Guaranteed 2% return?

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zonester
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Guaranteed 2% return?

Post by zonester » Fri Feb 23, 2018 10:14 am

Hi,
I am hoping someone can help me here. I have a large loan due in 5 years. The interest rate is extremely low (~2%). Due to some unexpected winnings, I have the ability to pay that loan money right away. From a purely financial sense, do I a) pay it off? b) invest the money somewhere else that can guarantee a 2.5-3% after-tax return on investment? High interest money market accounts either cap the investment to a few thousand dollars, or cap the interest rate to less than 2%. I also need to come ahead after taxes on any investment returns.

I was thinking of temporarily parking this money in a tax exempt fund like VWIUX and then pay the loan off in 5 years. Is there a better idea? What would you do in my situation?

RRAAYY3
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Re: Guaranteed 2% return?

Post by RRAAYY3 » Fri Feb 23, 2018 10:17 am

What’s giving you a 2% guaranteed after tax return ?

thangngo
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Re: Guaranteed 2% return?

Post by thangngo » Fri Feb 23, 2018 10:20 am

Maybe not from a pure financial standpoint, but I'd pay off any debt I have. Then, I will be on the fast lane to save, save, save, and then some.
Last edited by thangngo on Fri Feb 23, 2018 10:21 am, edited 2 times in total.

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Kenkat
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Re: Guaranteed 2% return?

Post by Kenkat » Fri Feb 23, 2018 10:20 am

Five year treasury is paying around 2.5% right now; that’s very safe but after taxes, I am not sure you will come out ahead. Anything else, you are taking some level of risk to try to exceed the rate on your loan.

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greg24
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Re: Guaranteed 2% return?

Post by greg24 » Fri Feb 23, 2018 10:21 am

There isn't anything that guarantees the return you seek. You can come close, but taxes will probably get ya.

I'd pay it off.

SDLinguist
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Re: Guaranteed 2% return?

Post by SDLinguist » Fri Feb 23, 2018 10:24 am

Regardless of whether or not you could get a guaranteed 2.5%, another question is how much is .5% of the loan? Is that extra money gained going to be of any real use? If for example the difference between the two approaches ends up being $100 after 5 years is it worth the effort vs how much you value not having debt?

Those are only things you an answer.

RRAAYY3
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Re: Guaranteed 2% return?

Post by RRAAYY3 » Fri Feb 23, 2018 10:26 am

Maybe I’m wrong, but I see no point in carrying any debt whatsoever if it can be completely paid off without altering your day to day / month to month life

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flamesabers
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Re: Guaranteed 2% return?

Post by flamesabers » Fri Feb 23, 2018 10:30 am

If I was in your situation I would just pay off the debt in full. The satisfaction of being debt-free for me is worth more then earning a few extra dollars over the next 5 years.

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Kenkat
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Re: Guaranteed 2% return?

Post by Kenkat » Fri Feb 23, 2018 10:33 am

RRAAYY3 wrote:
Fri Feb 23, 2018 10:26 am
Maybe I’m wrong, but I see no point in carrying any debt whatsoever if it can be completely paid off without altering your day to day / month to month life
If you can achieve a guaranteed after tax return exceeding the rate on the loan, you should take that deal. For example, if you are willing to loan me money at 1% for 5 years, I would borrow as much as you would allow and buy 5 year treasury bills at 2.5%.

These arbitrage situations rarely occur, but you should take advantage of them if they do.

jacoavlu
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Re: Guaranteed 2% return?

Post by jacoavlu » Fri Feb 23, 2018 10:34 am

Do you have other debt? A mortgage? Upcoming large expenses other than the loan? How is the loan amortized - I would confirm that you save interest charges by paying off early.

Personally I wouldn't not pay off the loan, so that I could instead invest the money.

RRAAYY3
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Re: Guaranteed 2% return?

Post by RRAAYY3 » Fri Feb 23, 2018 10:36 am

Kenkat wrote:
Fri Feb 23, 2018 10:33 am
RRAAYY3 wrote:
Fri Feb 23, 2018 10:26 am
Maybe I’m wrong, but I see no point in carrying any debt whatsoever if it can be completely paid off without altering your day to day / month to month life
If you can achieve a guaranteed after tax return exceeding the rate on the loan, you should take that deal. For example, if you are willing to loan me money at 1% for 5 years, I would borrow as much as you would allow and buy 5 year treasury bills at 2.5%.

These arbitrage situations rarely occur, but you should take advantage of them if they do.
Absolutely ... this just doesn’t seem to be one of those cases.

SimplicityNow
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Re: Guaranteed 2% return?

Post by SimplicityNow » Fri Feb 23, 2018 11:07 am

The best 5 year CDs are paying 3% according to www.depositaccounts.com. That is before taxes.

Depends on your tax situation whether it is worth it.

If it was me, I'd just pay it now.

Grt2bOutdoors
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Re: Guaranteed 2% return?

Post by Grt2bOutdoors » Fri Feb 23, 2018 11:48 am

Pay it - NOW!! You can't get a guaranteed real rate of return after taxes in a 30 year TIP or a 30 Year US Treasury - what does that tell you when the risk free rate is below the threshold you require?
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Watty
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Re: Guaranteed 2% return?

Post by Watty » Fri Feb 23, 2018 11:54 am

One complication is if you will have ongoing loan payments of just a balloon payment at the end of five years.

This could be an issue if you put the money into a bond or CD that matures in five years and would have to make the monthly payments out of other funds.

gips
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Re: Guaranteed 2% return?

Post by gips » Fri Feb 23, 2018 12:03 pm

are the interest payments tax deductible? if so, that changes the amount of return needed for a positive roi.

this makes me nervous:
"Due to some unexpected winnings..."

Is it possible you' may have some unexpected losses over the next five years? If so, might be better to pay off the loan to shield your winnings.

zonester
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Re: Guaranteed 2% return?

Post by zonester » Fri Feb 23, 2018 12:17 pm

thanks for all your valuable suggestions. Couple updates based on questions:-

- not sure how this matter's but it is a balloon payment with interest and principal due at the end of term, interest is accrued monthly but not due till end of term. the ~2% interest rate is historically low and is a corporate loan.
- someone asked if the 0.5% really matters. For perspective, the total loan is over a million dollars, so the potential 0.5% interest matters to me.
- the interest payments are not tax deductable
- unexpected earnings were a one-time surprise windfall due to gift reasons. not a business windfall

Thanks!
Last edited by zonester on Fri Feb 23, 2018 12:21 pm, edited 1 time in total.

jacoavlu
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Re: Guaranteed 2% return?

Post by jacoavlu » Fri Feb 23, 2018 12:20 pm

If you pay it off early, do you save the interest? (I would want to be certain.)

zonester
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Re: Guaranteed 2% return?

Post by zonester » Fri Feb 23, 2018 12:21 pm

jacoavlu wrote:
Fri Feb 23, 2018 12:20 pm
If you pay it off early, do you save the interest? (I would want to be certain.)
yes

Valuethinker
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Re: Guaranteed 2% return?

Post by Valuethinker » Fri Feb 23, 2018 12:30 pm

zonester wrote:
Fri Feb 23, 2018 10:14 am
Hi,
I am hoping someone can help me here. I have a large loan due in 5 years. The interest rate is extremely low (~2%). Due to some unexpected winnings, I have the ability to pay that loan money right away. From a purely financial sense, do I a) pay it off? b) invest the money somewhere else that can guarantee a 2.5-3% after-tax return on investment? High interest money market accounts either cap the investment to a few thousand dollars, or cap the interest rate to less than 2%. I also need to come ahead after taxes on any investment returns.

I was thinking of temporarily parking this money in a tax exempt fund like VWIUX and then pay the loan off in 5 years. Is there a better idea? What would you do in my situation?
Any gain is marginal and there is unlikely to be any risk free return (after tax) of that magnitude.

Just pay off the loan and be debt free.

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czeckers
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Re: Guaranteed 2% return?

Post by czeckers » Fri Feb 23, 2018 12:30 pm

The best 5 year CD I could find on bankrate.com is 2.65%

On a $1M amount, the excess 0.65% would earn you almost $33,000.

However, the total interest on the CD would total almost $140,000. So if your taxes on the $140,000 would be less than $33,000, then you come out ahead. Otherwise, the differential will be completely eaten up by taxes. If your tax rate is say 30%, then you would pay $42,000 in taxes to earn the extra $33,000 in interest. I'd pay off the loan right away.

I imagine not having a $1M balloon payment hovering over your head will give you some peace of mind too.
The Espresso portfolio: | | 16% LCV, 16% SCV, 16% EM, 8% Int'l Value, 8% Int'l Sm, 8% US REIT, 8% Int'l REIT, 20% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."

WhiteMaxima
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Re: Guaranteed 2% return?

Post by WhiteMaxima » Fri Feb 23, 2018 12:35 pm

10 year treasure recently auctioned for 2.9%. If you have them in Roth, you get 2.9% return guaranteed. Will see far it will go. 4% 4.5%? I don't know.

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czeckers
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Re: Guaranteed 2% return?

Post by czeckers » Fri Feb 23, 2018 12:45 pm

Since you can withdraw the principal from a Roth penalty free, this might work on a smaller scale where the amount might be $5,000 or less. However, with $1M, there is no way to contribute such a large amount into a Roth or any other tax-deferred vehicle.

I also wouldn't use a 10-year treasury to fund an obligation that is 5 years away. The 10-year treasury is risk free as long as you hold until maturity. However, if interest rates go up, then the value of the 10-year note will drop and you may end up losing money when you sell it at 5 years.
The Espresso portfolio: | | 16% LCV, 16% SCV, 16% EM, 8% Int'l Value, 8% Int'l Sm, 8% US REIT, 8% Int'l REIT, 20% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."

emoore
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Re: Guaranteed 2% return?

Post by emoore » Fri Feb 23, 2018 12:51 pm

czeckers wrote:
Fri Feb 23, 2018 12:45 pm
Since you can withdraw the principal from a Roth penalty free, this might work on a smaller scale where the amount might be $5,000 or less. However, with $1M, there is no way to contribute such a large amount into a Roth or any other tax-deferred vehicle.

I also wouldn't use a 10-year treasury to fund an obligation that is 5 years away. The 10-year treasury is risk free as long as you hold until maturity. However, if interest rates go up, then the value of the 10-year note will drop and you may end up losing money when you sell it at 5 years.
+1. I'm maxing my Roth IRA instead of paying off my Student Loans early but it's only $12k, not $1M. I'd just pay it off since the loan is so much.

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telemark
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Re: Guaranteed 2% return?

Post by telemark » Fri Feb 23, 2018 12:54 pm

Just to take the other side of the argument, inflation makes debt more attractive since you are paying it off in cheaper dollars. Not that I have any idea what future inflation rates will be like. Maybe we will see deflation...

Also: why does it need to be a very safe investment? You were presumably planning to pay off the loan anyway, do you need to earmark this money for that purpose?

zonester
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Re: Guaranteed 2% return?

Post by zonester » Fri Feb 23, 2018 1:13 pm

telemark wrote:
Fri Feb 23, 2018 12:54 pm
Just to take the other side of the argument, inflation makes debt more attractive since you are paying it off in cheaper dollars. Not that I have any idea what future inflation rates will be like. Maybe we will see deflation...

Also: why does it need to be a very safe investment? You were presumably planning to pay off the loan anyway, do you need to earmark this money for that purpose?
it depends on what you define "very safe" investment. I just meant that I need to guarantee that I come out ahead if I absorb the loan over the 5 year term. Else it just makes more sense to pay it off early.

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whodidntante
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Re: Guaranteed 2% return?

Post by whodidntante » Fri Feb 23, 2018 1:45 pm

Here's what I would do.

Take the winnings and treat it as positive cash flow. Do whatever you normally do with positive cash flow. Spend it on hamburgers or invest it for the long term.

Continue making minimum payments on the 2% loan.

Continue earning money for five years and allocating your positive cash flow to hamburgers and investments.

When the loan is due, take some of your money and pay it off.

In my opinion using buckets and thinking about guarantees will likely produce a worse outcome, is more complicated, and is likely rooted in loss aversion. I am assuming that you will have the resources to pay off the loan.

jacoavlu
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Re: Guaranteed 2% return?

Post by jacoavlu » Fri Feb 23, 2018 1:51 pm

if it's a corporate loan, isn't the interest deductible to the corporation?

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Earl Lemongrab
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Re: Guaranteed 2% return?

Post by Earl Lemongrab » Fri Feb 23, 2018 3:08 pm

I have no negative emotions towards debt. It's a tool. It's like hating and fearing your power saw.

I would absolutely keep a loan with that rate.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

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Watty
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Re: Guaranteed 2% return?

Post by Watty » Fri Feb 23, 2018 3:39 pm

Do you by any chance have a mortgage that you could pay down then use your "mortgage payment" to save up enough to pay off the loan in five years?
zonester wrote:
Fri Feb 23, 2018 12:17 pm
the ~2% interest rate is historically low and is a corporate loan.
I am not a tax guru but I would be concerned that a below market interest rate on a loan would be taxable income to you for the amount that it is below the current market rate. Google "Applicable Federal Rates" for more information.

It would also be good to consider what happens to the loan if you leave that job or die before five years is up.

There could also be complications if something happens like you get divorced or sued while you have a large amount invested.

The amount involved sound like it could be worth pursuing but this might be a good situation to work with a tax CPA or fee only financial planner to help you figure out what is best to do.

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Cycle
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Re: Guaranteed 2% return?

Post by Cycle » Fri Feb 23, 2018 3:44 pm

Debt free life is simple and worth it imo, including mortgages

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Tamarind
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Re: Guaranteed 2% return?

Post by Tamarind » Fri Feb 23, 2018 4:31 pm

If it weren't for taxes, you could get this with a CD, individual bond, or stable value fund.

I think taxes mean your return will be better for paying it off now. That said, it's close enough that you could be justified in keeping the loan and investing in something riskier IF you would have no problem raising the money later.

ThePrince
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Re: Guaranteed 2% return?

Post by ThePrince » Fri Feb 23, 2018 5:41 pm

zonester wrote:
Fri Feb 23, 2018 10:14 am
Hi,
I am hoping someone can help me here. I have a large loan due in 5 years. The interest rate is extremely low (~2%). Due to some unexpected winnings, I have the ability to pay that loan money right away. From a purely financial sense, do I a) pay it off? b) invest the money somewhere else that can guarantee a 2.5-3% after-tax return on investment? High interest money market accounts either cap the investment to a few thousand dollars, or cap the interest rate to less than 2%. I also need to come ahead after taxes on any investment returns.

I was thinking of temporarily parking this money in a tax exempt fund like VWIUX and then pay the loan off in 5 years. Is there a better idea? What would you do in my situation?
I would pay off the debt; it is not a pet.

Mors
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Re: Guaranteed 2% return?

Post by Mors » Fri Feb 23, 2018 6:01 pm

I would keep it as long as I can guarantee the minimum payments. Maybe increase my emergency fund a bit to compensate for the added risk.

DrGoogle2017
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Re: Guaranteed 2% return?

Post by DrGoogle2017 » Fri Feb 23, 2018 6:22 pm

I would take the unexpected winnings and pay it off.

gips
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Re: Guaranteed 2% return?

Post by gips » Fri Feb 23, 2018 7:03 pm

are the interest payments tax deductible? If so, it's a no-brainer to invest the money in CDs or treasuries and net about $10k-20k but I'd want to run it by my tax accountant.

can't really understand the arguments to the contrary. Might go with treasuries for liquidity in case things don't go as planned.

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