Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

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InvestVS
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Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by InvestVS » Mon Oct 14, 2019 1:51 am

Hi, we have been spending a lot of time in Bogleheads lately; thanks for creating such a wonderful community. We are looking at getting the investment & planning advice from this community.

Emergency funds: Yes, for 6 Months expenses

Tax Filing Status: Married Filing Jointly

Tax Rate: 37% Federal, 11.3% State

State of Residence: California

Age: 45, 43

Kids and College Plan:
(We are planning to put $30K for both kids 529 for next 4 years to bring them to near $150K each so that it can pay their 80-90% of college fee)
1. Kid 1 going to college in 2022, have $32K in each 529 account, Invested in Vanguard Aggressive Age-Based Option: Vanguard Moderate Growth Portfolio
2. Kid 2 going to college in 2027, has $32K in each 529 account, Invested in Vanguard Aggressive Age-Based Option: Vanguard 70% Stock/30% Bond

Debt:
1. Home Loan $925K, Interest rate 2.875%, 7 Years ARM, 2.875% Rate will finish in 2023 (rate will increase by 2% after that for the first year)
2. Car Loan $48K Interest rate 0.99%, Will be fully paid in 2023


Portfolio:
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 30% of stocks

Portfolio Size: 3.18M
Cash: 15% (470K) (In Vangaurd Treasury Money Market Fund)
Bond: 16%
International: 15.5%
US Market: 50.5%
REIT: 3%

New annual Contributions:
$19000 his 401k
10K Employer Match for his 401k
$19000 her 401k
5K Employer Match for her 401k
$100K-$200K for long term retirement investment through annual savings and RSU vestings
30K for kid 1 529 (for 4 more years)
30K for kid 2 529 (for 4 more years)

Goals:
Long term financial savings to achieve financial independence by 52-55 age. We do not want to retire at 52-55 age but my take less stressful, more enjoyable and less paying job to relax and enjoy life more (and also get medical insurance through our employer).

Some details for our risk ability, willingness, and need -

Ability to take the risk:
- Investment horizon: Long term, does not need money in the short term
- Stability of your earned income: Our income is pretty stable, in case one of us loses the job; hopefully other will still have the job and we can find a new job in 3-4 months easily.
- The need for liquidity: May need money to buy some investment property if real estate market crash
- Options that can be exercised should your existing plan fail to meet your objective: We will be getting 100-200K of RSU getting vested each year, can use those for some urgent cash need. Also, we can continue to work beyond 52-55 ages.

Willingness to take the risk: Yes

The need to take the risk:
As we are looking to achieve financial independence by 52-55 age, we feel we have a need to take some risk. In the worst case, we can continue to work beyond 52-55 ages. However large value of our portfolio (all our life's savings) also makes us feel that we should reduce the risk - NEED SOME GUIDANCE HERE FROM EXPERTS!

Questions:
Based upon Mr. Bogle's last interview where he suggested to hold a little larger than the desired allocation in bond as he foresees turbulence in the market for the next couple of years, I have kept this cash outside of the market to reduce my risk as I just have 16% off in Bonds. This makes cash and bond as 31% of my portfolio. If there is a market crash in the next 1-2 years; I was thinking of using 10% for this cash to buy index funds to bring my asset allocation to 80% stocks / 20% bonds.

Another reason for this cash was to explore if we can buy another house when the market goes a little down (we live in silicon valley) for investment.

Now I had this cash for almost this whole year and as nobody can predict, I am not sure when is the recession is coming to give me opportunity to buy at dip or real estate market crash to give me to buy real estate investment at dip (I got it, both of these are market timing). So I starting exploring what is the best option for this cash.

Option 1: Keep the cash in the Money Market Fund and wait for market or real estate to go down to buy at that time. It's reducing my portfolio risk in the meantime but not earning a lot till then.

Option 2: Use Dollar cost average and start putting this money in Index funds based upon my Asset Allocation. The risk here is that when the market is down I will not have large cash to buy some more at discount.

Option 3: Pay off my mortgage. I have some sub-options here.
- Option 3a: Pay off my mortgage 100% now.
- Option 3b: Pay off my mortgage 100% in 2023 when 7 years ARM term ends and the rate goes up.
- Option 3c: Refinance to a 15-year Fixed-rate as rate looks good right now. I can probably get 3.25% rate for a 15-year Fixed-rate.

Please advise which one of these options will be better.

Thanks for reading our post and we appreciate all your suggestions!
Last edited by InvestVS on Mon Oct 14, 2019 2:45 pm, edited 1 time in total.

Jimsad
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by Jimsad » Mon Oct 14, 2019 5:16 am

I think you should refinance and put the cash to work by investing

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RickBoglehead
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by RickBoglehead » Mon Oct 14, 2019 5:29 am

OP, I suspect your ARM rate COULD increase UP TO 2%, per year WITH a max increase of perhaps 6%.

Since you are years away, I would leave the mortgage alone for now, revisit every 6 months for refinancing to a fixed term loan if rates drop.
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grabiner
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by grabiner » Mon Oct 14, 2019 8:01 am

InvestVS wrote:
Mon Oct 14, 2019 1:51 am
Tax Rate: 37% Federal, 11.3% State
1. Home Loan $925K, Interest rate 2.875%, 7 Years ARM, 2.875% Rate will finish in 2023 (rate will increase by 2% after that for the first year)
That is enough interest that any prepayment will be against fully deductible interest (with $10K in state tax, you can deduct all mortgage interest over $14,400 even if you contribute nothing to charity), so your return is only 1.49% on a mortgage prepayment. If you refinance to 15 years fixed at 3.25%, you lock in an after-tax rate of 1.68% for 15 years.

At those rates, you would be better off investing in CA municipal bonds. Admiral shares of Vanguard CA Long-Term Tax-Exempt yield 1.77%, so you could refinance the mortgage to 15 years, invest your cash in the CA muni fund, and come out slightly ahead. You would also retain the option of keeping the mortgage (if rates rise) or paying it off later (if rates fall, or if rates stay the same for long enough that the muni duration becomes less than the mortgage duration.)
Wiki David Grabiner

mortfree
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by mortfree » Mon Oct 14, 2019 8:16 am

From my reading on here I believe CA is a non-recourse state.

If you don’t know what that means look it up.

I am not expert enough to tell you but I did a quick google search
a non-recourse state prohibits mortgagors from suing the person on top of the foreclosure process.

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InvestVS
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by InvestVS » Mon Oct 14, 2019 2:10 pm

grabiner wrote:
Mon Oct 14, 2019 8:01 am
InvestVS wrote:
Mon Oct 14, 2019 1:51 am
Tax Rate: 37% Federal, 11.3% State
1. Home Loan $925K, Interest rate 2.875%, 7 Years ARM, 2.875% Rate will finish in 2023 (rate will increase by 2% after that for the first year)
That is enough interest that any prepayment will be against fully deductible interest (with $10K in state tax, you can deduct all mortgage interest over $14,400 even if you contribute nothing to charity), so your return is only 1.49% on a mortgage prepayment. If you refinance to 15 years fixed at 3.25%, you lock in an after-tax rate of 1.68% for 15 years.
Thanks for the response!

Not sure what math you are using here, will appreciate if you can share some more details. How are you coming to 1.49% and 1.68%?

Topic Author
InvestVS
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by InvestVS » Mon Oct 14, 2019 2:12 pm

mortfree wrote:
Mon Oct 14, 2019 8:16 am
From my reading on here I believe CA is a non-recourse state.

If you don’t know what that means look it up.

I am not expert enough to tell you but I did a quick google search
a non-recourse state prohibits mortgagors from suing the person on top of the foreclosure process.
Thanks! How does that relate to my situation?

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JoeRetire
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by JoeRetire » Mon Oct 14, 2019 2:41 pm

InvestVS wrote:
Mon Oct 14, 2019 1:51 am
1. Home Loan $925K, Interest rate 2.875%, 7 Years ARM, 2.875% Rate will finish in 2023 (rate will increase by 2% after that for the first year)

Option 3: Pay off my mortgage. I have some sub-options here.
- Option 3a: Pay off my mortgage 100% now.
- Option 3a: Pay off my mortgage 100% in 2023 when 7 years ARM term ends and the rate goes up.
- Option 3a: Refinance to a 15-year Fixed-rate as rate looks good right now. I can probably get 3.25% rate for a 15-year Fixed-rate.

Please advise which one of these options will be better.
Option 3d: Wait until 2023. See what mortgage options and rates are available at that time.
It's the end of the world as we know it. | It's the end of the world as we know it. | It's the end of the world as we know it. | And I feel fine.

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grabiner
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by grabiner » Mon Oct 14, 2019 3:48 pm

InvestVS wrote:
Mon Oct 14, 2019 2:10 pm
grabiner wrote:
Mon Oct 14, 2019 8:01 am
InvestVS wrote:
Mon Oct 14, 2019 1:51 am
Tax Rate: 37% Federal, 11.3% State
1. Home Loan $925K, Interest rate 2.875%, 7 Years ARM, 2.875% Rate will finish in 2023 (rate will increase by 2% after that for the first year)
That is enough interest that any prepayment will be against fully deductible interest (with $10K in state tax, you can deduct all mortgage interest over $14,400 even if you contribute nothing to charity), so your return is only 1.49% on a mortgage prepayment. If you refinance to 15 years fixed at 3.25%, you lock in an after-tax rate of 1.68% for 15 years.
Thanks for the response!

Not sure what math you are using here, will appreciate if you can share some more details. How are you coming to 1.49% and 1.68%?
2.875 * (1-0.37-0.113) = 1.49. Since your marginal tax rate is 48.3%, your tax will increase by 48.3% of the interest savings, so paying down $10,000 of the loan saves you $288 of interest annually but only $149 after tax; the $288 and $149 will both increase if the ARM resets to a higher rate in the future. Similarly, if you refinance to 3.25% fixed, the return on a prepayment is 1.68% after tax, and that return is fixed until the loan is paid off.
Wiki David Grabiner

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Meg77
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by Meg77 » Mon Oct 14, 2019 4:15 pm

InvestVS wrote:
Mon Oct 14, 2019 1:51 am

Debt:
1. Home Loan $925K, Interest rate 2.875%, 7 Years ARM, 2.875% Rate will finish in 2023 (rate will increase by 2% after that for the first year)
2. Car Loan $48K Interest rate 0.99%, Will be fully paid in 2023

These are very good rates, close to or perhaps below the inflation rate.

Portfolio:
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 30% of stocks

I think this target AA makes sense given your age, life expectancy, portfolio size, and goal to be FI in 10 years.

Portfolio Size: 3.18M
Cash: 15% (470K) (In Vangaurd Treasury Money Market Fund)
Bond: 16%
International: 15.5%
US Market: 50.5%
REIT: 3%

As you know, your current AA does not mirror your target. I would begin dollar cost averaging toward your goal by systematically investing the cash over 6-12 months.

New annual Contributions:
$19000 his 401k
10K Employer Match for his 401k
$19000 her 401k
5K Employer Match for her 401k
$100K-$200K for long term retirement investment through annual savings and RSU vestings
30K for kid 1 529 (for 4 more years)
30K for kid 2 529 (for 4 more years)

So you're adding around $200K a year to your portfolio, plus another $60K a year once college is paid for in 4 years. At that rate you'll nearly double your portfolio size in 10 years even assuming ZERO growth. You don't say how much you want to be able to spend each year, but with nearly $6MM invested you'll certainly be FI at least as far as being able to cover a comfortable baseline of existence indefinitely, particularly outside of Silicon Valley.

Goals:
Long term financial savings to achieve financial independence by 52-55 age.

The need to take the risk:
As we are looking to achieve financial independence by 52-55 age, we feel we have a need to take some risk. In the worst case, we can continue to work beyond 52-55 ages. However large value of our portfolio (all our life's savings) also makes us feel that we should reduce the risk - NEED SOME GUIDANCE HERE FROM EXPERTS!

Given your ambivalence with regard to risk, I don't think it makes sense to use much leverage. For example, I would knock out the car loan. The spread you're theoretically getting by borrowing 1% to buy bonds in a taxable account is negligible, especially on $48K. The same could be said for the mortgage as well of course. I would aim to have that paid off in 10 years at most given your goal to be FI by then. Doing it by 2023 is even better and would protect you from some sequence of return risk. Plus the peace of mind of having much lower monthly fixed payments should enable you to have a bit more peace of mind with a riskier 80/20 portfolio. And it's that much less income you need the portfolio to generate later in retirement as well.

Questions:
Based upon Mr. Bogle's last interview where he suggested to hold a little larger than the desired allocation in bond as he foresees turbulence in the market for the next couple of years, I have kept this cash outside of the market to reduce my risk as I just have 16% off in Bonds. This makes cash and bond as 31% of my portfolio. If there is a market crash in the next 1-2 years; I was thinking of using 10% for this cash to buy index funds to bring my asset allocation to 80% stocks / 20% bonds.

If you stick to your target AA, you'll naturally be buying more stocks when values are down and vice versa via normal rebalancing. Don't overcomplicate things by trying to time the market further. You have a VERY long timeline (life) hopefully, and the extra $200K plus or minus in bonds today versus cash is not going to make a difference in the scheme of your entire financial life or future retirement lifestyle.

Another reason for this cash was to explore if we can buy another house when the market goes a little down (we live in silicon valley) for investment.

If and when there is a real estate market "crash" (which is far from likely in the near term), you can always sell part of your taxable portfolio and/or raid your EF temporarily and/or borrow more to buy in. You don't have enough money to leave huge chunks of cash on the sidelines for years on end losing purchasing power on the off chance there might be a good buying opportunity in your local RE market. Besides, if and when there is one it will be due to a tech crash which I'm assuming will negatively impact your incomes or even jobs. Not the best time to be buying a big property even with lower values.

Option 1: Keep the cash in the Money Market Fund and wait for market or real estate to go down to buy at that time. It's reducing my portfolio risk in the meantime but not earning a lot till then. Bad idea. I know people who have been waiting for a big correction for 5+ years to "get back in!"

Option 2: Use Dollar cost average and start putting this money in Index funds based upon my Asset Allocation. The risk here is that when the market is down I will not have large cash to buy some more at discount. Yes. This is what I'm currently doing. I had a windfall from some RE sales and am not ready to pay off my 2.75% mortgage because we may buy a new property within a year and convert this one to a rental.

Option 3: Pay off my mortgage. I have some sub-options here.
- Option 3a: Pay off my mortgage 100% now.
This is really not a bad idea. It'll free up a lot of cash flow to reinvest and saves you from having the angst of investing a lot of cash near all time stock and bond highs. I know it feels like a low rate, but low rates could be the new normal and are suppressing bond and even stock returns as well.
- Option 3b: Pay off my mortgage 100% in 2023 when 7 years ARM term ends and the rate goes up.
This is also an option, but it still leaves the question of what to do with all your excess cash in the interim. I don't think I'd invest in stocks OR bonds for only 4 years in the hopes that my total return would materially exceed 2.85%, which would in effect be what you are doing.
- Option 3c: Refinance to a 15-year Fixed-rate as rate looks good right now. I can probably get 3.25% rate for a 15-year Fixed-rate. NO. You do NOT want to pay closing costs just to increase your rate, especially when you can afford to pay the whole thing off.

Thanks for reading our post and we appreciate all your suggestions!
There is no wrong answer of course. The good news is that you literally have more money than you know what to do with - which is a great problem to have. In those cases, paying off debt could be viewed as a no-brainer. Investing a large chunk in bonds while you keep even cheap debt might feel safe but from a balance sheet perspective it really doesn't make a lot of sense. Plus having no mortgage feels psychologically different (read: better) to many people than having the same amount invested. It's a personal decision though!
"An investment in knowledge pays the best interest." - Benjamin Franklin

newpup
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by newpup » Mon Oct 14, 2019 5:08 pm

I would advise paying off the mortgage. I was in a similar situation and did the same. You just can't find 2.875% guaranteed anywhere in the current environment, and you will sleep like a baby with the mortgage paid off. Use cash flow saved at that point to dollar cost average into your 80/20 target. Good luck!

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Watty
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Re: Advise on Large cash investment options in current market - Invest in market OR Pay off Mortgage

Post by Watty » Mon Oct 14, 2019 5:56 pm

There is a wiki on this choice if you have not seen it.

https://www.bogleheads.org/wiki/Paying_ ... _investing
InvestVS wrote:
Mon Oct 14, 2019 1:51 am
Debt:
1. Home Loan $925K, Interest rate 2.875%....

Portfolio:
Desired Asset allocation: 80% stocks / 20% bonds
Desired International allocation: 30% of stocks

Portfolio Size: 3.18M
Cash: 15% (470K) (In Vangaurd Treasury Money Market Fund)
Bond: 16%
International: 15.5%
US Market: 50.5%
REIT: 3%
It is not exact but in a lot of ways a mortage can be considered as a negative bond in your asset allocation. If you subtract out your mortage from your bond asset then you end up with an asset allocation of 100% stocks and 0% bonds.
InvestVS wrote:
Mon Oct 14, 2019 1:51 am
Age: 45, 43
...
1. Kid 1 going to college in 2022,
I don't know where they draw the official line but with a kid that is getting close to going to college you are getting near to being middle age so it would be a good time be more conservative.

I would go on and pay off the mortage and then you could use your "mortage payment" to invest or pay for college costs.

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