Author Topic: Vanguard Recommendations for a ca. 10 year mortgage pay-off account  (Read 5259 times)

justajane

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My apologies if this has been covered before (I did multiple searches and couldn't find anything), but my husband received a pretty good bonus/raise this year, and we currently have 40K or so sitting in a checking account, plus another 5-10K in various online accounts. We want to hold at least 30K of it for an emergency fund and the beginnings of a basement remodel we expect to do in the next 2-3 years. I just maxed out my Roth, and he increased his retirement contributions by a percentage point. This is all pretty modest by MMM standards, but this is mostly informed by the fact that he has no intention to RE.

With the remaining excess we would like to open our first non-retirement investment account, probably with Vanguard where I have my Roth (VTSAX and VGSTX). We would start with at least 10K (to qualify for Admiral Shares), and our hypothetical intention for the account would be a lump sum mortgage payoff in ca. 10 years. We want to time all this right, in order to end the mortgage directly before our oldest son goes to college. This will increase our cash flow, as well as position us better for the FAFSA. Of course we could start pre-paying our mortgage (currently ca. 110K at 4.25%), but we want this account as a hedge against job loss.

With this mind, what funds do you all suggest? I filled out the Vanguard questionnaire, and they suggested the LifeStrategy Conservative Growth Fund. We're pretty firm on the 10 year withdrawal, if not earlier, depending on if we could actually pay it off in full. I know this is a personal risk assessment question, but is a 60/40 bond/stock usually the preferred allocation for this scenario? And will that beat or at least equal the 4.25% interest rate (crystal ball notwithstanding)?

Or should I be looking at this all differently? I just don't want to lock money into the house until we are much closer to paying it off in full. Any help would be greatly appreciated. We are new to all this investment stuff. We spent our twenties not saving much outside of the match, our thirties having babies and spending a lot of money remodeling our home (and still doing so), and intend to spend our 40s building up our wealth in anticipation of college (3x) and eventually retirement.


Wolf359

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #1 on: February 22, 2015, 06:16:33 PM »
We're in a similar situation to you, minus the bonus.  (congrats!)  We actually started down the pre-payment path, until I did the math and figured out that I could potentially get better investment returns in stocks.  My kids will also be in college in about 10 years. 

My risk profile is a little more aggressive than yours.  I decided to do 80/20 stocks/bonds.  Our plan is to aggressively save towards retirement, building our taxable savings.  These funds are used jointly as a hedge against job loss, the basis for paying off the mortgage, helping to pay for college, and conversion to retirement savings.  The timeframe of some of the objectives is greater than 10 years. 

The way I see it, if the mortgage doesn't get paid off, the additional funds saved over 10 years (to that point) will pay for the mortgage while income is diverted to tuition.  It's just a big emergency fund at that time.  Once the tuition expenses are gone, most of the savings should still be intact.  The idea is that the taxable savings provides a buffer and options.  An investment fund will grow faster than the 4.25% return on the mortgage loan.  And if the investments do well enough, you still have the option to pay off the mortgage if you still want to.

justajane

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #2 on: February 22, 2015, 06:50:47 PM »
Thanks, Wolf. Glad to know others have the same thought process as I do. I'm not risk averse per se. My only concern was that my timeline is pretty firm, so if the market is down at that time and most of the money is in stocks....I just don't want to feel like I "lost" money.

Have you thought about situating your assets best for the FAFSA form? That's what we're attempting to do. If my husband continues on his current trajectory, we probably wouldn't qualify for grants anyway, but I don't want money that could have been put in the mortgage to keep us from any funding or advantageous loans for the kiddos (we expect them to at least pay part of their education via cash or loans), especially since being mortgage free would enable us to free up so much income to pay for tuition.

It's hard, because part of me just wants to write a 10K check to the bank to bring the number down considerably. It's immediate gratification. But I don't like locking the money up.

rpr

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #3 on: February 22, 2015, 07:38:18 PM »
justajane--

It isn't clear to me if you are contributing the maximum to your retirement accounts. I would think that this money would be sheltered from FAFSA calculations.

Though I guess if this is more of a hedge against job loss, then you should try to quantify how much you would need in this account.  You already have an emergency fund. Maybe the size of that should be larger than the 30k that you currently have in it. 


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justajane

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #4 on: February 22, 2015, 08:06:04 PM »
justajane--

It isn't clear to me if you are contributing the maximum to your retirement accounts. I would think that this money would be sheltered from FAFSA calculations.

Though I guess if this is more of a hedge against job loss, then you should try to quantify how much you would need in this account.  You already have an emergency fund. Maybe the size of that should be larger than the 30k that you currently have in it. 


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Hi rpr. Thanks for replying. No, we are not maxing out our retirement accounts. My husband puts 7% in his 401K (ca. 7K + 6K match), and we have been contributing sporadically to my Roth but are now committed to maxing it out. We eventually plan to open a second Roth in his name and max that out, as that is our primary savings vehicle for college. We also have a 529 with around 5K in it and ca. 6K in an HSA.

He is 40 and has 200K in his 401K and a small pension. I have 15K in the Roth.

I know it's MMM heresy not to max out the 401K. You're also right that the emergency fund is possibly not large enough. One reason we don't have a larger one is that the severance package at my husband's institution would likely be one year. Unless the rules change, it's one month for each year at the company, and my husband has been there 12+ years. 

Edited to add that one reason we have been hesitant to max out the 401K is that we want that money accessible for college tuition, but I guess we need to put on our own oxygen mask first, right?
« Last Edit: February 22, 2015, 08:09:27 PM by justajane »

rpr

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #5 on: February 22, 2015, 08:28:31 PM »
At this age, you are doing good. If your marginal tax bracket is high currently, then you are usually better off investing in 401k etc.


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GGNoob

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #6 on: February 23, 2015, 08:37:44 AM »
Edited to add that one reason we have been hesitant to max out the 401K is that we want that money accessible for college tuition, but I guess we need to put on our own oxygen mask first, right?

Yes, focus on your own retirement before helping your kids with college. Bring them up right with money and they will be fine, even if they need to take out large loans.

In your case, I would make sure you have the safety net that you need, and then max Roth IRAs for both of you and up the 401k as much as you can. Keep in mind that you can always withdraw the contributions to the Roth IRA, penalty free.

Personally, I wouldn't pay a penny extra to the mortgage, ever.

Wolf359

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #7 on: February 23, 2015, 05:18:25 PM »
Thanks, Wolf. Glad to know others have the same thought process as I do. I'm not risk averse per se. My only concern was that my timeline is pretty firm, so if the market is down at that time and most of the money is in stocks....I just don't want to feel like I "lost" money.

Have you thought about situating your assets best for the FAFSA form? That's what we're attempting to do. If my husband continues on his current trajectory, we probably wouldn't qualify for grants anyway, but I don't want money that could have been put in the mortgage to keep us from any funding or advantageous loans for the kiddos (we expect them to at least pay part of their education via cash or loans), especially since being mortgage free would enable us to free up so much income to pay for tuition.

It's hard, because part of me just wants to write a 10K check to the bank to bring the number down considerably. It's immediate gratification. But I don't like locking the money up.

I really want to pay off my mortgage as well, but I did the math and calculated that the potential return over the time left was outweighed by potential gains in the market over the same timeframe.  I'm now playing it by ear as to whether or not I actually pay off the house in ten years.  If the market is up, I may still do it.  If the market is down, I would just use it to supplement my income (and not make the whole amount disappear into the house.)  The reason for this is that within a few years after your youngest finishes college, you will be about to retire (or within about 5 years of it.)  If the taxable account is big enough, it may allow you the option of retiring early, or at least pushing off the day when you tap the tax advantaged accounts (letting them compound longer.)

I'd echo some of the other comments, and fully fund your retirement accounts first.  Time works for you.  Maximize tax advantaged accounts while you can.

No, I'm not preparing to resituate my assets this early for the FAFSA.  I'm not anticipating that we're going to qualify for grants or even subsidized loans. I'll revisit when it gets closer, but I'm planning for having to pay for everything ourselves.  (So far, we're on track for that.)  If the kids end up going to Harvard, then we may have to get assistance.  But if they get into one of our best state schools, we have them fully covered already.

BaldingStoic

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #8 on: February 23, 2015, 05:26:22 PM »
I recommend a different approach.  First and foremost, Max out the retirement accounts!!!  The tax savings for the 401K is a huge incentive so make this the top priority, followed by maxing out Roth accounts.  Once this is done, if you have extra left over, start paying down your mortgage principle now!  I'm a pretty aggressive investor (90% stock / 10% bond) but in my view it doesn't make sense to invest in a risky taxable account to payoff your mortgage, instead paying down your mortgage now offers an instant return and zero risk.   

rpr

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #9 on: February 23, 2015, 09:33:28 PM »
I recommend a different approach.  First and foremost, Max out the retirement accounts!!!  The tax savings for the 401K is a huge incentive so make this the top priority, followed by maxing out Roth accounts.  Once this is done, if you have extra left over, start paying down your mortgage principle now!  I'm a pretty aggressive investor (90% stock / 10% bond) but in my view it doesn't make sense to invest in a risky taxable account to payoff your mortgage, instead paying down your mortgage now offers an instant return and zero risk.   

For quite a while, I assumed that it is much better to save in taxable than prepay the mortgage. I finally decided to do the calculations for myself. It is an obvious fact that this is a strong function of the interest rate. Here is a hypothetical situation:

Principal $100000
Interest rate  4%
Duration 30 years
Monthly payment $477.42.

Let's assume that you have an extra $100. If you were to use this to prepay then the loan will be paid of in 21.6 years.

If the extra $100 were instead invested over 21.6 years in a taxable account, then these would be the excess after paying off the mortgage at the various interest rates:

Interest rateExcess in taxable
5%$5394
6%$11704
7%$19078
8%$27711
9%$37838
10%$49737
11%$63741
12%$80248

Whether the amounts are significant or not is up to you. I have ignored taxes. 

Heckler

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #10 on: February 24, 2015, 08:51:52 AM »
I recommend a different approach.  First and foremost, Max out the retirement accounts!!!  The tax savings for the 401K is a huge incentive so make this the top priority, followed by maxing out Roth accounts.  Once this is done, if you have extra left over, start paying down your mortgage principle now!  I'm a pretty aggressive investor (90% stock / 10% bond) but in my view it doesn't make sense to invest in a risky taxable account to payoff your mortgage, instead paying down your mortgage now offers an instant return and zero risk.   


In addition, a paid off mortgage is the best insurance against job loss IMO.  It sounds like justajane is a mirror of my situation (200k retirement savings at 40) but we are just 12 months from not needing a 100k job to survive.   Once the mortgage is paid off, our 20% savings rate will jump up to 60-70%.

GGNoob

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #11 on: February 24, 2015, 09:32:57 AM »
I recommend a different approach.  First and foremost, Max out the retirement accounts!!!  The tax savings for the 401K is a huge incentive so make this the top priority, followed by maxing out Roth accounts.  Once this is done, if you have extra left over, start paying down your mortgage principle now!  I'm a pretty aggressive investor (90% stock / 10% bond) but in my view it doesn't make sense to invest in a risky taxable account to payoff your mortgage, instead paying down your mortgage now offers an instant return and zero risk.   


In addition, a paid off mortgage is the best insurance against job loss IMO.  It sounds like justajane is a mirror of my situation (200k retirement savings at 40) but we are just 12 months from not needing a 100k job to survive.   Once the mortgage is paid off, our 20% savings rate will jump up to 60-70%.

Personally, I think $100k in a taxable investment account will get me a lot farther than having $0 in that same account but having my $100k mortgage paid off.

But its really up to the OP on what they want to do.

Wolf359

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #12 on: February 24, 2015, 09:56:41 AM »
I recommend a different approach.  First and foremost, Max out the retirement accounts!!!  The tax savings for the 401K is a huge incentive so make this the top priority, followed by maxing out Roth accounts.  Once this is done, if you have extra left over, start paying down your mortgage principle now!  I'm a pretty aggressive investor (90% stock / 10% bond) but in my view it doesn't make sense to invest in a risky taxable account to payoff your mortgage, instead paying down your mortgage now offers an instant return and zero risk.   


In addition, a paid off mortgage is the best insurance against job loss IMO.  It sounds like justajane is a mirror of my situation (200k retirement savings at 40) but we are just 12 months from not needing a 100k job to survive.   Once the mortgage is paid off, our 20% savings rate will jump up to 60-70%.

Is your mortgage half your income right now?  (70-20=50%)?  That's pretty high.  That by itself is an argument for prepaying it.

On the other hand, if your mortgage is low or at least reasonable relative to your income, then building cash reserves is a better job-loss hedge than a pre-paid mortgage.  You can't eat a paid-off house.  You can buy groceries with cash reserves.  Stretching your hang time (the amount of time you can be between jobs) is easier to achieve by building up reserves.  It doesn't take as much money as paying off the mortgage.

By cash reserves, I don't mean actual cash.  I mean investments in a taxable liquid account I can tap without penalty if things get dire enough.  If I need cash, it only takes a couple of days to transfer funds back into my checking account from a mutual fund.  How long does it take to get it out of a house?  Another mortgage, or selling the house?

justajane

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #13 on: February 24, 2015, 10:03:31 AM »
Thanks for the replies, everyone! You've all given me and my husband a lot to think about. We had a good discussion, and for now, we've decided to postpone our remodeling project at least another year, in order to be sure we have our financial house in order.

The argument to stretch ourselves on retirement savings now that we are still young(ish) is a compelling argument. In 12 years, when our first goes to college, we can possibly dial back a bit to contribute to their education.

My husband works in finance, and for that reason, I do always concern myself with layoffs. They hadn't had a round of them for a long time, but just last month they laid off over 200 people! No one could discern any actual reason, and while I am confident in my husband's performance (he got a 6% raise and a 26% bonus), such events can certainly make one feel a little disconcerted.

This thread definitely brings up the differing viewpoints on a mortgage. Prepayment is satisfying in its immediacy and guaranteed return. But my biggest fear is that, in the event of extended job loss, we might have to sell to unlock the ca. 100+K equity we have in the house. If that happened, I would be kicking myself for prepaying. For that reason, I think we will likely open a taxable investment account, probably the VBIAX, and automate about $150 a month deposit (or more?) into this. Based on my cursory reading, it appears to do pretty well in a bull market, and in a bad market still returns slightly over our interest rate. Like Wolf, I will consider this my emergency mortgage account. Even starting with the 10K to open it, that could float us for 10 months of mortgage payments in the future.

Other than that, we will probably max the Roths first and then work on increasing the 401K contribution. This will still leave us with around 35K in liquid cash.

For those of you who recommended either the Roth or the 401K first, do you mind sharing your reasons?   

rpr

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #14 on: February 24, 2015, 12:40:54 PM »

This thread definitely brings up the differing viewpoints on a mortgage. Prepayment is satisfying in its immediacy and guaranteed return. But my biggest fear is that, in the event of extended job loss, we might have to sell to unlock the ca. 100+K equity we have in the house. If that happened, I would be kicking myself for prepaying.


Exactly. The benefits of lower monthly expenses by prepaying a mortgage are fully realized only when the loan is completely paid off. What happens if you are aggressively pre-paying your mortgage without building up a buffer in savings and then lose your job a year or two before the mortgage is fully paid off. Now you still have the mortgage payment and an almost fully paid off house but no cash cushion to tide you through this period of unemployment. Furthermore, you can't now remortgage your house since you don't have a job. For this reason, I hope to aggressively build up a taxable account for prepaying my mortgage.  Only if and when the balance exceeds in this taxable account exceeds the mortgage balance, I will consider paying off the mortgage. Yes, I know that the return from the market is not guaranteed and that prepaying the mortgage is a guaranteed rate of return.

Heckler

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #15 on: February 24, 2015, 01:53:46 PM »

Is your mortgage half your income right now?  (70-20=50%)?  That's pretty high.  That by itself is an argument for prepaying it.

Mint has it (plus condo fees) at 58%-61% of our spending per month, but that doesn't include 30% off the top RRSP investments I save off my paycheck.  Net income fluctuates fairly close to zero. 

Welcome to Vancouver, the second best place in the world to be house poor. 

I've been laid off twice in 14  years, and my wife just got laid off, but she's already had two companies approach her with potential offers.   Having it paid off will be a great weight off our shoulders, regardless of how much better it could have/would have/should have done with investments instead.

Since we've increased voluntarily our payments to burn a 20 year mortgage in 13 years, if I also got laid off today, we would revert back to our minimum mortgage payments and extend it's life until we both were working again.
« Last Edit: February 24, 2015, 02:06:13 PM by Heckler »

rpr

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #16 on: February 24, 2015, 02:31:44 PM »
Heckler-- does the 58-61% include extra payments. How much is the minimum payment?


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Heckler

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Re: Vanguard Recommendations for a ca. 10 year mortgage pay-off account
« Reply #17 on: February 24, 2015, 03:56:58 PM »
oh, it includes extra payments alright, but I don't know what they are, as it was all the wife's doing to kill our mortgage.  Just kept increasing it every year, biweekly payments.