Photo (cc) by AlicePopkorn
Here’s a question from a reader who definitely has it together better than I did at his age.
Read one of your articles today and loved it. The Ten Commandments of Being Financially Fit (or something like that). (Editor’s note: It was probably The 10 Commandments of Wealth and Happiness.)
Every day I work on being more financially fit, and I’m doing OK.
I’m 29 years old, recently married, I own a home, I have a full-time job, my wife also works full-time. I have ALWAYS been a saver. Since I started mowing lawns at 9 years old, I’ve been happy to stick money in the bank and to play around with investments (as a kid, I just bought mutual funds that my grandfather also had).
So, here’s where I stand today:
I have a mortgage on my house (I bought in 2008 with the first-time home buyers credit) that I could pay off completely by cashing out most of the money I have in the stock market. My home interest loan is 5.825%. If I bought the house outright, I’d still have about a $40,000 nest egg in the stock market. Without a mortgage to pay, I could boost my monthly savings to about $1200/month.
What I can’t get any one to tell me intelligently is — IS IT SMART TO BE COMPLETELY DEBT FREE? As in, pay off the house? Instead of having $150,000 in debt and $190,000 in the stock market, I’d have zero debt and 40,000 in the stock market.
The simple answer I get from money managers is, “keep the debt, we’ll get you a larger return on investment in the stock market.” I’m not convinced.
In the last few years, my returns have been pretty flat, and frankly, I feel like I have tons of earning power left — I mean, I’m only 29! So, I could be saving with no debt for the next twenty years, and have ZERO pressure because I wouldn’t have any debt hanging over my head.
Anyway — what would Stacy do?
As it happens, Grant, I’m in the same position you are – no debt other than a mortgage, and money enough in savings to pay it off. So rather than tell you what I would do, I can tell you what I’m actually doing.
I pay a little extra on my mortgage every month, but essentially I’m keeping money in savings – both money market and stocks – and not paying off my mortgage.
Why do I do this? Here’s what I wrote in the “Ask Stacy” column from last year in answer to a similar question:
Reasons I’m keeping money around rather than retiring debt
- I might need it. As I mentioned in another recent post (Ask Stacy: Why Aren’t You Buying Stocks?), I think real estate is a bargain right now and I might want to buy more. I also like to have some cash around in case I see other investment opportunities – that’s how I was able to invest in stocks near the bottom of the market a couple of years ago, and it’s possible that I may want to buy more. (See my personal portfolio.)
- The interest on my debt is tax-deductible. Tax-deductible interest lowers the effective rate I’m paying. For example, my mortgage interest rate is 4.75 percent, and I’m in a 30 percent tax bracket. This effectively reduces my after-tax interest by 30 percent: So rather than paying 4.75 percent, I’m actually paying 3.325 percent. However, that’s still a lot more than I’m earning on my money market account – which leads us to the real reason I’m keeping so much cash…
- It feels good. The truth is that when you live a frugal life for decades and finally wake up one day to find yourself sitting on a fat bank account, it’s a very, very nice feeling. Sure, the math commands you drain that bank account and satisfy those remaining debts, but you don’t care. It’s like having tons of food in the freezer, or having your files organized, or your laundry done, or your house clean. Feeling safe, secure, and flexible is good. I’d recommend it to anyone.
When it comes to money, we like to pretend the answers are all objective. It certainly makes life easy for advice-givers like me: If you’re earning X and paying Y, do Z. But let’s be real. The answers to many questions about money involve more than math. Keeping money in a low-return savings account while paying higher interest on a debt comes at a cost. But it also gives you peace of mind. And that’s something that’s hard to put a price tag on.
Bottom line? Do the math – but then do what feels good.
Now, back to Grant’s question: IS IT SMART TO BE COMPLETELY DEBT FREE? Answer? Absolutely. And that’s especially true when the money you’re earning is less than the interest you’re paying. So if Grant is paying 5.825 percent on his mortgage and earning less than that on his investments, the math suggests using the investments to retire the debt.
But it’s also smart to do something less objectively measurable: Keep money around to seize potential opportunities, or just because it feels good.
How about a combo approach?
Rather than all or nothing, Grant could choose to use some of his savings to retire part of his mortgage while refinancing to a lower rate.
He’s paying 5.825 percent – call it 6 percent. Right now he could lock in 3.5 percent on a 15-year loan (see our mortgage search), which would save a ton of interest. So he could take $50,000 of his savings and refinance into a new $100,000, 15-year, 3.5 percent mortgage. Then he’d have a smaller mortgage, be paying as little as 2.5 percent after-tax interest on that mortgage, and still have $140,000 in stocks.
Whether that makes sense depends on how much it costs to refinance and how long he’s going to stay in his house. (See Should I Refinance My Home?)
Although Grant doesn’t say, we’re hoping he also has money that isn’t in the stock market. If his entire savings are in stocks, he’s definitely taking too much risk. He should have no more than 70 percent of his long-term savings in risk-based investments.
The bottom line
Grant is in the catbird seat. Because of his age, his proclivity to save, and the small amount he has in debt, his biggest risk is that the stock market tanks. While that would reduce his savings and probably result in some stress, as he points out, he’s only 29 and has plenty of earning years left.
My advice? Reduce the mortgage, refinance to a lower rate, make sure you don’t have too much exposure to the stock market, and pat yourself on the back. Grant, you should be writing blogs about what to do, not reading them.