Author Topic: Investing vs. Low interest debt - math?  (Read 15230 times)

smalllife

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Investing vs. Low interest debt - math?
« on: November 07, 2012, 05:04:26 PM »
Some advice I've often seen here on MMM regarding mortgages or any other low interest debt is to invest until you have enough to pay it off in one lump sum.  When this is suggested, do you mean invest in a taxable account?  For low to medium incomes, this would mean forgoing maxing out tax advantaged retirement vehicles.  I'm trying to understand the logistics of investing my "extra payments" and not taking a huge tax hit at the end or fees during.  I don't remember seeing brokerage fees and tax at sale ever included in the "but you'll average 7% on your investments" advice - and please correct me if I'm wrong.


Say you have around $150 - $500 loose money in the budget each month to pay extra on the mortgage/HELOC/whatever.  This money is variable (freelance income, second job, extra money because you are Mustachian and are working to raise your income).

The Roth IRA is maxed out at $5,500 each year which takes up around 20% of take home pay.  401k might be an option but maxing out is not a feasible route. 

How is it efficient to pay brokerage fees on these small deposits and then take a huge tax hit 10-15 years down the road?  I understand that the likelihood of appreciation would help but I rarely see the tax implications included in this suggestion.  Not to mention that if you funnel these funds into your retirement vehicles you are either hit with a penalty in a 401K or reduce/wipe out the amount you can withdraw penalty free from a Roth.

Basically my question is this: at what point do the inherent costs of taxable investment accounts overcome the potential gains, especially for small time investors?


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JohnGalt

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Re: Investing vs. Low interest debt - math?
« Reply #1 on: November 07, 2012, 05:52:24 PM »
Assuming you have already made the decision that the interest rate is low enough that you expect to come out ahead investing over paying down the debt early and you have a low to medium income - I think this should be the priority of investment vehicles.

1. 401k to max any company match - that's free money
2. Max out Roth IRA - lock in that low tax rate
3. max out 401k or save in taxable account depending on expected future earnings (i.e. if your current tax bracket is 15% but you expect to be in the 25% tax bracket in a few years and then retire on a lower income putting you in a 15% effective tax bracket, you're better off with that money growing tax free in the 401k)

Other comments....

Paying off in a lump sum - If you've already decided that you're better off investing rather than paying down the debt - I would just let it go straight through it's amortization even if I had enough to pay it off at some point.

Brokerage Fees - should not be an issue with the 401k, for a taxable or Roth account - most of the discount brokers (Schwab, Ameritrade, Fidelity, Vanguard) have free trades for a list of funds.  Or, you don't have to invest every month if you are just adding a few hundred dollars - you can wait until you have enough to dilute the transaction fee to a reasonable level.

Taxes - this is why you get money into the tax advantaged accounts - but even taxable accounts shouldn't come to a whole lot in taxes if you aren't frequently turning over your stocks. 

smalllife

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Re: Investing vs. Low interest debt - math?
« Reply #2 on: November 07, 2012, 06:45:24 PM »
1. 401k to max any company match - that's free money
2. Max out Roth IRA - lock in that low tax rate
3. max out 401k or save in taxable account depending on expected future earnings

My whole point was that for people with low to mid incomes, it is really really hard to get past point #3 (or point #2 depending on the generosity of the company match).  Do you expect a big payout to come from retirement investments?  Or at this level of "play money" is it even worth entering the taxable investment game to get ahead on debt?

I wanted to know whether, with standard assumptions (2-4% debt, 7% returns) whether it made sense to invest with a payoff in mind if all you have are retirement tax-advantaged vehicles.
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Jack

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Re: Investing vs. Low interest debt - math?
« Reply #3 on: November 07, 2012, 07:46:32 PM »
I think the issue comes with the "then pay off the debt in one lump sum" part. If you are profiting from the leverage afforded by investing instead of paying your mortgage at an accelerated rate, there's no reason to change your strategy just because your assets increase beyond the payoff balance. Instead, just keep investing and pay off the mortgage at its normal amortization schedule.

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #4 on: November 07, 2012, 08:13:38 PM »
I think the issue comes with the "then pay off the debt in one lump sum" part. If you are profiting from the leverage afforded by investing instead of paying your mortgage at an accelerated rate, there's no reason to change your strategy just because your assets increase beyond the payoff balance. Instead, just keep investing and pay off the mortgage at its normal amortization schedule.

*slow clap*

Thread over?

;)
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smalllife

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Re: Investing vs. Low interest debt - math?
« Reply #5 on: November 07, 2012, 09:26:21 PM »

Thread over?

;)

Not if one's goal is part-time work ASAP rather than a full FI retirement.  . . but I suppose there are only so many options.
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arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #6 on: November 07, 2012, 11:04:06 PM »
Not if one's goal is part-time work ASAP rather than a full FI retirement.  . . but I suppose there are only so many options.

Huh?  I'm not following.  Jack's post is the matematically superior way, whether you go for a "full FI retirement" (whatever that means) or part time work when FI, or whatever.

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smalllife

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Re: Investing vs. Low interest debt - math?
« Reply #7 on: November 08, 2012, 05:43:30 AM »
Not if one's goal is part-time work ASAP rather than a full FI retirement.  . . but I suppose there are only so many options.

Huh?  I'm not following.  Jack's post is the matematically superior way, whether you go for a "full FI retirement" (whatever that means) or part time work when FI, or whatever.

I'm not following how my cash flow will be reduced enough to drop employment levels simply because I have investments . . .
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Jack

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Re: Investing vs. Low interest debt - math?
« Reply #8 on: November 08, 2012, 06:59:49 AM »
Not if one's goal is part-time work ASAP rather than a full FI retirement.  . . but I suppose there are only so many options.

Huh?  I'm not following.  Jack's post is the matematically superior way, whether you go for a "full FI retirement" (whatever that means) or part time work when FI, or whatever.

I'm not following how my cash flow will be reduced enough to drop employment levels simply because I have investments . . .

You're right: my suggestion doesn't help if your goal is to minimize your monthly expenses by eliminating the mortgage payment. (I almost wrote a second paragraph pointing that out in my previous post, but I was typing on a touchscreen and couldn't be bothered; sorry!)

However, I think there is another choice you haven't considered: instead of investing in growth stocks where you can't get your money out until you sell, invest in dividend stocks such that the dividend income pays the mortgage. That way you can get the cash flow you want without sacrificing the leverage.

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #9 on: November 08, 2012, 07:22:00 AM »
Quote
uthor=smalllife link=topic=2487.msg36214#msg36214 date=1352378610]
I'm not following how my cash flow will be reduced enough to drop employment levels simply because I have investments . . .

We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
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twinge

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Re: Investing vs. Low interest debt - math?
« Reply #10 on: November 08, 2012, 07:51:38 AM »
This didn't strike me as trolling...just questions.
 
Quote
How is it efficient to pay brokerage fees on these small deposits and then take a huge tax hit 10-15 years down the road?

I think this might be your source of confusion: Taxable investments don't necessarily include brokerage fees.  You can do the same low-cost index funds in a taxable account that you do in your Roth, 401k etc.  I can throw $100  into my taxable index fund anytime I want and there are no fees involved (other than the ultra-low expense ratio that has nothing to do with transactions). If you want to do low cost investing in individual companies you can do drip investments with minimal fees.

So if your mortgage is less than 6%-7% the odds are in your favor to invest if you follow a reasonable low-cost approach that is also advocated here.  As for expenses, money is money--you generate either income to replace an expense or you get rid of the expense.  Your cash flow will be the same regardless of your approach.   For mortgage, it makes more sense at the current rates to generate investment income to replace that expense.  Any other decision is in the realm of psychology rather than numbers (which is fine if you want to go with the psychology of something just be aware that you are).


JohnGalt

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Re: Investing vs. Low interest debt - math?
« Reply #11 on: November 08, 2012, 08:36:38 AM »
Not if one's goal is part-time work ASAP rather than a full FI retirement.  . . but I suppose there are only so many options.

Huh?  I'm not following.  Jack's post is the matematically superior way, whether you go for a "full FI retirement" (whatever that means) or part time work when FI, or whatever.

I'm not following how my cash flow will be reduced enough to drop employment levels simply because I have investments . . .

I think if you have different goals than just optimizing your return - you'll need to evaluate things differently.

However - say you have $150,000 house locked into a 3.5%, 30 years mortgage as well as $150,000 invested with an expected return of 7%.  The mortgage payment will be $675/mo but the investments will throw off $875/mo - netting you $200/mo in positive cash flow over just paying off the mortgage for 30 years.  Obviously, there are different risks involved that you'll need to take into account - but, if you're just looking at the numbers - you come out way ahead by investing that money rather than paying down the debt.

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #12 on: November 08, 2012, 08:40:53 AM »
Not if one's goal is part-time work ASAP rather than a full FI retirement.  . . but I suppose there are only so many options.

Huh?  I'm not following.  Jack's post is the matematically superior way, whether you go for a "full FI retirement" (whatever that means) or part time work when FI, or whatever.

I'm not following how my cash flow will be reduced enough to drop employment levels simply because I have investments . . .

I think if you have different goals than just optimizing your return - you'll need to evaluate things differently.

However - say you have $150,000 house locked into a 3.5%, 30 years mortgage as well as $150,000 invested with an expected return of 7%.  The mortgage payment will be $675/mo but the investments will throw off $875/mo - netting you $200/mo in positive cash flow over just paying off the mortgage for 30 years.  Obviously, there are different risks involved that you'll need to take into account - but, if you're just looking at the numbers - you come out way ahead by investing that money rather than paying down the debt.

This.  And that extra cash flow means you could reduce your work hours sooner (i.e. "part time work ASAP")...
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smalllife

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Re: Investing vs. Low interest debt - math?
« Reply #13 on: November 08, 2012, 10:50:54 AM »
@JohnGalt: If the investments were in taxable  I would completely agree, but they would be in either a 401K or a Roth if I follow the standard advice of maxing them out first.  Wouldn't I be limiting my future 401K income by accessing that money via a 42t early?  Especially if I plan to continue working? 

@arebelspy: not trolling, just don't have a lot of money to play with. 

@twinge: You're right, that is a source of my confusion.  I can find no-fee brokerages, so I guess it is the taxes that I'm worried about.  At this point my investment stache is still just minor peach fuzz and the thought of it growing big enough seems so far away.
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JohnGalt

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Re: Investing vs. Low interest debt - math?
« Reply #14 on: November 08, 2012, 11:02:21 AM »
@JohnGalt: If the investments were in taxable  I would completely agree, but they would be in either a 401K or a Roth if I follow the standard advice of maxing them out first.  Wouldn't I be limiting my future 401K income by accessing that money via a 42t early?  Especially if I plan to continue working? 

Roth conversion pipeline is my plan to access 401k money early.  When I leave my job, I will roll my 401k into a traditional IRA.  Then, each year, I will convert what I expect to need to withdraw 5 years down the line to a Roth IRA account.  I will have to pay my marginal tax rate (which should be much lower than my current marginal tax rate) on the converted amount.  Once the money sits in the Roth for 5 years, it can then be withdrawn tax and penalty free.  So, that just leaves covering the first 5 years from somewhere else.  That's where my current roth IRA contributions come into play as they can be withdrawn tax and penalty free at any time (or taxable accounts could be used to cover this).   

If you don't plan on leaving your employer where your 401k is located - this may not work as you may have a difficult time converting it to an IRA. 

KulshanGirl

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Re: Investing vs. Low interest debt - math?
« Reply #15 on: November 08, 2012, 05:30:06 PM »
Smalllife, I'm where you are.  I mean to go part time in the next 4-5 years.  The math stated above doesn't apply to my situation, I can't generate enough interest income from investments to cover the mortgage payment within that short timeframe.  But I CAN probably pay it off.   Maximum returns/early retirement is not really my goal, I am only semi-mustachian I guess.  I like to work and plan to continue to do so. :)  I kind of get a kick out of the ones here who are all Investing In Stocks For Maximum Returns Are The Only Way To Go Or You Are Doing It Wrong.  I think maybe they are just as much a slave to the dollars as those in the hole.   If someone who doesn't make much money is able to kick away their mortgage and make a part time lifestyle without utilizing investments (that won't add up for a decade or more in their particular case) I don't see the problem with that.  At all.  Financial independence has more to do with the choices you have available to you than it does the dollars. 

Edited to add:  I am investing 20% total in my 401K and investing some money as well as working to pay off my mortgage.  I'm not bashing the investing part, but it's not the sure path.  Or the only path. 
« Last Edit: November 08, 2012, 05:35:12 PM by KulshanGirl »

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #16 on: November 08, 2012, 06:11:44 PM »
Smalllife, I'm where you are.  I mean to go part time in the next 4-5 years.  The math stated above doesn't apply to my situation, I can't generate enough interest income from investments to cover the mortgage payment within that short timeframe.  But I CAN probably pay it off.   Maximum returns/early retirement is not really my goal, I am only semi-mustachian I guess.  I like to work and plan to continue to do so. :)  I kind of get a kick out of the ones here who are all Investing In Stocks For Maximum Returns Are The Only Way To Go Or You Are Doing It Wrong.  I think maybe they are just as much a slave to the dollars as those in the hole.   If someone who doesn't make much money is able to kick away their mortgage and make a part time lifestyle without utilizing investments (that won't add up for a decade or more in their particular case) I don't see the problem with that.  At all.  Financial independence has more to do with the choices you have available to you than it does the dollars. 

Edited to add:  I am investing 20% total in my 401K and investing some money as well as working to pay off my mortgage.  I'm not bashing the investing part, but it's not the sure path.  Or the only path.

I disagree, and think you probably haven't actually done the math on it.  But if you can gets dividends at 3%, and a mortgage at 3%, any mortgage interest deduction is gravy, plus you have the potential of capital gains, and the freedom of liquidity.

Tying up a huge chunk of money into equity in your house seems like the exact opposite thing to do to me if you're going part time or will have unstable income.

Sure bills are less, but in an emergency you have very little to deal with it.  If you have a portfolio you are paying the mortgage from, you also have funds you can deal with an emergency from.

YMMV, do whatever works for you, I just think you haven't actually considered the other possibilities with an open mind.
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Nancy

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Re: Investing vs. Low interest debt - math?
« Reply #17 on: November 08, 2012, 06:22:21 PM »
Roth conversion pipeline is my plan to access 401k money early.  When I leave my job, I will roll my 401k into a traditional IRA.  Then, each year, I will convert what I expect to need to withdraw 5 years down the line to a Roth IRA account.  I will have to pay my marginal tax rate (which should be much lower than my current marginal tax rate) on the converted amount.  Once the money sits in the Roth for 5 years, it can then be withdrawn tax and penalty free.  So, that just leaves covering the first 5 years from somewhere else.  That's where my current roth IRA contributions come into play as they can be withdrawn tax and penalty free at any time (or taxable accounts could be used to cover this).   

If you don't plan on leaving your employer where your 401k is located - this may not work as you may have a difficult time converting it to an IRA.

This is a good idea. Hadn't thought of it.  Thanks for sharing!

KulshanGirl

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Re: Investing vs. Low interest debt - math?
« Reply #18 on: November 08, 2012, 10:16:48 PM »
I think that the difference here is that you assume that everyone wants the largest number of dollars possible.  You are right that the stock market will likely give me the most dollars between now and when I am an old lady.  The thing is, I don't require the most dollars possible to meet my goal.   I need this certain amount of dollars before one specific date, which is on the soon side.  And the good news is that I can do that just by doing it.  No risk required, no stress, no worries.  I'm giving up potentially MORE dollars, sure, but that's not what matters to me. 

It's also a pretty unimpressive amount of money that I have to work with compared to many here.  It certainly won't let me retire particularly early, or even go part time any time soon if I have to factor in both continuing mortgage payments AND health insurance premiums that I'll be taking on by going part time.  But I CAN go part time in comfort if I pay off the mortgage. 

I make less than $50K, and my mortgage is less than $100K remaining.  My 401k is chugging along, I have 6 months expenses and growing in the emergency fund, growing college savings for the little'un soon to go into stocks, no consumer debt ... I'm in no way worried about my finances.

So my pie will be smaller overall than it could be.  I don't see the problem if I still get the perfect piece of the pie I want and need, with no risk, and sooner.  My goal is not early retirement, it's a sustainable part-time work lifestyle, as soon as I can manage it.

College savings for 2 year old = 16 year horizon = stock market for sure.
Retirement = 25 year horizon = stock market for sure.
My goal to go part time = 4-5 year or sooner horizon = nope, no stock market risk wanted/tolerated here.

You are 100% correct though, for someone who is concerned with maximizing returns on their dollars and no other factors.  That might not be everyone though.
 



« Last Edit: November 08, 2012, 10:20:46 PM by KulshanGirl »

Portland Man

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Re: Investing vs. Low interest debt - math?
« Reply #19 on: November 09, 2012, 07:59:02 AM »
KulshanGirl,

Your lack of tolerance for risk is reason enough to pay down the mortgage rather than invest, but I think you miss the point.

Mathematically, investing with a higher return is 100% superior than paying off the mortgage with the lower interest rate.  You want part time work, say you have an mortgage rate of 3.5% after deductions (those deductions will shrink away as you pay down principle, btw) and you can get a pretty safe 5.5% "in the market," which I think is pretty doable.

If you invest the amount at which you'll pay down principle for the next 5 years, at the end of that time period you'll have a loan, but, you'll also have a cash stream that is greater than your loan payment, and a nest egg that is more liquid than owning your home.  It will be like have someone else pay your mortgage payment, plus slip a couple benjies in your pocket each month.


I'm mostly with you on the risk tolerance, although I think MMM has written a time or two about being careful not to be too safe.... 

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #20 on: November 09, 2012, 08:34:30 AM »
It will be like have someone else pay your mortgage payment, plus slip a couple benjies in your pocket each month.

Right.  Kulshan, let's say instead of paying off that 100k mortgage you invested it in something yielding more than your mortgage interest.  That invested amount would let you pay that mortgage.  Math doesn't lie.

It would likely let you get to that part time work even faster than paying down the mortgage would.  It's not about having the most money, but having the most freedom as quickly as possible, whether that's full time or part time FI, and by mathematically optimizing it you can do it better and more efficiently.

And then when rates rise (which they will over the next 30 years, very likely over the next 5-10) you'll have an income stream much greater than the mortgage payment, and you'll be liquid.

Option 1: expenses of 2k/mo and get $5-600 cash flow from larger portfolio + you get the potential of capital gains + have a bunch of money liquid
Option 2: expenses of 1500/mo. No extra cash flow. No potential gains.  No liquid money.

To me, scenario 1 sounds better.  And, by doing it along the way, you likely get there quicker than you do get to option 2 (i.e. you can build up a portfolio to cover your mortgage payment FASTER than you can actually pay off the mortgage payment, because you're investing at a higher rate, meaning you can go part time even earlier).

Again, do what works for you.  If it lets you sleep at night to hit that partial retirement a little later, but have no mortgage, go for it.  But don't try to convince yourself that it's better, because of your situation.  It's not.  It's just what you want to do.  If that's the case, fine. Own up to it and accept it.  But face punches are needed when one is playing mental tricks on themselves to convince themselves their suboptimal way is the better way.
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KulshanGirl

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Re: Investing vs. Low interest debt - math?
« Reply #21 on: November 09, 2012, 10:14:58 AM »
I understand what you're saying.  I know the math doesn't lie.  But it depends on the stock market doing well within a short five year window, which is not really something that appeals to me.  Stock market in the long term does, which is why I use it for things like my retirement and college savings for the child.  One can choose to increase income or reduce expenses to reach their financial sweet spot.  I do invest, for particular goals.  Some of my goals I don't want to depend on the stock market for, ones I can achieve without risk while keeping on with my abundant life and watching my net worth grow.  Slower than the max possible maybe, but grow.  Money is just a tool,  We're all here wealthy beyond the dreams of much of the world.  I spend exactly zero time worrying about money, and I don't mean to start now by putting all of my eggs into the stock market basket.  :)  Of course my mileage varies, but I do know exactly what time I'm going to get where I want to be.  Gamble for sooner and risk later?  Not this goal.  (which if you haven't seen us in this volley before, is switching to working part time to be home after school for my daughter when she gets to school age)

All of that said, I have considered putting it in savings and paying it in one lump at the end to keep liquid between now and then.  But well then, that's even less dollars in the end.  Aaaand, I'll just stay out of other people's investing threads, I'm clearly doin' it wrong and should just pipe down and go have a dance party in the gauntlet room.  Hehe.

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Re: Investing vs. Low interest debt - math?
« Reply #22 on: November 09, 2012, 10:55:54 AM »
One thing you might want to consider is your goal is not to spend all the money at a single point in 5 years.  What you are trying to do is to create a supplemental income that starts in 5 years and goes on for many years after that.  I would not try to fund 10 or 15 years of supplemental income starting five years from now entirely with low yield cash savings.  To do that, I would divide the savings into two or three pots.  I might fund the first three years with low risk savings and the next few years by taking on a little more risk now, reducing the risk as I got closer to needing the money and opportunities to take profits appeared.  As my needs and employment changed, I would adjust the pots accordingly.  This way I would insure the first few years and maximize my supplemental income for the remaining time I wanted to work part time.

smalllife

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Re: Investing vs. Low interest debt - math?
« Reply #23 on: November 09, 2012, 05:02:06 PM »
It will be like have someone else pay your mortgage payment, plus slip a couple benjies in your pocket each month.

Option 1: expenses of 2k/mo and get $5-600 cash flow from larger portfolio + you get the potential of capital gains + have a bunch of money liquid
Option 2: expenses of 1500/mo. No extra cash flow. No potential gains.  No liquid money.

Show me the math at how $2-500 of investments per month will produce $5-6k cash flow per month over a period of 10 years, because the math I've done doesn't add up with that one.   Remember also that at this level of investments it is likely to be tied up in a 401K.
Also, why does option 2 assume that we spend the entire nest egg on paying off the mortgage?
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KulshanGirl

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Re: Investing vs. Low interest debt - math?
« Reply #24 on: November 09, 2012, 05:51:15 PM »
If someone can post me a link to somewhere that will earn 5.5% guaranteed with no risk, my mind is changed and I'm all over it.  Go on, I'll wait.  :)

Oh, except that in order for $80K to generate $7600 per year to cover my mortgage, I'll need closer to 10% when you factor in taxes and fees.  Ok, go.

......
 
:)  Okay, now I'm kind of trolling. 


arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #25 on: November 09, 2012, 06:58:38 PM »
It will be like have someone else pay your mortgage payment, plus slip a couple benjies in your pocket each month.

Option 1: expenses of 2k/mo and get $5-600 cash flow from larger portfolio + you get the potential of capital gains + have a bunch of money liquid
Option 2: expenses of 1500/mo. No extra cash flow. No potential gains.  No liquid money.

Show me the math at how $2-500 of investments per month will produce $5-6k cash flow per month over a period of 10 years, because the math I've done doesn't add up with that one.   Remember also that at this level of investments it is likely to be tied up in a 401K.
Also, why does option 2 assume that we spend the entire nest egg on paying off the mortgage?

Uhhh... not sure you're following this thread at all.  We're discussing paying off the mortgage versus investing, over a short time period to semi ER.

So it's not 5-6k/mo cash flow, it's 100,000 (the amount you could have paid to the mortgage) to produce $500-600 per month.  Scenario one you still carry a mortgage of $500/mo, so your expenses are 500 higher.  Scenario 2 you have no mortgage, so lower expenses.  Either way the rest of your nest egg and what it kicks off is irrelevant to this comparison.  So option 2 assumes you spend the whole amount necessary to pay off the mortgage.

Are you following now?

If someone can post me a link to somewhere that will earn 5.5% guaranteed with no risk, my mind is changed and I'm all over it.  Go on, I'll wait.  :)

Oh, except that in order for $80K to generate $7600 per year to cover my mortgage, I'll need closer to 10% when you factor in taxes and fees.  Ok, go.

......
 
:)  Okay, now I'm kind of trolling. 



Well your mortgage could easily be refi'd to be the lower amount.  In essence you can't compare what the payment is from a higher amount to now, when you have the refi possibility.  You compare what the payment would be on a 100k (or 80k or whatever) mortgage versus investing that same money, what return you'd need.  It's nowhere near 10%.  Likely not even 5.  And yes, I understand you want it on a shorter timeframe, but you seem to think total return is the only possible investment option, since you keep talking about worrying about it not being there.  You may need to invest in something more stable, or go the dividend or real estate route, or whatever.

In fact, let's use that as an example.

Let's say you have expenses of 2000/mo (500 housing, 1500 other).  You can pay off the house over the next 5 years with extra payments, which will take ~100k.  Or you could, each time you get 25k, invest in a property at 25% down worth 100k each.  Whatever portfolio you have outside this consideration is basically irrelevant to this comparison.  We'll say it's $X and you just leave it alone to let it grow.  You want to go part time in 5 years such that you'll only be earning $1500.  If you have the mortgage and are spending $2k, you can't afford to go full time, unless you pay off that mortgage or invest such that you get > 500/mo.

Scenario 1: Pay down mortgage.  End of year 5, you have 1500 in expenses, your $X portfolio, and a part time job earning 1500.  All of the 100k equity is trapped in the house, and if an emergency comes up, hope that $X portfolio can be tapped (though it may have penalties)

Scenario 2: Buy a house each year (except year 1, when still saving, so years 2-5) to total 4 houses.  Spent 100k, equity in them is 100k. Mortgage of 75k on each, 5% interest rate.  Rent each for 1100.  Gross monthly expenses ~550, monthly payment 400.  Cash flow $150 each x 4 houses = $600.  That pays your mortgage plus gives you an extra $100/month in your pocket plus gives you the potential for four houses appreciating, rents adjust upward with inflation, and they're paying off the mortgages for you (they pay ~1100/house per year towards the principal, so you're gaining ~4500 per year in equity).

Before someone starts with the "what if they aren't rented," I added in a large margin (50% rule, 550/mo) to cover vacancies.  And that's paying someone else to manage them.  You can gain an extra ~400/mo if you manage them.   In a typical month where they are all rented and you manage them and there is no maintenance, you bring in a gross of 4400, have mortgages on those 4 for ~1600 and keep 2800/mo.  That covers your mortgage payment of 500, puts 100 in your pocket, and saves $2200/month for the vacant time times/repairs/paying for management/etc!  That $2200 surplus grows your $X portfolio until it needs to be tapped.

That's one scenario.  It's not liquid, but you can tap the equity same as with your house.  It's providing much more gains (5k/year, and growing each year.. in 30 years you'll own 4 extra houses, and how secure will your retirement seem then), versus the paid off home providing no gains.

Dividend investing is another scenario.

There are mathematical scenarios that are safer than a total return / high stock percentage that very well may put more money in your pocket and let you semi-RE sooner than you would paying off the mortgage.
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smalllife

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Re: Investing vs. Low interest debt - math?
« Reply #26 on: November 09, 2012, 07:31:23 PM »
I somehow read an extra zero into your option 1, so that was my mistake.   

Except for the dilemma of taking a large sum of money (or small monthly amounts) of a 401K at the age of 35-40 I'm starting to see how the math works out.  I feel like a taxable account would be more accessible but that would be leaving tax advantaged investments on the table.

I also realized that I was looking at invested returns adjusted for inflation, which is unnecessary when looking at paying a fixed cost payment such as a mortgage.

Of course I make all of my assumptions without assuming the potential for raises or switching careers to something more lucrative, so maybe it's a moot point anyway. 
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arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #27 on: November 09, 2012, 07:52:25 PM »
Gotcha, no worries.  :)

Yes, I do think you need to be comparing it to taxable investments for more apples to apples.  You would be leaving taxed advantaged investments on the table, but you'd be doing so for a reason - to have the portfolio available to access regularly to pay the mortgage.

Kulshan's scenario is a good example.  Your investing should align with your goals, but that doesn't necessarily mean that options are ruled out.
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Re: Investing vs. Low interest debt - math?
« Reply #28 on: November 10, 2012, 12:04:25 PM »
Yes, I do think you need to be comparing it to taxable investments for more apples to apples.  You would be leaving taxed advantaged investments on the table, but you'd be doing so for a reason - to have the portfolio available to access regularly to pay the mortgage.
Not to be that guy, but you can take money out of a Roth IRA anytime (even if it originally came from a Roth 401k).

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #29 on: November 10, 2012, 12:11:39 PM »
Yes, I do think you need to be comparing it to taxable investments for more apples to apples.  You would be leaving taxed advantaged investments on the table, but you'd be doing so for a reason - to have the portfolio available to access regularly to pay the mortgage.
Not to be that guy, but you can take money out of a Roth IRA anytime (even if it originally came from a Roth 401k).

Touché.  5k / yr for 5 years gives you 25k principal you can withdraw, which would cover mortgage payments of 500/mo for about 4 years.  If you're investing 100k over those 5 years, you'd still compare to 75k taxable and 25k Roth, as I see it.

If you're investing extra money anyways (beyond the extra mortgage pay down/ extra investment) as Kulshan is, you may want to just leave the Roth untouched (I.e. max the Roth and have a separate taxabale bucket for paying the mortgage from).
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smalllife

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Re: Investing vs. Low interest debt - math?
« Reply #30 on: November 10, 2012, 04:19:10 PM »

Not to be that guy, but you can take money out of a Roth IRA anytime (even if it originally came from a Roth 401k).

I had that thought, but I want to leave that money untouched as long as possible as an emergency fund of sorts or eventually as part of the pot of money available during the 5 year 401K rollover.  It is an option, but not one that I would use for this situation.

If you're investing extra money anyways (beyond the extra mortgage pay down/ extra investment) as Kulshan is, you may want to just leave the Roth untouched (I.e. max the Roth and have a separate taxabale bucket for paying the mortgage from).

That's kind of how I'm leaning right now.  It would mean leaving my 401k unmaxed but give me more options and flexibility given the time frame and numbers I am working with.  I need to play with the tax implications of doing so but I feel more comfortable knowing I have access at any time with less hoops to jump through.
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JohnGalt

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Re: Investing vs. Low interest debt - math?
« Reply #31 on: November 12, 2012, 11:20:59 AM »
Yes, I do think you need to be comparing it to taxable investments for more apples to apples.  You would be leaving taxed advantaged investments on the table, but you'd be doing so for a reason - to have the portfolio available to access regularly to pay the mortgage.
Not to be that guy, but you can take money out of a Roth IRA anytime (even if it originally came from a Roth 401k).

I'm happy to be that guy and point out that you could even use a self directed IRA/RothIRA to purchase those houses within the tax advantaged accounts.  More restrictions would apply to how you manage the properties but it would keep the money (and earnings) tax protected.  Also let's you tap 401k funds for real estate investing if you were to leave your job (so you can convert the 401k to the self directed IRA).

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Re: Investing vs. Low interest debt - math?
« Reply #32 on: November 15, 2012, 10:26:17 AM »
Galt, thanks for bringing that up! I've been thinking about that and worry about accessing the funds.

If you are investing in income producing real estate inside of a tax advantaged IRA/Roth IRA, with a goal of FI/early retirement- I would figure you can't access the profits of the investment for your living expenses when you're 35.  You have to wait for retirement age or pay the penalty, right?


JohnGalt

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Re: Investing vs. Low interest debt - math?
« Reply #33 on: November 15, 2012, 01:41:58 PM »
Galt, thanks for bringing that up! I've been thinking about that and worry about accessing the funds.

If you are investing in income producing real estate inside of a tax advantaged IRA/Roth IRA, with a goal of FI/early retirement- I would figure you can't access the profits of the investment for your living expenses when you're 35.  You have to wait for retirement age or pay the penalty, right?

I can't say I'm speaking from experience by any means here - so I would definitely advise talking to a CPA or someone with similar professional experience because I think this could get complicated - but I believe you should still be able to access the profits via a roth conversion pipeline or SEPP withdrawals - so long as there was sufficient liquidity/cash flow. 

WageSlave

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Re: Investing vs. Low interest debt - math?
« Reply #34 on: November 20, 2012, 01:04:19 PM »
I'm surprised no one's posted this link yet: Bogleheads: Paying Down Loans vs Investing.

My takeaway from that article is that it's really only fair to compare a paying down mortgage to investing in guaranteed/safe-as-possible investments, i.e. insured CDs or US Treasuries.  In other words, paying down the mortgage is a no-risk way of getting a return equal to the interest rate (less write-offs of course).  And as KulshanGirl said, find me a US Treasury product or CD that pays better than a mortgage.  Furthermore, just as you have to factor in your "real" mortgage rate by including tax-writeoffs, you have to include income taxes you'll pay against investment income.

Option 1: expenses of 2k/mo and get $5-600 cash flow from larger portfolio + you get the potential of capital gains + have a bunch of money liquid
Option 2: expenses of 1500/mo. No extra cash flow. No potential gains.  No liquid money.

My comments:

Option 1:
  • Expenses of 2k/mo and get $5-600 cash flow from larger portfolio: what investment product provides these guaranteed monthly returns?  Only insured CDs/UST have this kind of guarantee.  Are you talking rental income?  REITs?  Stock dividends?  These returns are simply not as safe and certain as paying down a mortgage.  Over a long-enough time, these returns are likely as an average, but they will certainly be volatile over that long timeframe.
  • You get the potential of capital gains: you also have the potential of capital losses, depending on your investment vehicle.  This option is presumably investing in stocks, which are by definition volatile.  If you're talking about investing in rental properties, well, the capital gains potential is the same as Option 2, i.e. capital gains on your real estate.
  • Have a bunch of money liquid: what money, the extra income?  Or are you talking about the investment portfolio?  Again, if your investment is in stocks, it's only as liquid as you are comfortable with drawing on volatile assets.
Option 2:
  • Expenses of 1500/mo. No extra cash flow: what about that money that used to go to the mortgage?  Isn't that extra cash flow?
  • No potential gains: what about capital gains on the now-paid off house?  And, presumably, you'll start investing the extra cash flow that results from having lower monthly expenses.  Then you'll start seeing gains.  See this discussion.
  • No liquid money: what about a HELOC on the paid-off property?  I've seen several mentions of this PenFed 1.99% 5-year HELOC on the Bogleheads forum.
Not everybody wants to be a landlord, and even for those that do, I believe it's potential upside is very location dependant.  I'm renting out my first house, which is 150 miles away.  I have a property manager.  He charges 7% of the rent.  It's a relatively new house, so has required little maintenance, and I've been lucky to not have any vacancy periods and good tenants for the last few years.  But property taxes are killing me.  After expenses, as a function of the house's purchase price, I'm making about 4.2% before income taxes are considered.  This house is completely paid-for, so from my perspective, it's quite hands-off; the property manager does all the work.  But if I had multiple properties with loans?  That would basically be a second job for me.  I certainly don't have time for it now, and if I did have the time, I'd have mixed feelings about it anyway.

At the end of the day, to me, loans are leverage: they are like steroids for financial transactions.  If you can use the leverage to amplify gains, it's great.  But understand, you can amplify your losses just the same if things don't go as planned.  It's like SpiderMan: "with great power comes great responsibility".  I think it boils down to a matter of risk tolerance.  Are you a detail-oriented entrepreneur/meticulous researcher/business guru?  Then leverage can probably work for you.  Are you risk-adverse/wanting to keep things simple/willing to trade potential big gains for the security of no big losses?  Then pay down the mortgage.

WageSlave

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Re: Investing vs. Low interest debt - math?
« Reply #35 on: November 20, 2012, 01:31:59 PM »
Scenario 2: Buy a house each year (except year 1, when still saving, so years 2-5) to total 4 houses.  Spent 100k, equity in them is 100k. Mortgage of 75k on each, 5% interest rate.  Rent each for 1100.  Gross monthly expenses ~550, monthly payment 400.  Cash flow $150 each x 4 houses = $600.  That pays your mortgage plus gives you an extra $100/month in your pocket plus gives you the potential for four houses appreciating, rents adjust upward with inflation, and they're paying off the mortgages for you (they pay ~1100/house per year towards the principal, so you're gaining ~4500 per year in equity).

Before someone starts with the "what if they aren't rented," I added in a large margin (50% rule, 550/mo) to cover vacancies.  And that's paying someone else to manage them.  You can gain an extra ~400/mo if you manage them.   In a typical month where they are all rented and you manage them and there is no maintenance, you bring in a gross of 4400, have mortgages on those 4 for ~1600 and keep 2800/mo.  That covers your mortgage payment of 500, puts 100 in your pocket, and saves $2200/month for the vacant time times/repairs/paying for management/etc!  That $2200 surplus grows your $X portfolio until it needs to be tapped.

If these numbers are realistic for you, I'm jealous of your rental market.  :)  In your example, the mortgage payment is $400/month.  Then you say $550/month for: property tax, insurance, management commission, maintenance and vacancy contingency.  My rental's property taxes are about 3.35% of the house's purchase price.  Using this as a proxy for your example, your rental homes would have annual taxes of $3353/year or $279/month.  My rental dwelling insurance is about $500/year, I'll be generous and say you can do $252/year, so that's another $21/month, bringing you up to $300/month.  So now you're really down to $150/month for maintenance, management commission and vacancy contingency.  My property manager charges 7%, so that's $77/month out of your rent.

So now you're down to $73/month (150-77) per house in maintenance and vacancy contingency.  Personally, I'd want a bigger contingency and maintenance fund, so I'd have to give up more profit... and now we're looking at some pretty lean profits for a leveraged investment.  (Of course some of these expenses can be written off your taxes, so that would make the picture look a little better.)

But let's say you do keep $150/month per house as profit.  That's $1800/year or 1.8% profit on your leveraged investment.  Let's say you have no maintenance or vacancies and self-manage.  Now your monthly take is $150+73+77=$300, or $3600/year.  That brings you up to 3.6% returns.  But if you have a major maintenance episode or vacancies or get the tenant-from-hell... well, I hope you enjoy the role of being a landlord. :)
« Last Edit: November 20, 2012, 03:20:31 PM by matt_garman »

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #36 on: November 20, 2012, 08:48:16 PM »
Your property tax estimate is high by about 200/mo.  Mine are ~750/yr.  My total P&I payments avg around 270 monthly (Total all in cost of 25% down on purchase price + closing costs + rent ready expenses avg. ~25k per house on an 80k home).  Rent is about 1100/mo.

Rerun your numbers and lmk what you get.

My spreadsheets show expenses (inc. 8% property management) of 44.68% of my gross rent.
« Last Edit: November 20, 2012, 08:49:56 PM by arebelspy »
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Re: Investing vs. Low interest debt - math?
« Reply #37 on: November 21, 2012, 03:53:01 PM »
My takeaway from that article is that it's really only fair to compare a paying down mortgage to investing in guaranteed/safe-as-possible investments, i.e. insured CDs or US Treasuries.
I disagree. If you've got a thirty or eighty year time horizon, you shouldn't give two shits what the stock market does tomorrow; you don't need it to be risk free in the near term. You're doing the cost-benefit analysis for your two options, and your actual in-real-life investment option isn't t-bills, it's mostly stocks.

Sacadoh

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Re: Investing vs. Low interest debt - math?
« Reply #38 on: November 22, 2012, 04:06:25 AM »
So I have a flexible mortgage with the availability to drawdown another £100k at UK bank base plus 1% variable, currently 1.5%, for the next 20 years.

I am in the process of taking advantage of UK pension pot (gross of tax savings) & UK ISA (gross of tax income) allowances to transfer equity into low cost worldwide trackers. Sounds like I am on the right track?
« Last Edit: November 22, 2012, 04:49:15 AM by Sacadoh »

WageSlave

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Re: Investing vs. Low interest debt - math?
« Reply #39 on: November 22, 2012, 09:23:42 PM »
Your property tax estimate is high by about 200/mo.  Mine are ~750/yr.  My total P&I payments avg around 270 monthly (Total all in cost of 25% down on purchase price + closing costs + rent ready expenses avg. ~25k per house on an 80k home).  Rent is about 1100/mo.

Rerun your numbers and lmk what you get.

My spreadsheets show expenses (inc. 8% property management) of 44.68% of my gross rent.

My point was that the quality of rental markets are location dependent, at least in my experience.  Either that or I'm charging way too little rent (but my property manager is constantly discouraging me from raising rents).  I just looked at my numbers, and my expenses are about 70% of gross rent---and I own the house outright!

The numbers I used in my example were the same as mine, just scaled proportionally based on purchase price.  FWIW, my house cost $164k in 2004.  Gross rent is $1200/month; manager takes 7%, and property taxes alone were $5500 for 2011.  (Note that there's a tax surcharge for "non-owner occupied structure", and to add insult to injury, you have to pay $50/year just to file your house as non-owner occupied.)  Add in random maintenance and an $800 range/oven I had to buy this year and the profits are pretty slim even without a mortgage.


WageSlave

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Re: Investing vs. Low interest debt - math?
« Reply #40 on: November 22, 2012, 10:25:20 PM »
My takeaway from that article is that it's really only fair to compare a paying down mortgage to investing in guaranteed/safe-as-possible investments, i.e. insured CDs or US Treasuries.
I disagree. If you've got a thirty or eighty year time horizon, you shouldn't give two shits what the stock market does tomorrow; you don't need it to be risk free in the near term. You're doing the cost-benefit analysis for your two options, and your actual in-real-life investment option isn't t-bills, it's mostly stocks.

It depends on your goals.  Yes, I agree, that in most cases, for investors with a 30+ year horizon, stocks are probably the best bet.  How much risk you're willing to accept in the near-term is basically a matter of personal preference.  But say you are dependent on a consistent, regular cash flow over that 30-year period: that is the definition of a fixed-income product, and stocks simply won't do.  Yes, in most long-term scenarios, stocks outperform fixed-income products, but that performance has always come with volatility.  And if you're the person who (for whatever reason) would be ruined by an inevitable equity "rough patch", then you need some kind of cushion (such as fixed-income products or a job or whatever).

Stocks-to-bonds is an apples-to-oranges comparison.  A mortgage is basically a reverse bond, so comparing stocks to an early mortgage payoff is also an apples-to-oranges comparison.  That's not to say that it's an irrelevant discussion; but I think it's more of a case-by-case/personal circumstances discussion.

I recently ran across John Norstad's "Risk and Time" article.  He argues against the conventional "fact" that stocks held for a sufficiently long time are safe.

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #41 on: November 23, 2012, 08:16:03 AM »
My point was that the quality of rental markets are location dependent, at least in my experience.  Either that or I'm charging way too little rent (but my property manager is constantly discouraging me from raising rents).  I just looked at my numbers, and my expenses are about 70% of gross rent---and I own the house outright!

Absolutely agree it's location dependent.  If you're buying a rental property, choose a good location.  ;)

The amount of rent you charge should be what the market can bear; assuming your property manager is competent, taking his advice on this is probably wise

Owning the house outright or not is irrelevant, as debt service is separate from operating expenses.

Your 70% is definitely quite high.  Long term average is 50% (thus the name 50% rule) based on various studies done.

Is your house older (in need of more repairs), or what?  Is that based on a long term average, or are you only calculating that 70% based on this one year with the oven replacement?

The numbers I used in my example were the same as mine, just scaled proportionally based on purchase price.  FWIW, my house cost $164k in 2004.  Gross rent is $1200/month; manager takes 7%, and property taxes alone were $5500 for 2011.  (Note that there's a tax surcharge for "non-owner occupied structure", and to add insult to injury, you have to pay $50/year just to file your house as non-owner occupied.)  Add in random maintenance and an $800 range/oven I had to buy this year and the profits are pretty slim even without a mortgage.

Yes, 1200 rent for a 164k property (though you don't say what it's worth now, which is far more relevant than what it was purchased for 8 years ago) is not good.  And 5500 property taxes makes it even more so.  Definitely not worth buying as a rental property.

I understand that it was your primary home, so you didn't have much of a choice, but then it's not right to use it as an "example" when discussing why rental property might not be a good idea.  I'd assume any person looking to purchase a rental would pass on that deal quite quickly.  You may want to look into selling and investing the equity elsewhere.  You should easily be able to get 2k+ rent for your equity in it.

//EDIT: Just went and looked up my numbers and typical numbers more.

It's definitely your taxes that kill you.

1200/mo rent = 14400.  5500 taxes is 38% of your gross rent to property taxes.

My taxes average about 800/yr, gross rent 1050x12 = 12600 = 6.3% of my gross rent.

If you're averaging 70% expenses paying 32% more of your gross to property taxes, you're actually closer to a 40% (not counting the extra you pay to taxes) expense rate (though my taxes are probably lower than typical, so you're probably at more like a 45-50% expense ratio if your taxes were "typical", which is very in line with typical long term numbers).

Interesting that those high taxes didn't deflate the property value enough to make it cheaper.  Typically people buy based on what their payment will be (PITI) which means any of those numbers go higher (like taxes, or interest rates) the purchase price has to drop accordingly to afford it.  An investor would be working those taxes into his numbers and be paying much less on that property.

//END EDIT.

Regardless, it doesn't detract at all from the original conversation of investing versus paying off low interest debt.  Buying a rental at today's current low prices and low interest rates should be compared with real rental numbers, not "I became an accidental landlord of a property that doesn't cash flow due to ridiculous taxes so it sucks" numbers.  ;)

It depends on your goals.  Yes, I agree, that in most cases, for investors with a 30+ year horizon, stocks are probably the best bet.  How much risk you're willing to accept in the near-term is basically a matter of personal preference.  But say you are dependent on a consistent, regular cash flow over that 30-year period: that is the definition of a fixed-income product, and stocks simply won't do. 

(Emphasis mine.)

I disagree.  If you have 33x your annual expenses (for a 3% SWR), I feel you can be dependent on that cash flow, more or less, and be pretty good. That cash flow would come from once/yr. rebalancing / tax loss harvesting / selling, or dividends (or rental income).  Stocks would be one of the actual ways that would work over a long time frame like that, where fixed-income would have its lunch eaten by inflation. 

One might say "I'm 30 and retiring in 5 years, I need to have safer money that can be accessed in 5 years" - but really, as grant says, their time horizon is the rest of their life, not the 5 or 10 years from now they will be accessing it.  You're looking at a failure over that time period, and making sure you don't hit 0 at any point in there. See: FIRECalc.
« Last Edit: November 23, 2012, 09:11:50 AM by arebelspy »
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WageSlave

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Re: Investing vs. Low interest debt - math?
« Reply #42 on: November 23, 2012, 11:15:39 AM »
Is your house older (in need of more repairs), or what?  Is that based on a long term average, or are you only calculating that 70% based on this one year with the oven replacement?

That 70% came from a quick look at this year's net versus gross income.  I'm also in the process of appealing my taxes, and the guy doing this for me thinks he can knock a whole $1k/year off the tax bill, which would definitely help.

The house itself is fairly new; built in 2000.  The "guts" are solid, but some of the finishings are cheap.  I knew as much when I bought it.  The seller did this deliberately, as he put all his money into the foundation/frame/location/roof, and then didn't have any money left for trim/aesthetics.  He originally planned to be in the house long-term, and upgrade such things over time.  But then he got married and his wife wanted "their" house, not "his" house.  The guy was a lot like me, and it was clear he loved that house.  His thought process for how he intended to make it nicer over time made a lot of sense to me, and when I bought it, I intended to pick up where he left off.

When I was there I replaced most of the main-floor el-cheapo carpeting with nice wood, but the remaining rooms will definitely need new carpeting sooner or later.  And next year I'm already on the hook to nearly re-build the deck. 

Quote from: arebelspy
Yes, 1200 rent for a 164k property (though you don't say what it's worth now, which is far more relevant than what it was purchased for 8 years ago) is not good.  And 5500 property taxes makes it even more so.  Definitely not worth buying as a rental property.

I understand that it was your primary home, so you didn't have much of a choice, but then it's not right to use it as an "example" when discussing why rental property might not be a good idea.  I'd assume any person looking to purchase a rental would pass on that deal quite quickly.  You may want to look into selling and investing the equity elsewhere.  You should easily be able to get 2k+ rent for your equity in it.

I have no idea what it's worth now; Zillow thinks $160.  :(  But yeah, you are absolutely right: my experience as an accidental landlord isn't terribly relevant to a deliberate landlord.  Apples-to-oranges.

Quote from: arebelspy
Interesting that those high taxes didn't deflate the property value enough to make it cheaper.  Typically people buy based on what their payment will be (PITI) which means any of those numbers go higher (like taxes, or interest rates) the purchase price has to drop accordingly to afford it.  An investor would be working those taxes into his numbers and be paying much less on that property.

The taxes were reasonable back when I bought the place.  They've been going up ever since.  The most recent increase was the most dramatic.  Looking at other peoples' tax history in nearby homes, looks like most people got a big reduction around 2008.  I can only assume those people were smarter than me and appealed near the bottom of the crash.  So I'm definitely playing catch-up, and have probably been overpaying for the last few years.  (In hindsight, all the more reason why I may not be the best example of a landlord.)

Quote from: arebelspy
I disagree.  If you have 33x your annual expenses (for a 3% SWR), I feel you can be dependent on that cash flow, more or less, and be pretty good. That cash flow would come from once/yr. rebalancing / tax loss harvesting / selling, or dividends (or rental income).  Stocks would be one of the actual ways that would work over a long time frame like that, where fixed-income would have its lunch eaten by inflation.

I agree... it just seems that there's a caveat in there, that your investment portfolio (the 33x or whatever you want) has to be that much bigger if you're going to use it to pay a mortgage.  And you're still assuming that the returns of that investment portfolio will be greater than the mortgage interest rate.

CptMrPants

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Re: Investing vs. Low interest debt - math?
« Reply #43 on: November 26, 2012, 09:16:17 AM »

It depends on your goals.  Yes, I agree, that in most cases, for investors with a 30+ year horizon, stocks are probably the best bet.  How much risk you're willing to accept in the near-term is basically a matter of personal preference.  But say you are dependent on a consistent, regular cash flow over that 30-year period: that is the definition of a fixed-income product, and stocks simply won't do. 

(Emphasis mine.)

I disagree.  If you have 33x your annual expenses (for a 3% SWR), I feel you can be dependent on that cash flow, more or less, and be pretty good. That cash flow would come from once/yr. rebalancing / tax loss harvesting / selling, or dividends (or rental income).  Stocks would be one of the actual ways that would work over a long time frame like that, where fixed-income would have its lunch eaten by inflation. 

One might say "I'm 30 and retiring in 5 years, I need to have safer money that can be accessed in 5 years" - but really, as grant says, their time horizon is the rest of their life, not the 5 or 10 years from now they will be accessing it.  You're looking at a failure over that time period, and making sure you don't hit 0 at any point in there. See: FIRECalc.
[/quote]

Rebel,

What are your thoughts on a safe withdrawal rate for someone who is rental heavy?  Can they afford to live off 100% of what the rental properties throw off (after expenses/taxes/insurance/etc...)?  It seems like it's possible- So long as you have a nice rental emergency fund-  inflation can be dealt with through appreciation of property value and increased rent. 

I get a little confused at the SWR/33X rules when you are leveraging with rentals...

JohnGalt

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Re: Investing vs. Low interest debt - math?
« Reply #44 on: November 26, 2012, 09:25:08 AM »
I get a little confused at the SWR/33X rules when you are leveraging with rentals...

It would probably be appropriate to use a different number than 3% if you are heavy on the rentals.  3% comes from historical stock performance.  Rentals are a different animal - especially if they involve leverage and your time managing them.  The problem is - what number do you then use?  It's easy to use total stock market returns as you can actually invest in the total stock market.  It's not so easy to look at rental return history as your specific properties will vary greatly from any data available.  My thought is that 3% will be pretty conservative for someone who is heavily involved with their rentals and leveraged - but then, that type of investor shouldn't need a broad rule of thumb like the 3% rule to know if their investments can support them. 

Another Reader

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Re: Investing vs. Low interest debt - math?
« Reply #45 on: November 26, 2012, 10:12:00 AM »
If you have a lot of rentals, the question is, what percent of what value?  The equity?  The properties?  If the properties are leveraged and everything else is static, your equity should increase as your tenants pay down your mortgages.  You may pay off some or all of the mortgages at some point.  If market conditions warrant it, you may refinance one or more properties to buy more.  Percentages will decrease and increase over time.

Since I do not favor decumulation for income, I simply look at my stabilized net income from the real estate.  As long as I have reserves to cover capital improvements, I really don't worry about percentages.  If my income changes dramatically or the real estate market changes, I will make changes in my holdings or leverage.  Firecalc, which relies on historical returns of the stock market, is not necessary or even useful to someone heavily invested in real estate.

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #46 on: November 26, 2012, 05:27:58 PM »
I agree with Another Reader.

The traditional SWR is based on a mix of stocks/bonds.

Real estate investors can use their actual returns and projections.  Keep a nice buffer of reserves for Murphy's Law and add to it monthly and you'll be fine.

I try to be conservative in my projections, but I'm anticipating a "SWR" of at least 7% (possibly as high as 10%) based on equity.  So yeah, typical SWR rules of thumb go out the window a little when talking about real estate.

And yes, rents and property values rising with inflation (or - more accurately - wages) help make rentals more like a COLA'd annuity (that requires management) than a passive stock/bond mix.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
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Another Reader

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Re: Investing vs. Low interest debt - math?
« Reply #47 on: November 26, 2012, 07:24:35 PM »
Don't forget the tax shelter real estate income affords you.  While the person with a paid off house and a large paper portfolio they are decumulating is paying an unpleasantly large tax bill, those of us who get to deduct depreciation and other business expenses are generally pretty happy come April 15.

arebelspy

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Re: Investing vs. Low interest debt - math?
« Reply #48 on: November 26, 2012, 09:12:35 PM »
e
Don't forget the tax shelter real estate income affords you.  While the person with a paid off house and a large paper portfolio they are decumulating is paying an unpleasantly large tax bill, those of us who get to deduct depreciation and other business expenses are generally pretty happy come April 15.

My rental profit more than covers the depreciation on my properties, so I'm still quite in the positive in terms of owing taxes.  Still, doesn't hurt to save at least a little bit of it.  And I'd rather owe taxes due to profit than not owe due to no profit.  ;)
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (occasionally) blog at AdventuringAlong.com.
You can also read my forum "Journal."