and have an easily accessed emergency fund, but otherwise invest it all. 

Bjorn

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Re: What to do with the savings: kill debt or invest
« Reply #4 on: March 17, 2015, 07:24:42 AM »
Should I leverage the investments and get a second rental unit, being that this is my ultimate goal? Right now my cash holdings are about 13k including that tax-advantaged account, so I would need another 6 months to gather enough for a 10-20% downpayment.

Real estate prices is at an alltime high here. But so are stocks (everywhere it seems).

If I choose to leverage my total debt will be more than doubled. If interest rates then rise to 6-8% over the next few years it might hurt my finances badly unless rental prices also picks up. Is it therefore wise to fix the interest rates on the mortages?

I could also spend the next 3 months gathering enough cash to clear the whole student loan, which would give a nice feeling and lower my monthly bills.

When debating this with a smart friend of mine, he asked me the following: "Imagine you had no debt and no savings right now. Would you take on debt and invest the money?" My answer was no and he told me that's a good reason to pay down my debts before investing.

Yearly inflation is stable around 2 - 2.5% here.

nereo

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Re: What to do with the savings: kill debt or invest
« Reply #5 on: March 17, 2015, 09:43:16 AM »
Should I leverage the investments and get a second rental unit, being that this is my ultimate goal? Right now my cash holdings are about 13k including that tax-advantaged account, so I would need another 6 months to gather enough for a 10-20% downpayment.
My worry is being too heavily invested in any asset - in your case in real-estate as a landlord. Having multiple rental properties can be a great source of income, but it also exposes you to a lot of risk, especially if they are all in the same region.  Your personal comfort zone may differ, but I wouldn't want more than 60% of my portfolio to be in real-estate... and I'd want 35-40% (minimum) in the market, preferably as low-cost broad-market index funds.

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Real estate prices is at an alltime high here. But so are stocks (everywhere it seems).
Food for thought - the SP500 (a good measure of the US market) has reached an 'all-time high" in just over 50% of all years over the last century.  Real estate prices are similar, because they (on average) match inflation.  There are dips and spikes but in most years they will be higher than they ever have before.

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If I choose to leverage my total debt will be more than doubled. If interest rates then rise to 6-8% over the next few years it might hurt my finances badly unless rental prices also picks up. Is it therefore wise to fix the interest rates on the mortages?
This is perhaps the best reason to also have money invested in equities and bonds.  Right now mortgages in the US are near historical lows, and near historical inflation rates.  If your mortgages aren't fixed, now is a very good time to look into having them fixed. 
Also, rental rates typically move with interest rates (they are strongly correlated).  that's because landlords raise the rent whenever their mortgages go up, and it becomes less 'affordable' for people to buy their own home.

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When debating this with a smart friend of mine, he asked me the following: "Imagine you had no debt and no savings right now. Would you take on debt and invest the money?" My answer was no and he told me that's a good reason to pay down my debts before investing.
I'm not sure I agree with your friend's line of thinking, and given your talk of 'leveraging' to increase real-estate holdings, i'm not sure you do either.
From where I sit, you should ignore these alternative reality scenarios and only focus on what you have now and what your best course of action could be.  With interest rates below 3%, from a purely financial standpoint it makes the most sense to pay the minimum and invest the difference.  Inflation (at 2-2.5%) will nullify virtually all the interest you pay each year, and the likelihood that you will earn >3% before inflation has historically been a lock over longer time periods.

Also, if someone offered me the chance today of taking out a $98k loan @ 2.8% without needing to go to school or purchase another house... hell yes I'd do it.  I could cover the monthly payments and I would put it all into my index fund.
« Last Edit: March 17, 2015, 09:46:16 AM by nereo »