Help me decide if I should Invest or Payoff Loans?

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line1260skr
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Help me decide if I should Invest or Payoff Loans?

Postby line1260skr » Wed Jan 11, 2017 7:27 am

Hello Everyone,

I am looking for a little direction in making my next financial decision and was hoping I might be able to obtain a little input here before I make any moves... Basically, I have an excess of cash from savings and a recent cash-out home mortgage refinance and I can’t decide if it would be more prudent to pay off the remaining short-term loans, invest the excess cash in my Roth IRA, or possibly a combination both.

I have been planning to invest in Vanguard index funds starting with the Total Stock Market fund. However, I am hesitant to pull the trigger on the $3K minimum with the Vanguard index funds after having seen the stock market sky rocket in the last couple months. I wanted to get started in November but did not get my previous employers 401k rolled over to Vanguard Roth IRA or received the refinance check until the end of December when the market had already risen pretty substantially. I realize you shouldn’t give in to the temptation of timing the market.. but when starting out and needing to meet the minimum investment, and possibly investing much more in a lump sum, I feel like it is a little harder to look the other way… no?

Anyways, below is what my financial situation looks like. I’d really appreciate some input on if people think I should pay off the loans, invest the money, a combination of both, or maybe wait a couple months for the market to rebound a little bit...

Personal:
  • Age: 28 Years Old
  • Income: $50-55k / yr
  • Other: No Kids / Not Married

Assets:
  • $251,000 - Home (Appraised Value as of November 2016)
  • $40,000 - Bank Checking Account
  • $12,000 - Current Employer Traditional 401k Account (Stopped contributing in 2017 as employer match is only 2% and fee's much higher than just funding my own Roth IRA..)
  • $3,000 - Roth IRA / Money Market Account at Vanguard

Liabilities:
  • $160,000 Home Loan (25 Years @ 3.50% Fixed / First Payment is Feb 2017)
  • $16,000 Auto Loan on 2013 Volvo S60 T5 (5 Years Remaining @ 3.59% Fixed)
  • $3,500 Student Loan (4.25 Years Remaining @ 6.55% Fixed)

Thanks Guys,

Brian (Investment Newbie!)

Jack FFR1846
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Re: Help me decide if I should Invest or Payoff Loans?

Postby Jack FFR1846 » Wed Jan 11, 2017 9:17 am

I have a few questions. You say your employer's match is *only* 2%. What do you have to put in to get that 2%? If it's a 1 to 1 match, for example, where you put in 2% and they put in 2%, the fees could be 5% and you'd still be way ahead to contribute that 2%. Please also understand that many people assume that all 401k's have employer matches. In my employment, that has not been the case and I've had zero match many times. Do you plan to be with this employer forever? If yes, then sure.....fees are important. If no, who cares what the fees are. Get money in so it can later be rolled out.

Your student loan is very high interest and non-dischargable in the case of bankruptcy, so pay this off.

You're looking at the stock market and making silly assumptions. Stop it. When you're ready to invest, just invest. Don't even look at the market. Not at all.
Bogle: Smart Beta is stupid

bigred77
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Re: Help me decide if I should Invest or Payoff Loans?

Postby bigred77 » Wed Jan 11, 2017 9:43 am

Pay off the car. Pay off the Student loans. Max out your Roth IRA contribution for 2016 (you have until April to do this). Max out your Roth IRA contribution for 2017. Go in and change your 401k contribution to 10% of salary. Then reassess.

Your cash will have dropped down to about 10k by doing this. How much do yo need for the commonly recommended 6 months of expenses? Save this amount back up and then consider increasing your 401k contributions even more.

bds3
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Re: Help me decide if I should Invest or Payoff Loans?

Postby bds3 » Wed Jan 11, 2017 9:44 am

Pay off the student loan. Today.

Stop trying to time the market. What if it keeps going up? You'll wish you would've gotten in now.

mortfree
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Re: Help me decide if I should Invest or Payoff Loans?

Postby mortfree » Wed Jan 11, 2017 9:55 am

similar to above...

Pay off the student loan now.

Max 2016 Roth, max 2017 Roth - invest it right away and don't look at it. You'll be fine b/c I just invested $5500 yesterday so it'll go down now for you.

What fees are on your 401k - is it from the plan, the funds? maybe you're just not contributing enough so the fees have higher impact.. are there funds with lower expense ratios that you could choose?

I'm not sure on the car loan - what's the monthly payment and how much do you save per month right now?

Edited to add you may want to have an online money market/savings account - like Capital One or Ally or another that folks recommend. They pay 0.75% to 1%
Last edited by mortfree on Wed Jan 11, 2017 10:04 am, edited 1 time in total.

b42
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Re: Help me decide if I should Invest or Payoff Loans?

Postby b42 » Wed Jan 11, 2017 10:01 am

Welcome to the forums!

If you have the time, I'd check out this link: https://www.bogleheads.org/wiki/Getting_started

My thoughts:

1. You have 40k cash earning very little in your checking account. I would figure out how much cash you would need for 6-12 months of expenses and set it aside (you can keep it in the checking account or move it to a savings account if you would like the separation) as an emergency fund. That way you won't feel as "bad" spending the available cash since you will always have the backup funds in case something happens. I'm assuming $20k is what you will need for the emergency fund, leaving $20k to invest or pay off debts.

2. I would find out the payoff amount for your student loans and make a payment in full by the end of the month. An interest rate of 6.55% is relatively high, and you can essentially "lock in" a 6.55% return by paying off the loans now (Meaning: As a simplified example, if interest is credited only once a year, you'd have the loan jump from $3,500 to $3,729.25 in 12 months. You could either pay the loan off now for $3,500, or find an investment that would return at least 6.55% by the end of the year. It makes more sense to just pay off the loan now.)

3. I would also pay off the remaining amount on your car loan at 3.59% (2004 Volvo S40 here, nice choice!). This would free you of your relatively higher interest debt, and just leave the mortgage.

4. For the Roth IRA, I'd pull the trigger and start investing. Since you have a relatively small amount of money, even if the market drops 50% in the next few months, you are only out $1,500 if 100% equities. This would be more of a concern if you wanted to invest $300k, but for now it's more important to get started.

5. You mention your employers 401k plan. Can you list the available funds and the fees that you are aware of?

6. Depending on how much you are able to save, you can start making automatic withdraws to your 401k to get the employer match, and even automatic deposits into the Roth IRA once the fund is set up.

Carl53
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Re: Help me decide if I should Invest or Payoff Loans?

Postby Carl53 » Wed Jan 11, 2017 10:14 am

If you get the match with a only a two or four percent contribution, get it. It still is a 50 or 100% return in e first year. Lobby your employer as appropriate for better investment options.

Pay off the school and car loans with your cash.

Long term, do you see yourself married, and will you still be in the 25% bracket then and what might your bracket be in retirement? 401k is a great way to keep money out of the higher brackets if you might have lower tax brackets at other times in your life? Roths offer a way to avoid taxation of earnings. Seriously consider fully funding your 2016 Roth by the time you file your taxes and funding your 2017 Roth.

gr7070
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Re: Help me decide if I should Invest or Payoff Loans?

Postby gr7070 » Wed Jan 11, 2017 10:24 am

First, I'd put in (at least) the minimum amount needed to get that 2% matching. Even the worst 401k plans are likely the best option when there's matching involved. Other people's money!

I'd also pay off that school loan today. Assuming there's no penalties associated with that.

I'd also pay off the car. At the least refi it. 1% to 2% loans should be readily available. 3 year max.

You also mentioned a cash-out refi. You appear to have plenty if equity, so i might misunderstand, but i hope you never take cash out of a home in the future except in the most dire circumstances.

The state of the market does not matter. Invest whenever you are able, at all times. As much as capable.

Lastly a traditional retirement account, like a 401, had a good chance if being better than a ROTH when you retire. I'd prefer the 401k unless it is truly atrocious.

As mentioned make sure you have 3 to 6 month expenses saved up in a safe account like a money market.

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Watty
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Re: Help me decide if I should Invest or Payoff Loans?

Postby Watty » Wed Jan 11, 2017 11:40 am

+1 on
a) get the employer 401k match
b) pay off the student loan
c) pay off the car

Since you have $40,000 sitting in your checking account those are about the easiest "no brainer" choices as you will ever get in investing.

Buying the expensive car, even used, and doing a cash out refinance were not good choices. You will literally be paying for that car for the next 25 years even though you will be lucky if it lasts for 10. With the debt paid off start saving $500 a month to pay cash for your next car.


Single people get into the 25% federal tax bracket real quick and if you have state taxes too then a Roth in the 25% tax bracket may not be the best choice unless you can come up with a compelling reason to use one, which is possible.

https://www.bogleheads.org/wiki/Traditional_versus_Roth

If you are likely to get married some day and have kids then you could have in the ballpark of $100,000 in taxable income and still be in the 15% tax bracket so there may be better times to make Roth contributions.

You are also likely eligible to make a deductible IRA contribution even though you have a 401k. The income limits listed here are a modified adjusted gross income after a bunch of deductions so it is easier to qualify than just your gross income.

https://www.irs.gov/retirement-plans/20 ... an-at-work

There is a section in the wiki on how to decide what to do with a mediocre 401k.

https://www.bogleheads.org/wiki/401(k)#Expensive_or_mediocre_choices


I would fully fund the 2016 deductible IRA if you are eligible. If you made the $3000 Roth contribution in 2016 it may still be possible to characterize that into a deductible IRA.

In your situation I would make the future retirement account contribution in this order.

1) Put enough in the 401k to get the 2017 match.
2) $5,500 into deductible IRA if eligible in 2017.
3) More into the 401k.

If the choices are not dramatically more expensive in the 401k then I would just use that for everything. A 401k has a huge advantage in that the contributions are automatically done out of your paycheck so they are painless and they actually happen.

When I was your age I committed to myself to increase my 401k contributions by half of any future pay raises. That worked well for me and it was painless. If you do that then by the time you are 40 you could be saving a high percentage of your income.

Ace$
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Re: Help me decide if I should Invest or Payoff Loans?

Postby Ace$ » Wed Jan 11, 2017 6:17 pm

bigred77 wrote:Pay off the car. Pay off the Student loans. Max out your Roth IRA contribution for 2016 (you have until April to do this). Max out your Roth IRA contribution for 2017. Go in and change your 401k contribution to 10% of salary. Then reassess.

Your cash will have dropped down to about 10k by doing this. How much do yo need for the commonly recommended 6 months of expenses? Save this amount back up and then consider increasing your 401k contributions even more.


Nailed it.

And I'd recommend against doing cash-out refinances going forward.

line1260skr
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Re: Help me decide if I should Invest or Payoff Loans?

Postby line1260skr » Sun Jan 15, 2017 11:57 am

Wow, so many very helpful and reassuring responses. Thank you everyone!

Some Clarifications:

1) The primary reason I decided to stop contributing to my company's 401k was that I found out my employer provides 2% worth of matching regardless of my personal contribution. The way it was explained to me is that if I select to contribute as low as 0%, or even as high as 10%, I will still get a 2% match. My father, who is vice-president of the company and a benefit plan trustee, says it has to do with safe harboring or something? Also, no index funds were available within the plan. I just figured it would make more sense to avoid any fees charged by the mutual fund or the benefits company and go straight to the index fund with my own personal contributions.

2) The reason that I decided to refinance my home was because when I bought it, I had to take on two mortgages in order to pay for it. One was a 30 year @ 3.95% for 80% of the home value and one was a fully amortized balloon loan at 5.50% for a total of 10% of the home value. The balloon loan allowed me to make payments of $110/mo when I really should have been paying closer to $540/mo or something in order to pay it off in the short 3-5 year term, or whatever it was. Since buying the home I've never had the income to make that kind of payment on top of the 1st mortgage and other expenses, even prior to buying the Volvo (which by the way I realize on-paper was a bit pricey, but at only $21k, I feel was completely justifiable and well-worth the money for the piece of mind. It would be hard for me to go back to the older/cheaper cars I had before which kept having issues :D ) ..

Going Forward:

1) Paying off Student Loan - Based on everyone's responses, I think it pretty clear that I should just pay off this loan. This will free up around $100/month for me in payments which will be quite helpful. Wasn't sure about the benefits of the interest being deductible but if that isn't a concern then I am happy to pay it off.

2) Paying off Auto Loan - It seems like most people are saying to pay off this loan as well. Using the refinance money to pay off the auto loan would save me $300 a month, which could then be directed towards automatic monthly contributions into my Roth IRA. However, if I do this, aren't I really just turning the auto loan into a 25 year loan at basically the same interest rate and eliminating my option to pay off that debt ahead of time with any unexpected income and year-end bonuses? That additional 20 years at roughly the same rate equates to like another $7,000 added to the overall cost of the car in the form of interest (not accounting for any interest savings with the mortgage interest deduction which I guess I am assuming is minimal). After all it is a car and I don't plan keeping it more than another 3-4 years once the 100,000 warranty is up. I could really use the additional cash-flow each month, but I just want to make sure I know what I am trading off by doing so. What do you guys think?

3) Moving Wells-Fargo Checking to Online Money Market/Savings Account Like Ally - Is this something I should be doing? I mean I have always had a bank account like the one I have at Wells Fargo and hadn't really considered it. But now that I will have around $10,000 as my safety net in my account, would this be a better option? Are there any drawbacks like Risk or inability to have a debit card or anything? I guess I don't really care where the money is as long as it is as safe and liquid as cash. The benefit of being paid interest at ~1% would just make sense. Does Vanguard offer a solution like this where I could just use them for everything? or would a bank like Ally be better if I go this route?

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grabiner
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Re: Help me decide if I should Invest or Payoff Loans?

Postby grabiner » Sun Jan 15, 2017 8:26 pm

line1260skr wrote:2) Paying off Auto Loan - It seems like most people are saying to pay off this loan as well. Using the refinance money to pay off the auto loan would save me $300 a month, which could then be directed towards automatic monthly contributions into my Roth IRA. However, if I do this, aren't I really just turning the auto loan into a 25 year loan at basically the same interest rate and eliminating my option to pay off that debt ahead of time with any unexpected income and year-end bonuses?


Lengthening the loan term at the same rate is an advantage, not a disadvantage; this is why banks charge higher rates on longer-term loans. The reason it is an advantage is that you have the choice between making extra payments on the shorter-term schedule, or keeping the loan as long as possible if you have a better use for the money.

And contributing to the Roth IRA is probably a better use for the money. Yes, you'll pay more dollars in interest by increasing your mortgage balance, but you will also earn more dollars in investment gains by getting tax-free growth in the Roth IRA. At 3.50% on a 30-year mortgage, which is 2.68% after-tax in a 25% bracket, the Roth IRA should come out slightly ahead even without taking much risk; Admiral shares of Vanguard Intermediate-Term Bond Index earn 2.82%, and this fund has a shorter duration than your mortgage. You can also choose to invest in stock (and take more risk for the potential of higher returns).
David Grabiner

aristotelian
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Re: Help me decide if I should Invest or Payoff Loans?

Postby aristotelian » Sun Jan 15, 2017 9:30 pm

What others said. "Only 2%" match is still free money. That should be your top priority. Then get rid of debt. Then invest in an IRA.

As far as $3k minimums, you can avoid that by opening a brokerage account within your IRA and then buying ETFs (exchange traded funds). They are exactly the same as mutual funds but they are bought and sold as stocks and you can buy any quantity. If your IRA is at Vanguard, you can buy Vanguard ETFs for no fees.

line1260skr
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Re: Help me decide if I should Invest or Payoff Loans?

Postby line1260skr » Tue Jan 17, 2017 8:41 pm

Can anyone else elaborate on the issues in my latest response? Since writing I have paid off the student loan but have not paid off the auto loan, moved the checking account, or invested any more money. Thanks for all the help thus far!

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grabiner
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Re: Help me decide if I should Invest or Payoff Loans?

Postby grabiner » Tue Jan 17, 2017 8:53 pm

line1260skr wrote:Can anyone else elaborate on the issues in my latest response? Since writing I have paid off the student loan but have not paid off the auto loan, moved the checking account, or invested any more money. Thanks for all the help thus far!


If you have an adequate emergency fund, pay off the auto loan from your checking account. If not, pay it down until you have a minimum adequate emergency fund, put any spare cash against the auto loan until it is gone, and then contribute an equal out-of-pocket amount to your 401(k) or IRA. (By "out of pocket", I mean that you should contribute $1000 to the 401(k) if you are in a 15% bracket and have $850 available; that $1000 will only cost you $850 because you will have $150 less withheld.)

Your mortgage is low enough that I wouldn't even consider making an extra payment unless you are already contributing the IRS maximum to the IRA and 401(k).
David Grabiner

bjames310
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Re: Help me decide if I should Invest or Payoff Loans?

Postby bjames310 » Wed Jan 18, 2017 12:45 am

Pay off your debt entirely. I recently paid off $45k in student loan debt after getting my bonus. It was hard to let go of the cash, but I've never regretted it, and I swear I felt like I was floating for ten minutes when I realized I was debt free.

And since then I've taken time to read a few books on mutual funds to learn what to do with my income that used to go to the debt. So I've learned a lot on top of it all.


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