The Money Mustache Community
Learning, Sharing, and Teaching => Case Studies => Topic started by: Snowman99 on September 08, 2017, 03:40:14 AM
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We are maxing out our retirement accounts, and are wondering what to do with the extra cash we have. We are not all that excited about putting our extra cash in the market right now, as it may be overvalued, and we have some low interest debt that we would like to pay off. Here's the low down:
1. Maxing out 401k plus Roth IRA for wife and I.- 100% Total Stock Market Index Funds (we are in mid 30s).
2. Throwing $2k/year into 529 Plan for the kiddos to take advantage of state income tax deduction ($2k limit)
3. Have over a year's worth of living expenses saved in ordinary savings for emergency fund (ultra conservative due to work situation)
4. Have a mortgage at $320k at 3.25% for 30 years
5. Car Loan for about $10k at 1% interest- about 3-4 year repayment period left (financed before finding the wisdom of MMM)
6. Student Loan at about $30k at 2.5% interest- about 15 year repayment period left
We haven't paid down the debt because it is low interest and we needed to save money for needed home renovations. That money is now saved in an ordinary savings account and reserved for needed home renovations to occur within the next year. This is on top of the emergency fund noted above. We could always put more money into the house for what we could classify as "bonus" renovations.
My question is what to do now that we are coming into extra funds. There will be about another $40k or so extra to spend this year (and likely going forward), and we can throw some of it into the 529, throw it into a taxable investment account, or pay down the debt. I don't want to buy more stocks just to pay taxes and/or lose money in the short term because the stock market is too high now. I don't want to overfund the 529 accounts (my kids are 3 y/o and 5 months and who knows what will happen in 18 years).
I could front load the 529 to take advantage of the growth and tax savings, but this is assuming that my market timing for such a front load is ideal. Likely, it is not, and I will lose money for a few years.
I'm thinking about just throwing the extra money at the car and student loans, as we could just get rid of them now. The interest rates are super low, however, and the student loan gives us a tax deduction. My wife wants to save the money in a savings account for future "bonus" renovations to the house. The bonus renovations would be nice, but they are not a "necessity."
Just wondering what you guys would do if you were in my situation. Thanks.
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My personal bias is to pay off the student loans first since these are a mortgage on your life and likely cannot be discharged in bankruptcy. (Hopefully a very low probability for a Mustachian family, but things can happen.)
Having some insight into your tax situation would help. Do you itemize deductions? If so, an approximation of your 2016 deductions would help understand the actual impact of any significant mortgage pay down.
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Food for thought:
It seems you are already around #7, so whichever you do you are on a good track.
Personally I'd let the low interest debt lie and invest in taxable accounts (#8) but... your call.
WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.
WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 25%; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise.
See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
See Traditional versus Roth - Bogleheads for even more details and exceptions. State tax (or lack thereof) should also be considered.
The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals*.
5. See #4 for choice of traditional or Roth for 401k. In a 401k there are no income-based limits for deductions or contributions.
6. Applicability depends on the rules for the specific 401k
7. Again, take the risk-free return if high enough. Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
(e.g., target retirement date) that provides a blend of stock and bond returns. If you wish to consider separate bond funds, compare the yield on a fund
with a duration similar to the time remaining on the loan, and put your money toward the one with the higher interest/yield.
8. Because any earnings, even if taxed, will help your FI journey.
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i'm with nereo that debt is all such low debt that you should just put it into a vanguard brokerage account .... your future self will thank you for all that money you'll have made.
these loans are all basically at or below the rate of inflation making them free money. Please invest it.
Also food for thought on renovations. My wife and i have some planned. BUT we arent putting this money in a shitty ass savings account this money is invested in the market making us more money. Guess what renovations dont have time lines typically esp. since you called them bonus. So our plan is invest that money. and when its made enough in earnings to cover a renovation we do that renovation.
put the 40k into a taxable account
in 5 years at 7% you'll have made 16k
if you put it in a savings account in 5 years a -2.2% (1% savings return -3.2 normal inflation) you'll have lost - 4k
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also you made a great decision to finance a car at 1% assuming you bought a good car for a good price. now if you bought a brand new car then its not the best decision but take free money when you can get it. anyone giving you sub inflation rates on loans is giving you money.
Debt aversion is for the weak minded who likely dont understand math but like feelings.
Can't even believe someone mentioned paying down a mortgage. HAAHA HAHHAHAHAHA a 3.25% fixed mortgage paid down - you got to be kidding me. You must have gotten this mortgage in the summer of last year. congrats you hit the bottom of interest rates in history for fixed 30 year mortgages.
Earth surfer you mention paying down student loans with the risk of losing your job and going bankrupt then switch to talking about partial mortgage paydown. These statement contradict each other from a risk standpoint i would suggest you do some research into what you're speaking about before just throwing out kill the debt answers.
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If you are following the common strategies here, you are basing your retirement plans on being able to take out money at 4% from investments. Anything below that after tax deductions means you should be investing it instead.
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We are not all that excited about putting our extra cash in the market right now, as it may be overvalued
. . .
I don't want to buy more stocks just to pay taxes and/or lose money in the short term because the stock market is too high now.
. . .
I could front load the 529 to take advantage of the growth and tax savings, but this is assuming that my market timing for such a front load is ideal. Likely, it is not, and I will lose money for a few years.
This is the thinking you need to challenge: you are letting short-term market fears affect your planning for long-term market goals.
You are mid-30s. Everything you are investing for now (except the reno) is at least 15 years away (college), and some are multiple decades away (since even if you FIRE in a few years, that money needs to last for 40-50+ years if all goes well). Over these kinds of timeframes, it is extremely unlikely that you will lose money in the market. The much, much bigger risk is that you let your fear of a short-term loss keep you out of the market, so you miss the big upswings that represent probably half of the overall market gains. See http://www.businessinsider.com/cost-of-missing-10-best-days-in-sp-500-2014-3.
Please take it from someone who's been doing this a lot longer than you: you need to control your fear and not let it drive your decisions. I am generally pessimistic, and for at least 20 of the past 26 years I have been convinced the market was overvalued. I was right twice. If I'd listened to that fear, I wouldn't be close to FI now. Fundamentally, if the overall economy sucks so bad that the market can't beat 1% or 3% over the next 20+ years, none of us are FIREing anyway.
Tl;dr: If you can't get over the fear of short-term losses, then you should look for another path to FIRE, like RE investing or something similar. Trying to time the dips will hurt you far more than the dips themselves will.
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I missed your irrational fear/statement on markets being high so to put that to bed read this
http://awealthofcommonsense.com/2014/02/worlds-worst-market-timer/
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Don't try to time the market. Don't try to time the market. Don't try to time the market.
Just go ahead and invest the money. Every day you don't is a day of lost gains, right up until the day it drops... which could be tomorrow and could be in five years. You don't want to hold that cash, steadily losing value to inflation, trying to time the market. If you're that concerned about a drop, reconsider whether your asset allocation is too risky for you, but don't let that stop you from investing.