Concerns over funding priority when investing with debt

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majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Concerns over funding priority when investing with debt

Post by majiaknight » Tue Sep 18, 2018 7:37 pm

I've been following the below bogleheads wiki guidance to prioritize investments for several years now. However, recently several factors including the ratio of my current debt to investment portfolio, the stock market condition and the tax reform motivate me to reconsider whether I should prioritize payoff debt with the new money every month.
Some background:
  • dual-income family in mid-30s with 1 pre-school kid living in Very HCOL in CA
    32% tax bracket (Married Filing Jointly)
    ~$800K investment assets (401K+IRA+HSA+EE Savings Bond: $600K, Taxable+Emergency Fund: $200K)
    ~$600K mortgage (3% 5/1 ARM, reset in mid-2021, Primary residence now worth ~$1.4M )
Plan to max the following every year:
  • DW 401K: $18.5K (+$5.8K company match) -- done for 2018!
    Me 401K: $18.5K (+$5.5K company match) -- done for 2018!
    Backdoor Roth IRA: $5.5K x2 -- done for 2018!
    HSA: $6.9K -- on track
    Me 401K After-tax (support mega-backdoor): ~$31K -- on track but with ?
Here are my 2 questions:

1) Should I max the 401K after-tax ~$31K or save the money to pay extra principal of the mortgage?

2) As I don't plan to sell any taxable investment to accelerate the mortgage payoff, should I stop investing in taxable and pay extra principal of the mortgage each month?

Thanks!
Last edited by majiaknight on Tue Sep 18, 2018 11:41 pm, edited 3 times in total.

Thesaints
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Joined: Tue Jun 20, 2017 12:25 am

Re: Concerns over funding priority when investing with debt

Post by Thesaints » Tue Sep 18, 2018 7:44 pm

It depends mainly on your after-tax interest on the mortgage and the after-tax expected return on investments.
Keep in mind that mortgage payments have zero volatility. The same is not necessarily true for your investments.

HEDGEFUNDIE
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Joined: Sun Oct 22, 2017 2:06 pm

Re: Concerns over funding priority when investing with debt

Post by HEDGEFUNDIE » Tue Sep 18, 2018 7:45 pm

Why do you feel the urge to pay off the mortgage?

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Tue Sep 18, 2018 11:23 pm

Thesaints wrote:
Tue Sep 18, 2018 7:44 pm
It depends mainly on your after-tax interest on the mortgage and the after-tax expected return on investments.
Keep in mind that mortgage payments have zero volatility. The same is not necessarily true for your investments.
For my tax situation (32% tax bracket for 2018), I think it provides only a little tax benefit to do itemized deduction. Also, I expect to get >4% APR mortgage if I refinance before the 5/1 ARM reset in 2021. To me ~4% after tax return looks good.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Tue Sep 18, 2018 11:32 pm

HEDGEFUNDIE wrote:
Tue Sep 18, 2018 7:45 pm
Why do you feel the urge to pay off the mortgage?
It's a little bit market timing but I think there are other factors as I mentioned in the original post. I find my investment has grown very fast during the last 3 years which now exceeds the mortgage. I start to wonder what will be my comfortable investment/debt ratio?

Thesaints
Posts: 1619
Joined: Tue Jun 20, 2017 12:25 am

Re: Concerns over funding priority when investing with debt

Post by Thesaints » Tue Sep 18, 2018 11:45 pm

majiaknight wrote:
Tue Sep 18, 2018 11:23 pm
Thesaints wrote:
Tue Sep 18, 2018 7:44 pm
It depends mainly on your after-tax interest on the mortgage and the after-tax expected return on investments.
Keep in mind that mortgage payments have zero volatility. The same is not necessarily true for your investments.
For my tax situation (32% tax bracket for 2018), I think it provides only a little tax benefit to do itemized deduction. Also, I expect to get >4% APR mortgage if I refinance before the 5/1 ARM reset in 2021. To me ~4% after tax return looks good.
Just to match your mortgage rate you have to make 4% after taxes on your investment, which cannot be done without taking on some risk.
Not worth it, not even close, IMO.

HEDGEFUNDIE
Posts: 847
Joined: Sun Oct 22, 2017 2:06 pm

Re: Concerns over funding priority when investing with debt

Post by HEDGEFUNDIE » Wed Sep 19, 2018 12:00 am

majiaknight wrote:
Tue Sep 18, 2018 11:32 pm
HEDGEFUNDIE wrote:
Tue Sep 18, 2018 7:45 pm
Why do you feel the urge to pay off the mortgage?
It's a little bit market timing but I think there are other factors as I mentioned in the original post. I find my investment has grown very fast during the last 3 years which now exceeds the mortgage. I start to wonder what will be my comfortable investment/debt ratio?
Why is the investment / debt ratio important to you?

The only ratio that matters for your mortgage is your income-to-debt coverage ratio. If you believe your income will decline significantly in the near future then you should accelerate your mortgage payback.

If not, then you shouldn’t change a thing.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Wed Sep 19, 2018 12:14 am

HEDGEFUNDIE wrote:
Wed Sep 19, 2018 12:00 am
Why is the investment / debt ratio important to you?

The only ratio that matters for your mortgage is your income-to-debt coverage ratio. If you believe your income will decline significantly in the near future then you should accelerate your mortgage payback.

If not, then you shouldn’t change a thing.
Thanks. You made a good point.

To answer your question, one main reason might be when my investment matches the debt level, suddenly I start to feel I might have borrowed too much money to invest. This leads me to think whether I should 'rebalance' the investment / debt ratio or simply reduce the debt level. :confused
Last edited by majiaknight on Wed Sep 19, 2018 12:19 am, edited 1 time in total.

Thesaints
Posts: 1619
Joined: Tue Jun 20, 2017 12:25 am

Re: Concerns over funding priority when investing with debt

Post by Thesaints » Wed Sep 19, 2018 12:18 am

majiaknight wrote:
Wed Sep 19, 2018 12:14 am

To answer your question, one main reason might be when my investment matches the debt level, suddenly I start to feel I might have borrowed too much money to invest. Maybe I should 'rebalance' the investment / debt ratio. :confused
When your investment "matches" debt level it means you are investing 100% borrowed money. Which in turn means infinite leverage. Which in turn means infinite risk, although the risk might be all on the lender side at that point...

HEDGEFUNDIE
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Joined: Sun Oct 22, 2017 2:06 pm

Re: Concerns over funding priority when investing with debt

Post by HEDGEFUNDIE » Wed Sep 19, 2018 12:19 am

majiaknight wrote:
Wed Sep 19, 2018 12:14 am
HEDGEFUNDIE wrote:
Wed Sep 19, 2018 12:00 am
Why is the investment / debt ratio important to you?

The only ratio that matters for your mortgage is your income-to-debt coverage ratio. If you believe your income will decline significantly in the near future then you should accelerate your mortgage payback.

If not, then you shouldn’t change a thing.
Thanks. You made a good point.

To answer your question, one main reason might be when my investment matches the debt level, suddenly I start to feel I might have borrowed too much money to invest. Maybe I should 'rebalance' the investment / debt ratio or simply reduce the debt level. :confused
You have a great interest rate locked in until 2021. Take full advantage of it. Re-evaluate in 2021 when it resets.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Wed Sep 19, 2018 12:56 am

HEDGEFUNDIE wrote:
Wed Sep 19, 2018 12:19 am
majiaknight wrote:
Wed Sep 19, 2018 12:14 am
HEDGEFUNDIE wrote:
Wed Sep 19, 2018 12:00 am
Why is the investment / debt ratio important to you?

The only ratio that matters for your mortgage is your income-to-debt coverage ratio. If you believe your income will decline significantly in the near future then you should accelerate your mortgage payback.

If not, then you shouldn’t change a thing.
Thanks. You made a good point.

To answer your question, one main reason might be when my investment matches the debt level, suddenly I start to feel I might have borrowed too much money to invest. Maybe I should 'rebalance' the investment / debt ratio or simply reduce the debt level. :confused
You have a great interest rate locked in until 2021. Take full advantage of it. Re-evaluate in 2021 when it resets.
Thanks a lot for your comments which really clear my mind. Now I think I just confused myself about this 'investment/debt ratio' nonsense thing. I will stay the course with my investment strategy. :beer

HEDGEFUNDIE
Posts: 847
Joined: Sun Oct 22, 2017 2:06 pm

Re: Concerns over funding priority when investing with debt

Post by HEDGEFUNDIE » Wed Sep 19, 2018 4:32 am

majiaknight wrote:
Wed Sep 19, 2018 12:56 am
HEDGEFUNDIE wrote:
Wed Sep 19, 2018 12:19 am
majiaknight wrote:
Wed Sep 19, 2018 12:14 am
HEDGEFUNDIE wrote:
Wed Sep 19, 2018 12:00 am
Why is the investment / debt ratio important to you?

The only ratio that matters for your mortgage is your income-to-debt coverage ratio. If you believe your income will decline significantly in the near future then you should accelerate your mortgage payback.

If not, then you shouldn’t change a thing.
Thanks. You made a good point.

To answer your question, one main reason might be when my investment matches the debt level, suddenly I start to feel I might have borrowed too much money to invest. Maybe I should 'rebalance' the investment / debt ratio or simply reduce the debt level. :confused
You have a great interest rate locked in until 2021. Take full advantage of it. Re-evaluate in 2021 when it resets.
Thanks a lot for your comments which really clear my mind. Now I think I just confused myself about this 'investment/debt ratio' nonsense thing. I will stay the course with my investment strategy. :beer
:sharebeer

Valuethinker
Posts: 35983
Joined: Fri May 11, 2007 11:07 am

Re: Concerns over funding priority when investing with debt

Post by Valuethinker » Wed Sep 19, 2018 5:14 am

majiaknight wrote:
Tue Sep 18, 2018 7:37 pm
I've been following the below bogleheads wiki guidance to prioritize investments for several years now. However, recently several factors including the ratio of my current debt to investment portfolio, the stock market condition and the tax reform motivate me to reconsider whether I should prioritize payoff debt with the new money every month.
Some background:
  • dual-income family in mid-30s with 1 pre-school kid living in Very HCOL in CA
    32% tax bracket (Married Filing Jointly)
    ~$800K investment assets (401K+IRA+HSA+EE Savings Bond: $600K, Taxable+Emergency Fund: $200K)
    ~$600K mortgage (3% 5/1 ARM, reset in mid-2021, Primary residence now worth ~$1.4M )
Plan to max the following every year:
  • DW 401K: $18.5K (+$5.8K company match) -- done for 2018!
    Me 401K: $18.5K (+$5.5K company match) -- done for 2018!
    Backdoor Roth IRA: $5.5K x2 -- done for 2018!
    HSA: $6.9K -- on track
    Me 401K After-tax (support mega-backdoor): ~$31K -- on track but with ?
Here are my 2 questions:

1) Should I max the 401K after-tax ~$31K or save the money to pay extra principal of the mortgage?
It's generally better to maximize investment in tax deferred accounts - your annual allowances are not able to be carried over year by year (as I understand the US tax system). Only after you have done so does one look at repayment v investing.

An exception is high cost personal loans - when you are paying say 6%+ on student loans, credit card balances etc. then you probably just want to pay that off as fast as possible. Mortgage is harder because it's a liquidity backstop (have more liquid assets than if you paid off mortgage) and the interest rate is normally low.
2) As I don't plan to sell any taxable investment to accelerate the mortgage payoff, should I stop investing in taxable and pay extra principal of the mortgage each month?

Thanks!
Yes that's one way of doing it. Be careful of mental accounting - it's all just one big pool of money at the end of the day. What you want is the highest after tax return.

Dandy
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Joined: Sun Apr 25, 2010 7:42 pm

Re: Concerns over funding priority when investing with debt

Post by Dandy » Wed Sep 19, 2018 11:03 am

I tend to favor paying down mortgage, especially an ARM. Of course it depends on a lot of factors e.g. how secure is your employment, how risky is CA real estate (bubble?), etc.

What happened to some in 2008-9 was that the real estate market plunged, sales dried up and the ARMs reset. People lost jobs, couldn't afford the mortgage and lost their home. You seem to have significant financial assets so that is less likely in your case.

I'm pretty much old school (and old) so I feel if you are maximizing your retirement contributions the next priority is debt reduction/elimination. Of course my mortgage was 31k not 600k. :D

Flyer24
Posts: 281
Joined: Sun Apr 08, 2018 4:21 pm

Re: Concerns over funding priority when investing with debt

Post by Flyer24 » Wed Sep 19, 2018 11:17 am

I am in favor of paying down the mortgage if it is an ARM. It is likely the rates will jump so why not decrease the principal while it is more affordable.

KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Concerns over funding priority when investing with debt

Post by KlangFool » Wed Sep 19, 2018 11:41 am

majiaknight wrote:
Tue Sep 18, 2018 7:37 pm

~$800K investment assets (401K+IRA+HSA+EE Savings Bond: $600K, Taxable+Emergency Fund: $200K)
~$600K mortgage (3% 5/1 ARM, reset in mid-2021, Primary residence now worth ~$1.4M )[/list]

2) As I don't plan to sell any taxable investment to accelerate the mortgage payoff, should I stop investing in taxable and pay extra principal of the mortgage each month?
majiaknight,

You are "House Poor" asset wise. You have 800K investment versus a 1.4 million house. It is not wise to put more money (eggs) into the house basket.

KlangFool

ofckrupke
Posts: 531
Joined: Mon Jan 10, 2011 2:26 pm

Re: Concerns over funding priority when investing with debt

Post by ofckrupke » Wed Sep 19, 2018 12:16 pm

majiaknight wrote:
Tue Sep 18, 2018 11:23 pm
For my tax situation (32% tax bracket for 2018), I think it provides only a little tax benefit to do itemized deduction. Also, I expect to get >4% APR mortgage if I refinance before the 5/1 ARM reset in 2021. To me ~4% after tax return looks good.
Your marginal rate on taxable investments is 32+9.3+3.8*(1-0.093)% or around 44.8%.
You are SALT capped but now pay $19.2k in interest annually, so you are at least $5k into itemizing and will continue to itemize under the current loan terms until the loan balance drops by at least $100-150k (even figuring annual $400 increases in the standard deduction between now and 2021) or the rate resets. This means that until/unless the loan balance drops below the threshold, the effective return on prepays is 3%(1-.448) = 1.66%; and the duration is ~3 years (until the reset date); this is the bar an alternative low-risk investment needs to clear to be preferable to prepayment.
Vanguard Limited Term Tax-Exempt Fund has a duration of 2.5 years and the SEC yield on its Admiral Shares class is 2.03%, which is 1.84% after CA taxation. Even better: buy treasury notes maturing at the reset date; right now, the YTM on a 9/2021 is about 2.8%, which is 1.93% after fed and NII taxes.

So it should be pretty clear that there are better (comparable risk, higher yielding, more liquid) alternatives than prepaying for new money in the taxable account. Whether to pay a LTCG cost to de-risk a portion of existing taxable holdings, for re-investment in a prepayment-beating low-risk vehicle, is a separate question.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Wed Sep 19, 2018 1:16 pm

KlangFool wrote:
Wed Sep 19, 2018 11:41 am
You are "House Poor" asset wise. You have 800K investment versus a 1.4 million house. It is not wise to put more money (eggs) into the house basket.
Yes, I know. But even with $1.4M it only buys us a townhouse closer to work (no good school district). It's our primary house with no plan to sell it in the next a few years so I'm a little reluctant to count it as an "investment asset". The concern is more about the fear of another market crash like 2008 due to uncertainties in current economic/trade environment (I know this is market timing but it's hard to ignore it), where we may lose half of the investment and one of us may lose job but still have the $600K debt. At this debt level, it will be a huge pressure for a single income family with a young kid. I'll feel much more comfortable if our debt level is under $200K.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Wed Sep 19, 2018 1:21 pm

ofckrupke wrote:
Wed Sep 19, 2018 12:16 pm
Your marginal rate on taxable investments is 32+9.3+3.8*(1-0.093)% or around 44.8%.
You are SALT capped but now pay $19.2k in interest annually, so you are at least $5k into itemizing and will continue to itemize under the current loan terms until the loan balance drops by at least $100-150k (even figuring annual $400 increases in the standard deduction between now and 2021) or the rate resets. This means that until/unless the loan balance drops below the threshold, the effective return on prepays is 3%(1-.448) = 1.66%; and the duration is ~3 years (until the reset date); this is the bar an alternative low-risk investment needs to clear to be preferable to prepayment.
Vanguard Limited Term Tax-Exempt Fund has a duration of 2.5 years and the SEC yield on its Admiral Shares class is 2.03%, which is 1.84% after CA taxation. Even better: buy treasury notes maturing at the reset date; right now, the YTM on a 9/2021 is about 2.8%, which is 1.93% after fed and NII taxes.

So it should be pretty clear that there are better (comparable risk, higher yielding, more liquid) alternatives than prepaying for new money in the taxable account. Whether to pay a LTCG cost to de-risk a portion of existing taxable holdings, for re-investment in a prepayment-beating low-risk vehicle, is a separate question.
Thanks for the detailed calculations. Yes, I will re-evaluate the mortgage prepayment options in early 2021 when the 5/1 ARM resets.

KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Concerns over funding priority when investing with debt

Post by KlangFool » Wed Sep 19, 2018 1:38 pm

majiaknight wrote:
Wed Sep 19, 2018 1:16 pm
KlangFool wrote:
Wed Sep 19, 2018 11:41 am
You are "House Poor" asset wise. You have 800K investment versus a 1.4 million house. It is not wise to put more money (eggs) into the house basket.
Yes, I know. But even with $1.4M it only buys us a townhouse closer to work (no good school district). It's our primary house with no plan to sell it in the next a few years so I'm a little reluctant to count it as an "investment asset". The concern is more about the fear of another market crash like 2008 due to uncertainties in current economic/trade environment (I know this is market timing but it's hard to ignore it), where we may lose half of the investment and one of us may lose job but still have the $600K debt. At this debt level, it will be a huge pressure for a single income family with a young kid. I'll feel much more comfortable if our debt level is under $200K.
majiaknight,

<< I'll feel much more comfortable if our debt level is under $200K.>>

That does not make any sense. You have a 1.4M house. It is an illiquid asset. Keeping the debt level at 200K simply mean that you have a lot of eggs in the house basket. Your investment is not going to reach 2M or more any time soon. So, it is not safer to keep your debt at 200K. Plus you are in CA. It is a non-recourse loan state. You could walk away from the house if you need to. It is safer to pay as little as possible into the mortgage.

It is safer not to prepay the mortgage if you are afraid of the market crashes.

KlangFool
Last edited by KlangFool on Wed Sep 19, 2018 1:44 pm, edited 1 time in total.

ofckrupke
Posts: 531
Joined: Mon Jan 10, 2011 2:26 pm

Re: Concerns over funding priority when investing with debt

Post by ofckrupke » Wed Sep 19, 2018 1:43 pm

majiaknight wrote:
Wed Sep 19, 2018 1:21 pm
ofckrupke wrote:
Wed Sep 19, 2018 12:16 pm
Your marginal rate on taxable investments is 32+9.3+3.8*(1-0.093)% or around 44.8%.
You are SALT capped but now pay $19.2k $18k in interest annually, so you are at least $5k 4k into itemizing and will continue to itemize under the current loan terms until the loan balance drops by at least $100-150k (even figuring annual $400 increases in the standard deduction between now and 2021) or the rate resets. This means that until/unless the loan balance drops below the threshold, the effective return on prepays is 3%(1-.448) = 1.66%; and the duration is ~3 years (until the reset date); this is the bar an alternative low-risk investment needs to clear to be preferable to prepayment.
Vanguard Limited Term Tax-Exempt Fund has a duration of 2.5 years and the SEC yield on its Admiral Shares class is 2.03%, which is 1.84% after CA taxation. Even better: buy treasury notes maturing at the reset date; right now, the YTM on a 9/2021 is about 2.8% 2.9%, which is 1.93% 1.86% after fed and NII taxes.

So it should be pretty clear that there are better (comparable risk, higher yielding, more liquid) alternatives than prepaying for new money in the taxable account. Whether to pay a LTCG cost to de-risk a portion of existing taxable holdings, for re-investment in a prepayment-beating low-risk vehicle, is a separate question.
Thanks for the detailed calculations.
See strikethroughs and bolded corrections above. Need a scratching-head emoticon.

Following your reply to KF I'd say debt and liquidity concerns are interlinked and that you should probably re-direct the $31k annual that would have gone to Roth by megabackdoor into a low-risk debt-payoff/endowment sleeve in your taxable account, that can alternatively be bled through a protracted unemployment period to keep the house, in lieu of fair-weather liquidation of appreciated riskful holdings in taxable (unless they are bat-crazy stuff like employer stock). Keep in mind that in a worst case scenario the tax cost of liquidating the existing investments will drop through tax rate effects as well as likely gain erosion.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Wed Sep 19, 2018 6:35 pm

KlangFool wrote:
Wed Sep 19, 2018 1:38 pm
<< I'll feel much more comfortable if our debt level is under $200K.>>

That does not make any sense. You have a 1.4M house. It is an illiquid asset. Keeping the debt level at 200K simply mean that you have a lot of eggs in the house basket. Your investment is not going to reach 2M or more any time soon. So, it is not safer to keep your debt at 200K. Plus you are in CA. It is a non-recourse loan state. You could walk away from the house if you need to. It is safer to pay as little as possible into the mortgage.

It is safer not to prepay the mortgage if you are afraid of the market crashes.

KlangFool
Thanks. I think I understand your points better now. But I believe some folks including my wife won't agree with your way of looking at the primary house emotionally.

HornedToad
Posts: 888
Joined: Wed May 21, 2008 12:36 am

Re: Concerns over funding priority when investing with debt

Post by HornedToad » Wed Sep 19, 2018 6:51 pm

HEDGEFUNDIE wrote:
Wed Sep 19, 2018 12:19 am
majiaknight wrote:
Wed Sep 19, 2018 12:14 am
HEDGEFUNDIE wrote:
Wed Sep 19, 2018 12:00 am
Why is the investment / debt ratio important to you?

The only ratio that matters for your mortgage is your income-to-debt coverage ratio. If you believe your income will decline significantly in the near future then you should accelerate your mortgage payback.

If not, then you shouldn’t change a thing.
Thanks. You made a good point.

To answer your question, one main reason might be when my investment matches the debt level, suddenly I start to feel I might have borrowed too much money to invest. Maybe I should 'rebalance' the investment / debt ratio or simply reduce the debt level. :confused
You have a great interest rate locked in until 2021. Take full advantage of it. Re-evaluate in 2021 when it resets.
This. Evaluate when rate changes. You can always sell stocks then to pay off the mortgage if it's the right decision at that time.

Edit: I would also go top-down and decide on what your goals are. Are you saving more in Mega Backdoor Roth because you want to retire early or don't know what else to do with the money? Do you have plans for buying a different house anytime in the next 5 years and would you keep the current house or sell it, etc. It's easy when have excess cash to just keep throwing it into retirement accounts (and that's obviously not a poor decision by any means) but it can be helpful to figure out what the purpose of the money is for and how you want to use it and that will help drive your decisions.
Last edited by HornedToad on Wed Sep 19, 2018 6:54 pm, edited 1 time in total.

KlangFool
Posts: 10176
Joined: Sat Oct 11, 2008 12:35 pm

Re: Concerns over funding priority when investing with debt

Post by KlangFool » Wed Sep 19, 2018 6:52 pm

majiaknight wrote:
Wed Sep 19, 2018 6:35 pm
KlangFool wrote:
Wed Sep 19, 2018 1:38 pm
<< I'll feel much more comfortable if our debt level is under $200K.>>

That does not make any sense. You have a 1.4M house. It is an illiquid asset. Keeping the debt level at 200K simply mean that you have a lot of eggs in the house basket. Your investment is not going to reach 2M or more any time soon. So, it is not safer to keep your debt at 200K. Plus you are in CA. It is a non-recourse loan state. You could walk away from the house if you need to. It is safer to pay as little as possible into the mortgage.

It is safer not to prepay the mortgage if you are afraid of the market crashes.

KlangFool
Thanks. I think I understand your points better now. But I believe some folks including my wife won't agree with your way of looking at the primary house emotionally.
majiaknight,

The only reason why you stay at this location is that of the jobs. If both of you are unemployed, you are given the choice of

A) Stay at this location and bleed to death financially. Lose both the house and any remaining asset eventually.

Or,

B) Abandon the house and use the remaining asset to start over somewhere else

What would you choose?

With a 1.4M house and VHCOL, you would not last long at this location if both of you are unemployed.

I had been through this many times. Many folks did not survive because they were too attached to their houses. Between sheltering and feeding your family versus a house, which one should take priority?

Ask your wife is the house more important or the family is more important?

You are "House Poor".

Have you calculated how long can you survive if

A) Both of you are unemployed.

B) Both housing and stock market drops 50% and stays down at the same time

I am prepared for at least 5 years.

KlangFool

HornedToad
Posts: 888
Joined: Wed May 21, 2008 12:36 am

Re: Concerns over funding priority when investing with debt

Post by HornedToad » Wed Sep 19, 2018 6:56 pm

KlangFool wrote:
Wed Sep 19, 2018 6:52 pm
majiaknight wrote:
Wed Sep 19, 2018 6:35 pm
KlangFool wrote:
Wed Sep 19, 2018 1:38 pm
<< I'll feel much more comfortable if our debt level is under $200K.>>

That does not make any sense. You have a 1.4M house. It is an illiquid asset. Keeping the debt level at 200K simply mean that you have a lot of eggs in the house basket. Your investment is not going to reach 2M or more any time soon. So, it is not safer to keep your debt at 200K. Plus you are in CA. It is a non-recourse loan state. You could walk away from the house if you need to. It is safer to pay as little as possible into the mortgage.

It is safer not to prepay the mortgage if you are afraid of the market crashes.

KlangFool
Thanks. I think I understand your points better now. But I believe some folks including my wife won't agree with your way of looking at the primary house emotionally.
majiaknight,

The only reason why you stay at this location is that of the jobs. If both of you are unemployed, you are given the choice of

A) Stay at this location and bleed to death financially. Lose both the house and any remaining asset eventually.

Or,

B) Abandon the house and use the remaining asset to start over somewhere else

What would you choose?

With a 1.4M house and VHCOL, you would not last long at this location if both of you are unemployed.

I had been through this many times. Many folks did not survive because they were too attached to their houses. Between sheltering and feeding your family versus a house, which one should take priority?

Ask your wife is the house more important or the family is more important?

You are "House Poor".

Have you calculated how long can you survive if

A) Both of you are unemployed.

B) Both housing and stock market drops 50% and stays down at the same time

I am prepared for at least 5 years.

KlangFool
He has $200k in Taxable/Emergency funds. That would certainly last him awhile if they lost their jobs. However, your point about more taxable investments being safer than paying down mortgage in the event of job loss is a good one and why he shouldn't prepay until 2021 when rate resets and if he could pay OFF the mortgage, not just pay it down.

KlangFool
Posts: 10176
Joined: Sat Oct 11, 2008 12:35 pm

Re: Concerns over funding priority when investing with debt

Post by KlangFool » Wed Sep 19, 2018 7:03 pm

HornedToad wrote:
Wed Sep 19, 2018 6:56 pm
KlangFool wrote:
Wed Sep 19, 2018 6:52 pm
majiaknight wrote:
Wed Sep 19, 2018 6:35 pm
KlangFool wrote:
Wed Sep 19, 2018 1:38 pm
<< I'll feel much more comfortable if our debt level is under $200K.>>

That does not make any sense. You have a 1.4M house. It is an illiquid asset. Keeping the debt level at 200K simply mean that you have a lot of eggs in the house basket. Your investment is not going to reach 2M or more any time soon. So, it is not safer to keep your debt at 200K. Plus you are in CA. It is a non-recourse loan state. You could walk away from the house if you need to. It is safer to pay as little as possible into the mortgage.

It is safer not to prepay the mortgage if you are afraid of the market crashes.

KlangFool
Thanks. I think I understand your points better now. But I believe some folks including my wife won't agree with your way of looking at the primary house emotionally.
majiaknight,

The only reason why you stay at this location is that of the jobs. If both of you are unemployed, you are given the choice of

A) Stay at this location and bleed to death financially. Lose both the house and any remaining asset eventually.

Or,

B) Abandon the house and use the remaining asset to start over somewhere else

What would you choose?

With a 1.4M house and VHCOL, you would not last long at this location if both of you are unemployed.

I had been through this many times. Many folks did not survive because they were too attached to their houses. Between sheltering and feeding your family versus a house, which one should take priority?

Ask your wife is the house more important or the family is more important?

You are "House Poor".

Have you calculated how long can you survive if

A) Both of you are unemployed.

B) Both housing and stock market drops 50% and stays down at the same time

I am prepared for at least 5 years.

KlangFool
He has $200k in Taxable/Emergency funds. That would certainly last him awhile if they lost their jobs. However, your point about more taxable investments being safer than paying down mortgage in the event of job loss is a good one and why he shouldn't prepay until 2021 when rate resets and if he could pay OFF the mortgage, not just pay it down.
HornedToad,

<<He has $200k in Taxable/Emergency funds. That would certainly last him awhile if they lost their jobs. >>

1) We do not know how much of that 200K is stock or cash equivalent. Aka, how much of that 200K will remain after 50% market drop.

2) We do not know OP's annual expense.

3) In general, it is harder and takes longer to find a higher paying job.

4) In the worst case aka recession/economy crisis, no one knows how long someone needs to find a new job.

In summary, OP should calculate how long he could survive ahead of time.

One of my neighbors lost his job while his ARM reset in the 2008/2009 recession. It happened to many other folks too.

KlangFool

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Wed Sep 19, 2018 7:34 pm

KlangFool wrote:
Wed Sep 19, 2018 6:52 pm
The only reason why you stay at this location is that of the jobs. If both of you are unemployed, you are given the choice of

A) Stay at this location and bleed to death financially. Lose both the house and any remaining asset eventually.

Or,

B) Abandon the house and use the remaining asset to start over somewhere else

What would you choose?

With a 1.4M house and VHCOL, you would not last long at this location if both of you are unemployed.

I had been through this many times. Many folks did not survive because they were too attached to their houses. Between sheltering and feeding your family versus a house, which one should take priority?

Ask your wife is the house more important or the family is more important?

You are "House Poor".

Have you calculated how long can you survive if

A) Both of you are unemployed.

B) Both housing and stock market drops 50% and stays down at the same time

I am prepared for at least 5 years.

KlangFool
Wow, are you saying 5 years w/o any income? Based on my family's current expenses (tuition, property tax, insurance, mortgage all included) it means ~$8.5/month*12*5 = $510K !
That's extremely conservative. We would probably move after 1-year unemployment in that worst case scenario. We should be able to find high-tech jobs in other countries easily but w/ lower pay. TBH I have only prepared for 6-8 months. We were both in graduate school during the 2008 recession. So, we haven't been through any crisis yet.

KlangFool
Posts: 10176
Joined: Sat Oct 11, 2008 12:35 pm

Re: Concerns over funding priority when investing with debt

Post by KlangFool » Wed Sep 19, 2018 7:50 pm

majiaknight wrote:
Wed Sep 19, 2018 7:34 pm
KlangFool wrote:
Wed Sep 19, 2018 6:52 pm
The only reason why you stay at this location is that of the jobs. If both of you are unemployed, you are given the choice of

A) Stay at this location and bleed to death financially. Lose both the house and any remaining asset eventually.

Or,

B) Abandon the house and use the remaining asset to start over somewhere else

What would you choose?

With a 1.4M house and VHCOL, you would not last long at this location if both of you are unemployed.

I had been through this many times. Many folks did not survive because they were too attached to their houses. Between sheltering and feeding your family versus a house, which one should take priority?

Ask your wife is the house more important or the family is more important?

You are "House Poor".

Have you calculated how long can you survive if

A) Both of you are unemployed.

B) Both housing and stock market drops 50% and stays down at the same time

I am prepared for at least 5 years.

KlangFool
Wow, are you saying 5 years w/o any income? Based on my family's current expenses (tuition, property tax, insurance, mortgage all included) it means ~$8.5/month*12*5 = $510K !
That's extremely conservative. We would probably move after 1-year unemployment in that worst case scenario. We should be able to find high-tech jobs in other countries easily but w/ lower pay. TBH I have only prepared for 6-8 months. We were both in graduate school during the 2008 recession. So, we haven't been through any crisis yet.
majiaknight,

<<We would probably move after 1-year unemployment in that worst case scenario. >>

A) Then, why would you tie up more money with the house? You may not be able to sell the house within a year without a huge loss.

B) Even if you move, you still have to pay the mortgage and property tax of 40K to 60K. And, if you get a lower pay job, you may force to sell the house at a big loss if you run out of money.

<<That's extremely conservative.>>

1) My annual expense is 60K per year. I am not "House Poor". My total investment is about 3 times my house's price. My emergency fund is 90K. My taxable account is 500K at 100% stock. So, even after dropping 50%, I have 250K. Plus my emergency fund of 90K, I have 340K.

2) My plan is to survive the next recession whenever it shows up. My prediction is it will occur between now and next year.

KlangFool

MotoTrojan
Posts: 2276
Joined: Wed Feb 01, 2017 8:39 pm

Re: Concerns over funding priority when investing with debt

Post by MotoTrojan » Wed Sep 19, 2018 7:57 pm

I am not very familiar with a mega-backdoor Roth, but my understanding is that the money grows tax-free. Thus there is no reason I can even begin to think of where it would make sense to stop investing in the mega-Roth, and instead invest in taxable.

So max the tax-advantaged, and then put anything else into the mortgage is my vote. You have a plenty (maybe too depending on AA) large emergency fund/taxable account.

Dottie57
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Joined: Thu May 19, 2016 5:43 pm

Re: Concerns over funding priority when investing with debt

Post by Dottie57 » Wed Sep 19, 2018 8:09 pm

Looking at Klangfool’s posts, I would really start beefing up emergency fund. I do think that having a good amount in taxable brokerage account would be good. I wish I had made more effort to do so.

Right now my home is 12% of networth. Work to get a better balance.

JBTX
Posts: 4043
Joined: Wed Jul 26, 2017 12:46 pm

Re: Concerns over funding priority when investing with debt

Post by JBTX » Wed Sep 19, 2018 8:12 pm

majiaknight wrote:
Tue Sep 18, 2018 7:37 pm
I've been following the below bogleheads wiki guidance to prioritize investments for several years now. However, recently several factors including the ratio of my current debt to investment portfolio, the stock market condition and the tax reform motivate me to reconsider whether I should prioritize payoff debt with the new money every month.
Some background:
  • dual-income family in mid-30s with 1 pre-school kid living in Very HCOL in CA
    32% tax bracket (Married Filing Jointly)
    ~$800K investment assets (401K+IRA+HSA+EE Savings Bond: $600K, Taxable+Emergency Fund: $200K)
    ~$600K mortgage (3% 5/1 ARM, reset in mid-2021, Primary residence now worth ~$1.4M )
Plan to max the following every year:
  • DW 401K: $18.5K (+$5.8K company match) -- done for 2018!
    Me 401K: $18.5K (+$5.5K company match) -- done for 2018!
    Backdoor Roth IRA: $5.5K x2 -- done for 2018!
    HSA: $6.9K -- on track
    Me 401K After-tax (support mega-backdoor): ~$31K -- on track but with ?
Here are my 2 questions:

1) Should I max the 401K after-tax ~$31K or save the money to pay extra principal of the mortgage?
I would definitely not pay off the mortgage now at 3%. However, when it resets, depending on where it is at, you may want to work to pay it off. Or maybe refinancing will be an option. I depends entirely on what the rate turns out to be.

Should you do the full after tax mega backdoor roth? That is a tough call. Normally I'd say yes, but it would be nice to have some reserve in case interest rates/reset mortgage happen to go up a lot. I'd probably do the after tax / mega backdoor.

2) As I don't plan to sell any taxable investment to accelerate the mortgage payoff, should I stop investing in taxable and pay extra principal of the mortgage each month?

Thanks!
No. Either use money to do mega backdoor roth, or else accumulate in taxable, and if rates go up a lot, then consider paying off.

KlangFool
Posts: 10176
Joined: Sat Oct 11, 2008 12:35 pm

Re: Concerns over funding priority when investing with debt

Post by KlangFool » Wed Sep 19, 2018 8:13 pm

MotoTrojan wrote:
Wed Sep 19, 2018 7:57 pm
I am not very familiar with a mega-backdoor Roth, but my understanding is that the money grows tax-free. Thus there is no reason I can even begin to think of where it would make sense to stop investing in the mega-Roth, and instead invest in taxable.

So max the tax-advantaged, and then put anything else into the mortgage is my vote. You have a plenty (maybe too depending on AA) large emergency fund/taxable account.
MotoTrojan,

OP only has 6 months to 8 months worth of emergency fund. So, it is not that large.

KlangFool

HornedToad
Posts: 888
Joined: Wed May 21, 2008 12:36 am

Re: Concerns over funding priority when investing with debt

Post by HornedToad » Wed Sep 19, 2018 10:06 pm

MotoTrojan wrote:
Wed Sep 19, 2018 7:57 pm
I am not very familiar with a mega-backdoor Roth, but my understanding is that the money grows tax-free. Thus there is no reason I can even begin to think of where it would make sense to stop investing in the mega-Roth, and instead invest in taxable.

So max the tax-advantaged, and then put anything else into the mortgage is my vote. You have a plenty (maybe too depending on AA) large emergency fund/taxable account.
I was thinking taxable for future house fund if needed, college, new car, splurge vacation, investment property, etc. But I guess with Roth since you can always withdrawal the contribution at anytime then you could just save there. I prefer to treat retirement funds as untouchable in general.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Wed Sep 19, 2018 11:20 pm

KlangFool wrote:
Wed Sep 19, 2018 7:50 pm

<<We would probably move after 1-year unemployment in that worst case scenario. >>

A) Then, why would you tie up more money with the house? You may not be able to sell the house within a year without a huge loss.

B) Even if you move, you still have to pay the mortgage and property tax of 40K to 60K. And, if you get a lower pay job, you may force to sell the house at a big loss if you run out of money.

<<That's extremely conservative.>>

1) My annual expense is 60K per year. I am not "House Poor". My total investment is about 3 times my house's price. My emergency fund is 90K. My taxable account is 500K at 100% stock. So, even after dropping 50%, I have 250K. Plus my emergency fund of 90K, I have 340K.

2) My plan is to survive the next recession whenever it shows up. My prediction is it will occur between now and next year.

KlangFool
Re: A) As I said I never thought of the scenario that both DW and I would have unemployment for long time. The main reason why we relocated to the Bay area several years back was because of higher job security in high tech for both of us.

Re: B) We may also have the option to rent out the house in that case which should be able to cover the ~$43K/Year Mortgage+Property Tax.

After all I think you're right that I'm a little short of emergency fund which I may add more to cover 12+ months expenses in the near future.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Wed Sep 19, 2018 11:51 pm

@All: thank you for all the above excellent comments and suggestions. Below are my takeaways:

1) Continue to max the 401K after-tax ~$31K (mega-backdoor to roth to take advantage of the tax free growth);
2) Use the extra money to build a reserve fund (buy treasury, CD ladder, iBond?) until the 5/1 ARM reset in mid-2021 and then decide whether to do mortgage prepayment depending on the refinance rate;
3) Increase the emergency fund to cover 12+ month expenses. :beer

KlangFool
Posts: 10176
Joined: Sat Oct 11, 2008 12:35 pm

Re: Concerns over funding priority when investing with debt

Post by KlangFool » Thu Sep 20, 2018 7:16 am

majiaknight wrote:
Wed Sep 19, 2018 11:20 pm
KlangFool wrote:
Wed Sep 19, 2018 7:50 pm

<<We would probably move after 1-year unemployment in that worst case scenario. >>

A) Then, why would you tie up more money with the house? You may not be able to sell the house within a year without a huge loss.

B) Even if you move, you still have to pay the mortgage and property tax of 40K to 60K. And, if you get a lower pay job, you may force to sell the house at a big loss if you run out of money.

<<That's extremely conservative.>>

1) My annual expense is 60K per year. I am not "House Poor". My total investment is about 3 times my house's price. My emergency fund is 90K. My taxable account is 500K at 100% stock. So, even after dropping 50%, I have 250K. Plus my emergency fund of 90K, I have 340K.

2) My plan is to survive the next recession whenever it shows up. My prediction is it will occur between now and next year.

KlangFool
Re: A) As I said I never thought of the scenario that both DW and I would have unemployment for long time. The main reason why we relocated to the Bay area several years back was because of higher job security in high tech for both of us.

Re: B) We may also have the option to rent out the house in that case which should be able to cover the ~$43K/Year Mortgage+Property Tax.

After all I think you're right that I'm a little short of emergency fund which I may add more to cover 12+ months expenses in the near future.
majiaknight,

A) i) In a recession, the whole industry may not be hiring regardless of where you are. Folks in a VHCOL area will not last as long.

ii) 1 year of unemployment is not very long in that kind of situation.

B) In a full-scale recession, nobody is renting or buying the house. They can't. They have no job and their businesses are losing money.

It is better to be prepared.

KlangFool

CoAndy
Posts: 526
Joined: Thu Jun 06, 2013 4:45 pm

Re: Concerns over funding priority when investing with debt

Post by CoAndy » Thu Sep 20, 2018 9:26 am

As long as you have a nice emergency fund, I would continue maxing out both 401(k)'s and maybe cut the after tax investment in half, to $15.5k and then throw the other $15.5k to the mortgage every year. Seems like a good balance.

majiaknight
Posts: 52
Joined: Tue Jan 26, 2016 2:55 pm

Re: Concerns over funding priority when investing with debt

Post by majiaknight » Thu Sep 20, 2018 3:41 pm

KlangFool wrote:
Thu Sep 20, 2018 7:16 am

A) i) In a recession, the whole industry may not be hiring regardless of where you are. Folks in a VHCOL area will not last as long.

ii) 1 year of unemployment is not very long in that kind of situation.

B) In a full-scale recession, nobody is renting or buying the house. They can't. They have no job and their businesses are losing money.

It is better to be prepared.

KlangFool
Hi KF, Thanks a lot for sharing your insights. I fully understand your points, but I could also see there is a potentially big difference in terms of tolerance level of calculated risk between individuals. Please allow me to use the below chart to explain my view.
  • If I do the risk analysis of the above scenario like you described (e.g. full scale recession), I'd probably give it a Medium risk rating (Likelihood: Unlikely-Rare, Impact: Extreme). Should I care about it? Yes. Should I seriously prepare for it? IMHO the answer is maybe.
  • For another scenario that I may be more concerned about could be a big economic recession w/ 12+ month unemployment which I will give it probably a Medium-High risk rating (Likelihood: Moderate-Likely, Impact: Major).
You may not agree with my above ratings but that's totally fine as some criteria are subjective.

Image

KlangFool
Posts: 10176
Joined: Sat Oct 11, 2008 12:35 pm

Re: Concerns over funding priority when investing with debt

Post by KlangFool » Thu Sep 20, 2018 4:10 pm

majiaknight wrote:
Thu Sep 20, 2018 3:41 pm
KlangFool wrote:
Thu Sep 20, 2018 7:16 am

A) i) In a recession, the whole industry may not be hiring regardless of where you are. Folks in a VHCOL area will not last as long.

ii) 1 year of unemployment is not very long in that kind of situation.

B) In a full-scale recession, nobody is renting or buying the house. They can't. They have no job and their businesses are losing money.

It is better to be prepared.

KlangFool
Hi KF, Thanks a lot for sharing your insights. I fully understand your points, but I could also see there is a potentially big difference in terms of tolerance level of calculated risk between individuals. Please allow me to use the below chart to explain my view.
  • If I do the risk analysis of the above scenario like you described (e.g. full scale recession), I'd probably give it a Medium risk rating (Likelihood: Unlikely-Rare, Impact: Extreme). Should I care about it? Yes. Should I seriously prepare for it? IMHO the answer is maybe.
  • For another scenario that I may be more concerned about could be a big economic recession w/ 12+ month unemployment which I will give it probably a Medium-High risk rating (Likelihood: Moderate-Likely, Impact: Major).
You may not agree with my above ratings but that's totally fine as some criteria are subjective.

Image
majiaknight,

You are not a statistic. You are an individual. You cannot be 50% unemployed. So, probability and statistic are irrelevant to you.

You have to survive in order to succeed.

Please read the following article.

https://www.collaborativefund.com/blog/ ... -of-money/

<< 16. Optimism bias in risk-taking, or “Russian Roulette should statistically work” syndrome:
An over attachment to favorable odds when the downside is unacceptable in any circumstance.

Nassim Taleb says, “You can be risk loving and yet completely averse to ruin.”

The idea is that you have to take risk to get ahead, but no risk that could wipe you out is ever worth taking. The odds are in your favor when playing Russian Roulette. But the downside is never worth the potential upside.

The odds of something can be in your favor -- real estate prices go up most years, and most years you’ll get a paycheck every other week -- but if something has 95% odds of being right, then 5% odds of being wrong means you will almost certainly experience the downside at some point in your life. And if the cost of the downside is ruin, the upside the other 95% of the time likely isn’t worth the risk, no matter how appealing it looks>>

KlangFool

KlangFool
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Re: Concerns over funding priority when investing with debt

Post by KlangFool » Thu Sep 20, 2018 4:29 pm

OP,

I had been through many recessions and economic crisis. I had been unemployed for more than 1 year a few times. Through those experiences, I had learned that it makes a lot of difference how big your emergency fund is.

1) If you know you can only last 6 months before you need to sell an investment at a loss, you will not negotiate as hard for any job offer. Then, you will settle for any job offer that shows up. If you do that, you will be stuck at lower pay for many years.

2) If you know that you can survive 2 years without any permanent financial damage (sell your house or investment at a huge loss), you are in a better and stronger negotiating position for any new jobs.

In any case, do you really want to "Sleep Well At Night" (SWAN)? Those sleep are precious if and when laid off start happening at your employer and industry. If you are prepared, you do not need to worry. You know that you will not be harm under any circumstances.

I had been there. I survived 10+ years of quarterly and annual laid off. I could sleep well across multiple recession and economic crisis. I plan to SWAN across the next one too.

Are you prepared?

The preparation is minimal anyhow.

A) Increase your emergency fund.

B) Do not prepay your mortgage

C) Change your AA to be less aggressive.

Aren't (A) to (C) worth SWAN? The cost is minimum anyhow.

KlangFool

Flyer24
Posts: 281
Joined: Sun Apr 08, 2018 4:21 pm

Re: Concerns over funding priority when investing with debt

Post by Flyer24 » Thu Sep 20, 2018 4:43 pm

OP is doing very well. He is in his mid 30’s with dual income and approaching a million in retirement assets. Since is his already maximizing his retirement, I think it is a great idea to reduce the mortgage debt with prepay. I would do it in a heartbeat.

bloom2708
Posts: 4791
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Location: Fargo, ND

Re: Concerns over funding priority when investing with debt

Post by bloom2708 » Thu Sep 20, 2018 4:55 pm

Flyer24 wrote:
Thu Sep 20, 2018 4:43 pm
OP is doing very well. He is in his mid 30’s with dual income and approaching a million in retirement assets. Since is his already maximizing his retirement, I think it is a great idea to reduce the mortgage debt with prepay. I would do it in a heartbeat.
+1

Beef up the Emergency Fund. I would pay down the mortgage over the post-tax 401k.

Maybe at some point in the future a $600k mortgage will be considered small. Even on a $1.4 million home, I still consider a $600k mortgage a large number. I know it is all relative. We are in a LCOL area and never borrowed more than $130k. Even that amount kind of freaked me out for a number of years. Nothing wrong with chopping at it from both sides, especially when filling all the other buckets. The debt has to go at some point. :wink:
Where to spend your time: | 1. You completely control <--spend your time here! | 2. You partially control <--spend your time here! | 3. You have no control <--spend no time here!

KlangFool
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Re: Concerns over funding priority when investing with debt

Post by KlangFool » Thu Sep 20, 2018 5:17 pm

majiaknight wrote:
Tue Sep 18, 2018 7:37 pm

~$800K investment assets (401K+IRA+HSA+EE Savings Bond: $600K, Taxable+Emergency Fund: $200K)
~$600K mortgage (3% 5/1 ARM, reset in mid-2021, Primary residence now worth ~$1.4M )[/list]
majiaknight,

Let's assume that your annual expense is 100K per year. And, your AA including emergency fund is 60/40.

Your net worth is 1.6 million with 800K outside the house and 800K inside the house.

Let's assume that your emergency fund is 80K and the other 120K is 100% stock. At 60/40, it means that your other accounts are 360K in stock and 240K in bond.

If the stock market and housing market drops 50%, your house is only worth 700K and your portfolio are only worth 70% = 560K.

Your taxable account is only 80K + 60K = 140K. Your other accounts are 180K (stock) + 240K (bond) = 420K.

After 14 months of spending down the taxable account, you need to spend your Roth IRA contribution. Beyond that, you need to pay 10% tax penalty.

In this case, you have 80K of the emergency fund and 240K of the bond, you can last 32 months before you need to sell the stock and lock in the loss.

This is assuming that your AA is 60/40. If it is more aggressive, your safety margin is lower.

KlangFool

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