$1M in cash - invest or pay down mortgage

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entropy2017
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$1M in cash - invest or pay down mortgage

Post by entropy2017 » Sat Aug 11, 2018 1:56 am

Hello,

First, let me say I really appreciate all the helpful and valuable insight that everyone here shares.

I need to help my retired parents invest $1M in cash which they received as proceeds from home sale.

Here are their financial details:

Net worth: $6.5M


Assets: $7.95M
Investments: $3.03M ($1M in cash (37%), $1.5M S&P 500 index (50%), US Bonds $360K (13%)
Primary Home: $1.92M - mortgage details below
Second Home: $3M fully owned, no mortgage

Liabilities: $1.46M
Car Loan: $68K @ 1%
Mortgage on Primary Home: $1.39M @ 3.5%, 7 year ARM
————

Income
$220K/yr from Social Security and other sources. This income could be highly variable.

Expenses
$180K/yr

————

The second home is for sale though it may take a long time to sell, and the price may need to be lowered. Another option is to rent it out, which will probably yield $60K per year in rental income.

Their investment portfolio currently is U.S. stock heavy. It also has no international stock exposure.

Would like to keep $400K in CD ladder or other liquid source for expenses for next 4-5 years.

Option 1 - Invest the other $600K in US bond index. This would allow them to rebalance their investment portfolio to near 60/40. Still would be missing any international exposure.

Option 2 - Use the other $600K to pay down principal on the mortgage. This would save a considerable amount of interest, about $660K by my calculations. They plan to stay in this house for good so mortgage will eventually be paid down. A large part of their annual expenses are their mortgage ($6K/month)

Would you recommend one of these options, or maybe another option or approach?

Your thoughts and guidance would be greatly appreciated!

gostars
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Re: $1M in cash - invest or pay down mortgage

Post by gostars » Sat Aug 11, 2018 2:28 am

Pretty basic thoughts here. First, I would determine the best AA for their age and situation. 60/40 may be too aggressive for those already in retirement, and not having international may be taking on additional risk due to lack of diversity. Second, I would reconsider how much cash to keep on hand. Any cash kept, even in a good money market, CD, or high-yield savings, is probably losing value against inflation. As long as the cashflow generally exceeds expenses, it may be better to decrease the cash to typical emergency fund levels of 6-9 months of expenses, exclude that from the AA, and balance the rest accordingly. Third, at a 3.5% interest rate, I probably would not pay down the mortgage, as even a 50/50 allocation is likely to beat 3.5%. I don't know where it might go as an ARM, but if it started getting up around 5%, that's when I would consider paying it off faster.

Archimedes
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Re: $1M in cash - invest or pay down mortgage

Post by Archimedes » Sat Aug 11, 2018 3:42 am

The details you outlined are a little unclear. They sold a home and have an extra 1MM in cash, and they still own 2 more homes?

Their income is only 220k per year and their expenses are 180k despite owning 2 more homes worth almost 5MM?

What about running and maintaining those 2 expensive homes? It typically would cost quite a bit each year for those expenses. I don’t know about where they live, but it sounds like they are house poor with way too much net worth tied up in real estate for their income level. So it sounds good that they are trying to sell their most expensive property.

In our HCOL area, homes under 1 million go to multiple bids and sell over asking price. Then the market is more balanced between buyers and sellers between 1 and 2 MM. Above 2 MM, the market is a buyers market with price reductions and an oversupply of stagnant listings. How is the market for a 3MM dollar home in their location?

Jack FFR1846
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Re: $1M in cash - invest or pay down mortgage

Post by Jack FFR1846 » Sat Aug 11, 2018 6:41 am

I'd think about it like this: They can park the money by paying the mortgage on the house for sale. When it does sell, they get it back again to make the decision what to do with the money. In the mean time, they reduce the mortgage interest they're paying.
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Swampy
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Re: $1M in cash - invest or pay down mortgage

Post by Swampy » Sat Aug 11, 2018 6:49 am

I need to help my retired parents invest $1M in cash which they received as proceeds from home sale.

Here are their financial details:

Net worth: $6.5M
Your retired parents did quite well financially in their lives.

I have just one question:
Did they ask you to help?
If you fail to plan, you plan to fail. | Failure is not an option. | If I have seen further, it is because I was carried on the shoulders of giants.

Grt2bOutdoors
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Re: $1M in cash - invest or pay down mortgage

Post by Grt2bOutdoors » Sat Aug 11, 2018 6:52 am

Jack FFR1846 wrote:
Sat Aug 11, 2018 6:41 am
I'd think about it like this: They can park the money by paying the mortgage on the house for sale. When it does sell, they get it back again to make the decision what to do with the money. In the mean time, they reduce the mortgage interest they're paying.
House for sale has no mortgage.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

Nissanzx1
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Re: $1M in cash - invest or pay down mortgage

Post by Nissanzx1 » Sat Aug 11, 2018 7:19 am

They have worked hard and done well. A couple thoughts:

1) Awfully real estate heavy as a percentage. I'd get it down to one home that's payed off. Mortgages make most retired folks nervous (and they should- esp ARMS). They have plenty of money to vacation, just get a nice hotel room (don't need to own it).

2) The car loan is nuts. People worth $7M shouldn't fool around with car payments. Write the check and be done.

3) for such a high net worth, the expenses as a ratio to income are unreasonable. More money needs to be freed up to blow on fun stuff. Getting the home payed off and car loan payed off bring the expenses back to a level where they will really be having fun.

You are good to help them.

inbox788
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Re: $1M in cash - invest or pay down mortgage

Post by inbox788 » Sat Aug 11, 2018 7:26 am

entropy2017 wrote:
Sat Aug 11, 2018 1:56 am

Would you recommend one of these options, or maybe another option or approach?

Your thoughts and guidance would be greatly appreciated!
Selling the second home is a good idea to simplify their lives and reduce risks. How is it used now, and why haven't they sold it sooner? Renting out turns them into landlords with unnecessary worries and troubles.

A diversified US stock heavy isn't a major concern, and adding international exposure is a simple matter of finding a new allocation and rebalancing. Small issue IMO. If you are still concerned, take small steps until you're comfortable. You'll know you went too many steps when you ask if you have too much international exposure.

With $180k annual expenses, $400k is only about 2 years, which seems like enough and a good amount for retirement.

Paying down the 3.5% mortgage is top of my list, and something I'd do with my retirement savings. It would be very hard for me to justify doing anything else. If there was something really worthwhile, I'd be asking myself, shouldn't I be taking out a loan at 3.5% to invest? But those opportunities have been extremely rare for me.

Aside from the high mortgage, what are their other highest expenses? Is that pre or post tax? After mortgage/rent and car/transportation, if you take out big one time expenses like furniture and appliances or roof repairs, I find it hard to come up with $10k/month in recurring expenses without being a bit extravagant.

entropy2017
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Re: $1M in cash - invest or pay down mortgage

Post by entropy2017 » Sat Aug 11, 2018 4:06 pm

Thank you for all the helpful advice.

@Swampy: Yes, my parents proactively asked me to take over complete management of their finances. They have been able to build wealth through a combination of hard work, entrepreneurial risk-taking, and frankly good luck - not really a save and invest approach. Now they are looking to have peace-of-mind with good growth. I have exposed them to the Boglehead approach, and the saying "If you have won the game, why keep playing?" really resonates with them. I plan to develop several scenarios for them. They will choose one, and I will execute their wishes. I often reinforce with them that I will only be involved to the extent they want me to be.

@Archimedes: They sold a third rental home this generated the proceeds of $1M. Now, they have two homes. They just moved from the $3M home to the $1.9M home. The $3M home now sits empty is for sale. In that area, a $3M home is on the high end, and my perception is that this type of home will take a long time to sell. However, the area is growing rapidly. So the choice may come down to rent it out and hope it appreciates over a decade vs. dropping the price to have a better chance of selling.

@Nissanzx1: Thank you for the kind words. I agree they are real estate heavy. I hope that they will be able to sell the $3M house. This will help them pay off the mortgage on their primary home quickly. I think their expenses will go down quite a bit as they reach steady state in their new situation.

@gostars: Thank you for the investment advice. Lots to think about, and I will incorporate it in my planning.

@inbox788: Thank you. I think you are right and I have probably overestimated their expenses and these will decrease. They just moved so their one-time expenses are high. They do have a few hobbies, but these are not really that expensive.

Synthesizing the feedback I have received, I take away the main points of consensus.

1. Sell the $3M house, if possible.
2. Pay down mortgage on primary house
3. Rebalance portfolio to bring it to 60/40 or 50/50 adding some international exposure using 3-fund approach or as close as I can get for them.
4. Pay off car loan - makes no sense to carry it
5. Reduce expenses as much as possible to a base steady state
6. Once all this is done, everything should be on auto-pilot for them. I must encourage them to HAVE FUN and enjoy the fruits of their labor.

Thanks again for all the advice. I really appreciate it!

JBTX
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Re: $1M in cash - invest or pay down mortgage

Post by JBTX » Sat Aug 11, 2018 10:38 pm

Pay off the mortgage and annual expenses go to about $130k. $130k of expenses on 6 million net worth is less than 3.0% so I am not sure for the call to reduce expenses beyond the mortgage. And that isn't even taking into account offsetting social security income.

entropy2017
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Re: $1M in cash - invest or pay down mortgage

Post by entropy2017 » Sun Aug 12, 2018 3:30 pm

@JBTX: Thank you. That is a good point regarding paying off the mortgage and the impact on expenses. The lowered expense rate would also be offset by Social Security and other income. It seems like the "magic key" to making this happen is to sell the $3M home which would allow them to pay off their existing mortgage and invest the rest in their 3-fund portfolio. Thanks again.

My updated list:

1. Sell the $3M house, if possible.
2. Pay down mortgage on primary house
3. Rebalance portfolio to bring it to 60/40 or 50/50 adding some international exposure using 3-fund approach or as close as I can get for them.
4. Once all this is done, everything should be on auto-pilot for them. Stay the course.

I have taken "paying off car loan" off the list because the loan is at 1% rate. I have also taken off "lowering expenses" because minus the mortgage, they will be doing well in that regard.

Both my parents are in their early 70s. I will help them to find ways to enjoy their money that bring meaning and enjoyment to them. These things need not be expensive. Eating out a couple of times a week, taking a trip once a year, attending a show here and there, and spending time with the grandkids are the kind of things that bring them joy.

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Watty
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Re: $1M in cash - invest or pay down mortgage

Post by Watty » Sun Aug 12, 2018 3:41 pm

One thing that is not clear is the tax implications of selling the additional property. If they will be paying a lot of capital gains tax on the sale and they are older(80s+ ???) it could make sense to keep it as a rental then have the property eventually go to their estate at a stepped up cost basis. If it is an investment property a 1031 real estate exchange might be possible to get something less risky and easier to manage.

If the mortgage on their primary house was fixed deciding to pay it down would be more complicated, with a 7 year ARM that likely has less than 7 years left before it resets then paying it down is an easy choice since that is somewhat like buying a 3.5% risk free CD.
Nissanzx1 wrote:
Sat Aug 11, 2018 7:19 am
2) The car loan is nuts. People worth $7M shouldn't fool around with car payments. Write the check and be done.
+1

Even though it is at 1% that is a tax free 1% if they pay it off. Any possible after tax advantages are minimal if any.

inverter
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Re: $1M in cash - invest or pay down mortgage

Post by inverter » Sun Aug 12, 2018 3:51 pm

This looks almost exactly like my parent's situation, but they have a number of financial advisers involved. Subscribed.

Interested to know how they came to know they needed help.

entropy2017
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Re: $1M in cash - invest or pay down mortgage

Post by entropy2017 » Sun Aug 12, 2018 4:39 pm

@Watty: Thanks. That is a very good point. I will need to look into the tax implications of their selling the $3M house. My parents are in their early 70s so I hope it will be a very long time before any estate issues become relevant. The house is a very unique property in a very rapidly growing area, but one of the highest end properties in the area. I will look into the tax implications of a sale. I think their preference would be to sell it if they can get a price they are satisfied with. It would simplify their lives and they have no desire to be landlords. I'll also discuss the possibility of paying off the car loan with them since they have the liquidity to do it.

@inverter: My parents have not paid much attention to their investing strategy over the years. When I first looked at their portfolio 1.5 years ago, it was 100% US stock and they were in their late 60s. They certainly had no knowledge of Boglehead principles. A few years ago, they used the services of a well-known wealth management firm for about a year, but there was no obvious benefit really. They have also used Wealthfront, but again there was no obvious benefit.

I have transitioned my own finances to a Boglehead 3-fund approach during the past two years, and also strive to LBYM. I think my parents have seen the benefits of simplicity, low expenses, and peace-of-mind (set and forget) with this approach, and that is part of the reason they have asked for my help. Frankly, they also trust my judgement and that I will do what is in their best interest - I will do my best!

Again, I want to say how much I appreciate the input from the community. Learning about and adopting the Boglehead approach has been transformative for my finances, and other areas of my life!

Leemiller
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Re: $1M in cash - invest or pay down mortgage

Post by Leemiller » Sun Aug 12, 2018 5:23 pm

I think you could use some paid professional advice given the size of the portfolio, along with tax and estate planning considerations. Are you already managing a high six, low seven figure portfolio? No offense, but you seem new to investing and sometimes it is worth paying for professional advice.

Also, you have int’l exposure already - US companies operate globally. The 3m parcel of real estate may not be worth so much if it can’t be sold at that price. They are extremely heavy in real estate that isn’t income producing.

inbox788
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Re: $1M in cash - invest or pay down mortgage

Post by inbox788 » Sun Aug 12, 2018 5:56 pm

Leemiller wrote:
Sun Aug 12, 2018 5:23 pm
I think you could use some paid professional advice given the size of the portfolio, along with tax and estate planning considerations. Are you already managing a high six, low seven figure portfolio? No offense, but you seem new to investing and sometimes it is worth paying for professional advice.

Also, you have int’l exposure already - US companies operate globally. The 3m parcel of real estate may not be worth so much if it can’t be sold at that price. They are extremely heavy in real estate that isn’t income producing.
Yes, it's prudent to seek out the RIGHT kind of professional advice. Unfortunately, there is too much WRONG kind of professionals out there that can wind up worsening the situation. Be careful about "free" advice, no free lunch and all, but paying for bad advice is the worst of all.

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

entropy2017
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Re: $1M in cash - invest or pay down mortgage

Post by entropy2017 » Sun Aug 12, 2018 6:23 pm

@Leemiller: Thanks, and no offense taken. I think it is important to know one's own limits and blind spots. They've got a good CPA and I'm currently helping them to source a good estate lawyer. I manage my own $2M portfolio using a 60/40, 3-fund approach across 401K, IRA, 529s, and taxable accounts.

Regarding the paid advice on the investment side, I have figured that since they plan to use a 3-fund Boglehead portfolio with a 50/50 or 60/40 split, this would obviate the need for a paid financial advisor. So far, I have suggested to them using a paid CPA and trust lawyer, but taking a self-managed approach to investments given the simplicity of the Boglehead approach. Are there other types of added value that a paid financial advisor might bring to the table? I am happy to recommend they consult an advisor it if adds net value, but I'd like to understand what they bring to the table.

Regarding the $3M parcel and overallocation to real estate, I agree on all counts. I am helping them to unwind and correct this situation. You are right that the $3M property may indeed not be worth that amount. The price was set based on input from real estate agents and comps, but for houses like this there are few comps.

Tdubs
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Re: $1M in cash - invest or pay down mortgage

Post by Tdubs » Sun Aug 12, 2018 6:44 pm

Nothing more certain than the return on paying off a mortgage.

beachwalkerwalker
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Re: $1M in cash - invest or pay down mortgage

Post by beachwalkerwalker » Tue Aug 14, 2018 3:57 pm

My wife and I found ourselves in a similar boat a few years back (at 56 but with higher net worth) and so I only can offer our story as anecdotal and not based on any presumed expertise.

We paid down all the debt we had while maintaining our primary residence and a smaller vacation home. We reduced our asset allocation to something in the neighborhood of 40/60. We keep (and I know this will draw gasps from the rafters) 4 years of expenses in a CD ladder and another 6 months of expenses in a money market account to use to enjoy ourselves whenever the mood strikes without feeling guilty about spending.

We got all our legal, insurance and estate paperwork in order. We discussed and decided on how important legacy versus current spending was to us and our heirs/charities/etc. We reduced the number of financial firms we have accounts with to Vanguard (for the majority of our investible assets) but also maintain a outside advisor to oversee a smaller portion of these assets as a way to insure another set of eyes is looking at things. Surprisingly, they have performed quite nicely.

I have no idea if this would work for your parents but it has considerably simplified our financial lives. We significantly reduced variability of our income and reduced our cash flow needs. Your parents draw of $220M is less than 3.5% of their net worth. This is quite similar to our draw and we are quite comfortable with that. In fact, even with the above asset allocation, and having spent three wonderful years traveling and being together, we find our net worth today is about 6% higher than it was I retired. I am sure we could have made more in this market but at the cost of worrying more. We recognize that the market will not be good forever and have not adjusted our spending up as a result of our investment results.

To conclude, our decisions to make things simple, conservative and orderly have let us focus on enjoying time and one another. With the sort of assets of assets we are discussing, we believe the only way you can lose the game is to play the game.

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grabiner
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Re: $1M in cash - invest or pay down mortgage

Post by grabiner » Tue Aug 14, 2018 8:47 pm

Wiki article link:Paying down loans versus investing

Paying down that mortgage would be a risk-free 3.5% return. I don't know how long until the ARM resets, but if it is seven years, that would be equivalent to buying a seven-year bond. 3.5% is more than seven-year municipal-bonds earn, but 35% reduced by 37% tax is 2.20%, which is less than seven-year or even five-year bonds earn. Therefore, it makes sense to pay down the mortgage to the extent that it is deductible, which would be to $750K; beyond that, it's more based on how debt-averse they are. (And if they can pay off the whole mortgage, such as after selling the second home, that becomes a good deal again, as it no longer takes seven years to start getting the benefit.)
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goodenyou
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Re: $1M in cash - invest or pay down mortgage

Post by goodenyou » Tue Aug 14, 2018 9:10 pm

I would put BOTH houses up for sale and simplify. I would live in the $3M paid off home if that didn't sell in a timely fashion. Then, I would lower the percentage of my total net worth in property by buying a much less expensive home. I would take the proceeds of the real estate sales and $1M cash and put it in a 60/40 or 50/50 asset allocation. With lower overhead and liquidity, I would scream happily with my new found simplicity. Aging and illiquid with huge overhead sounds miserable to me. The property taxes alone have to be close to $100,000 per year on $5,000,000 of properties. That's before you turn on the lights and fix the toilets. No thanks. My goal is to keep my paid off house to less than 20% of my net worth as I get close to and into retirement. Whatever they are doing to generate $200+k per year with a $3M investable asset allocation that generates less than $40k per year better be very stable to meet those overhead demands. Social Security isn't filling that gap.
"Ignorance more frequently begets confidence than does knowledge" | "The best years you have left are the ones you have right now"

entropy2017
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Re: $1M in cash - invest or pay down mortgage

Post by entropy2017 » Tue Aug 14, 2018 10:52 pm

@Tdubs: Yes, I agree!

@beachwalkerwalker: Thank you for taking the time to share your experience. The path you took is essentially the same thing my parents want to accomplish - moving to a simple, conservative, orderly financial approach so they can focus on enjoying their retirement. It is great to hear it worked out for you and your wife. I will be asking my parents to read your post (and all the others).

@grabiner: The specific calculation you have provided on the pay-down strategy for their ARM mortgage is very useful. I think I will help them model this type of scenario with the key point being that it doesn't have to be an all-or-nothing scenario. They can pay down the mortgage and invest in a surgical, choreographed manner to maximize return.

@goodenyou: That is a very interesting approach, and probably more aligned to what I personally would be inclined to do. But they are happy living in the $1.9M primary house for good. The two houses are not geographically near to one another (thousands of miles apart). The majority of the $200K per year comes from a royalty stream that should be relatively stable for 5-10 years, but decline to a smaller amount over time. I definitely agree with you about aging and illiquid assets being a pain. I think if they can sell the $3M house that will eliminate a lot of this responsibility. From all the feedback received so far, that is job #1. Thanks!

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