Dealing with Debt in your AA

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eurowizard
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Dealing with Debt in your AA

Post by eurowizard » Tue Jan 05, 2010 6:53 pm

When it comes to Student Loans and Mortgages, and today's low bond and savings account yields, does it make sense to maintain your AA and still pay this debt?

Suppose you owed 8% student loan interest and had $100k portfolio that was 80/20. The bond portion of your portfolio is only yielding 4%. Wouldnt it make sense to put $20k towards the student loans and keeping $80k in stocks at 100% equity?

zotty
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Post by zotty » Tue Jan 05, 2010 7:40 pm

Amazing timing. I ask myself this question once a month, when my mortgage statement arrives.

I'm sitting here looking at a 77K mortgage and 80K in munis/prime not associated with my EF and pondering the exact same question.

For my case, i keep answering No. two reasons
1. Liquidity Premium. 8 years into a 15 year/5% note. I'm trading about 2K per year so that the money is available to our family if things get really desperate.

2. I'm 68/32 and don't want to sell stock to stay in balance.

New "after tax" money divides equally between taxable and mortgage, but i'm not willing to give up the liquidity for the savings.

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BL
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Post by BL » Tue Jan 05, 2010 11:43 pm

I wouldn't change the AA but 8% is hard to get even with equities over time so would personally pay off the loan ASAP without incurring withdrawal penatlies.

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eurowizard
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Post by eurowizard » Wed Jan 06, 2010 1:37 am

BL wrote:I wouldn't change the AA but 8% is hard to get even with equities over time so would personally pay off the loan ASAP without incurring withdrawal penatlies.
This is possible using Roth IRA money but then you would lose the tax-advantaged space forever. You also lose the ability to remain liquid to pay emergency medical or legal bills while going into a loan deferment.

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NightOwl
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Post by NightOwl » Wed Jan 06, 2010 1:50 am

At 8% interest, I personally would allocate a large portion of my resources to paying off the debt. 8% (tax free) is above most estimates of expected return for just about all asset classes. Those estimates could well be wrong, of course.

My loans are at 3.1%. Different story -- I was lucky enough to borrow too much for my education at a time when I could refinance at low rates. (Not saying borrowing for education is bad, just saying I borrowed too much for mine.)

But if I were you, I would probably not allocate ALL available resources to paying off student loan debt, for three reasons:

(1) student loans go away when you die, and (not to be flip) it would be very unlucky to die just after one pays off one's loan with ALL available resources;

(2) student loans provide inflation protection -- my final student loan payment is currently scheduled to happen 30+ years from now, and I'm willing to bet that my fixed ~$300 monthly payment is worth FAR less then than now -- actually, $300 is likely to be a joke 30 years from now;

(3) regular payments on a student loan are great for the FICO score. I plan to buy a home about ten years from now, so I want to keep that score high, even if for some inane vapid cockamamie reason I have to stay in debt to do so. FICO sets the rules, I just play by them.

On the other side of the argument, I'm sure that being debt-free feels amazing. The hyper-rational reasons I've listed above aside, I am not nearly enough of an optimizer to leave myself in debt if I ever get ahold of a lump sum that would enable me to pay off my loan in full. I'd probably take the hit on all three of the above fronts to get that monkey off my back. That said, I don't have that lump sum, and I'm not interested in throwing all my available monthly money at my large loan.

If you don't have the lump sum, I'd maintain your 80/20 allocation with some money while allocating most of my money to the debt.

In other words, split the difference, which is always a wise idea -- but I can't tell you exactly how to do so.

NightOwl
"Volatility provokes the constant dread that some investors know more than we do, making us fearful of ignoring such powerful price movements." | Peter Bernstein, "The 60/40 Solution."

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dmcmahon
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Post by dmcmahon » Wed Jan 06, 2010 3:27 pm

zotty wrote:Amazing timing. I ask myself this question once a month, when my mortgage statement arrives.

I'm sitting here looking at a 77K mortgage and 80K in munis/prime not associated with my EF and pondering the exact same question.

For my case, i keep answering No. two reasons
1. Liquidity Premium. 8 years into a 15 year/5% note. I'm trading about 2K per year so that the money is available to our family if things get really desperate.

2. I'm 68/32 and don't want to sell stock to stay in balance.

New "after tax" money divides equally between taxable and mortgage, but i'm not willing to give up the liquidity for the savings.
A HELOC can answer your first question, costs you nothing unless you actually tap the liquidity. Can't answer the second question except to suggest a refi. Note that the rates on 5-year or 7-year money are even lower than 5% now, so given that you have 7 years left on the note, a refi into a 5-year or 7-year ARM (that you'd plan to pay off in 5 or 7 years before the first reset) could lower the negative carry because your interest rate would be lower. You'd have to be absolutely sure you can pay it off by then so you don't get screwed by the reset, but then, you're currently on a payment schedule that pays it off in 7 years anyway.

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Random Musings
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Post by Random Musings » Wed Jan 06, 2010 3:50 pm

At 8% interest, I would pay off as soon as possible as long as it does not affect your:

- emergency funds (that can be held in different forms)
- short-term goals that should also be generally liquid (MM or short-term bonds depending on preference)
- tax deferred accounts

Big picture, the $20K in loans will look immaterial down the road when considering whether you count that as a negative bond in your current portfolio. For example, if you don't currently own a home now and plan to down the road, the mortgage assumed will get you back into this negative bond question again (hopefully at lower rates). Also, certain threads have discussed how about various income stream(s) and how some are more equity-like while others are more bond-like........

Set up a action plan, follow through with it, and then forget about it......

RM

Snowjob
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Post by Snowjob » Wed Jan 06, 2010 9:00 pm

Assuming everything was in a taxable account absolutely pay down the debt. 8% cost vs probably a 1% yeild on the MM. If you ever need liquidity in a pinch thats what margin or depending on the situation, a stock sale is for.

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eurowizard
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Post by eurowizard » Wed Jan 06, 2010 9:35 pm

Snowjob wrote:Assuming everything was in a taxable account absolutely pay down the debt. 8% cost vs probably a 1% yeild on the MM. If you ever need liquidity in a pinch thats what margin or depending on the situation, a stock sale is for.
In my case its 100% in a tax-deferred account and I dont want to lose the IRA space. I also finished converting everything to a Roth Tax-Free using all the tuition credits and such.

Snowjob
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Post by Snowjob » Wed Jan 06, 2010 9:41 pm

Yeah in the case suck it up and keep paying down the debt when you can. I suspect your willing to trade a few extra years of higher interest payments in order to stash more money in your tax exempt accounts.

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