Pay down 1.9% loan or invest

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mortfree
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Re: Pay down 1.9% loan or invest

Post by mortfree » Sun Jan 22, 2017 3:37 am

He is paying probably $16/month in interest at this point.

$16. Not $100. Not $200. $16.

This 1.9% is not going to compound to drive the debt deeper like a credit card with a 10% interest rate.

The loan has an endpoint that the monthly payment ensures the balance will go to $0.

I'm having a hard time discerning the bogleheads approach from the Ramsey approach on debt and am convinced that people would tell someone to pay off a 0% loan too.

stevekozak2
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Re: Pay down 1.9% loan or invest

Post by stevekozak2 » Sun Jan 22, 2017 9:17 am

I like reading threads with fairly simple questions, as it lets me know which posters' advice I am likely to be interested in when I have more complex questions.

As to the OP, I say pay it off, get that debt out of ypur life, and start investing that monthly payment in the investment of your choice.

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Texas Radio
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Re: Pay down 1.9% loan or invest

Post by Texas Radio » Sun Jan 22, 2017 9:29 am

Split the difference. On a monthly basis pay extra on the loan and invest extra as well.
A portfolio is like a bar of soap. The more you handle it the smaller it gets.

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grabiner
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Re: Pay down 1.9% loan or invest

Post by grabiner » Sun Jan 22, 2017 11:36 am

gilgamesh wrote:I dont want to hijack this thread. The difference in risk is the consequences of taking that risk. While working, it's a matter of working longer, at age 80 it's food on the table. That's the difference.

If 'risk-free' is your criteria in this decision, should that 'risk-free' be the criteria in retirement?
You can make independent decisions of how much risk to take, and what to do given that risk level. As long as you have low-risk bond investments (which almost all investors do), and a loan you have the option of selling those low-risk bonds and paying down your loan. This does not change your risk level, so it is a fair comparison. (This is how I view the decision. I could sell my taxable stock to pay off my mortgage, then sell bonds to buy stock in my retirement account, keeping my risk level. At current rates, that is not a good deal; I earn more on my bonds than I pay on my mortgage, so I wouldn't do it even if I could sell stock without a huge tax bill.)

Conversely, you could invest in stocks rather than paying down your loan, increasing your risk level for the potential of expected returns. But you could also do this without paying down your loan, selling your bonds to buy stocks.
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gilgamesh
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Re: Pay down 1.9% loan or invest

Post by gilgamesh » Sun Jan 22, 2017 12:55 pm

stevekozak2 wrote:I like reading threads with fairly simple questions, as it lets me know which posters' advice I am likely to be interested in when I have more complex questions.

As to the OP, I say pay it off, get that debt out of ypur life, and start investing that monthly payment in the investment of your choice.
Interesting. Curious, will you be interested in posts by posters that ageeed with you or those who didn't. I like to read posters that doesn't agree with me. That way if there's something to learn, I can learn something new.

gilgamesh
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Re: Pay down 1.9% loan or invest

Post by gilgamesh » Sun Jan 22, 2017 12:58 pm

grabiner wrote:
gilgamesh wrote:I dont want to hijack this thread. The difference in risk is the consequences of taking that risk. While working, it's a matter of working longer, at age 80 it's food on the table. That's the difference.

If 'risk-free' is your criteria in this decision, should that 'risk-free' be the criteria in retirement?
You can make independent decisions of how much risk to take, and what to do given that risk level. As long as you have low-risk bond investments (which almost all investors do), and a loan you have the option of selling those low-risk bonds and paying down your loan. This does not change your risk level, so it is a fair comparison. (This is how I view the decision. I could sell my taxable stock to pay off my mortgage, then sell bonds to buy stock in my retirement account, keeping my risk level. At current rates, that is not a good deal; I earn more on my bonds than I pay on my mortgage, so I wouldn't do it even if I could sell stock without a huge tax bill.)

Conversely, you could invest in stocks rather than paying down your loan, increasing your risk level for the potential of expected returns. But you could also do this without paying down your loan, selling your bonds to buy stocks.
Is this the concept of viewing debt as a negative bond?

Secondly, about making independent decisions on how much risk to take and what to do given that risk level, do they have to be consistent or not? Do you think not taking a 1.9% risk now, yet taking a 4% risk in retirement ( not quite, but for the sake of argument), consistent?

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grabiner
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Re: Pay down 1.9% loan or invest

Post by grabiner » Sun Jan 22, 2017 6:12 pm

gilgamesh wrote:
grabiner wrote:You can make independent decisions of how much risk to take, and what to do given that risk level. As long as you have low-risk bond investments (which almost all investors do), and a loan you have the option of selling those low-risk bonds and paying down your loan. This does not change your risk level, so it is a fair comparison.
Is this the concept of viewing debt as a negative bond?
Yes, this is one way to look at it. If you have $100K in stock, $10K in bonds, and $10K in a loan, your net investment is $100K, and that will lose half its value if the stock market does. If you sell your bonds to pay off the loan, this doesn't change the risk level.
Secondly, about making independent decisions on how much risk to take and what to do given that risk level, do they have to be consistent or not? Do you think not taking a 1.9% risk now, yet taking a 4% risk in retirement ( not quite, but for the sake of argument), consistent?
The decision of how much risk to take is very dependent on your situation. You might prefer to invest in stocks rather than in bonds yielding 3% while you are working, and then prefer to invest in the same bonds rather than stocks after you retire.

But the decision of what to do given that risk level should not depend on your situation (unless your situation adds additional issues such as taxes or liquidity). Regardless of your risk tolerance, you will come out ahead if you buy bonds yielding 3% rather than paying down a 1.9% loan, and you will come out ahead if you pay down a 4% loan rather than buying bonds yielding 3%.

One exception might apply if you don't have any bonds. You might prefer to sell bonds yielding 3% rather than paying down a 4% loan, but if you don't have any bonds to sell, you could rationally keep the loan. However, few investors want to take this much risk, holding a 100% stock portfolio and a loan in addition to that.

The more important exception is related to taxes. It may be worth investing in your 401(k) even if the bonds there earn less than your mortgage rate, because you get the longer-term benefit of tax-deferred growth in the 401(k) after the mortgage is gone.
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gilgamesh
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Re: Pay down 1.9% loan or invest

Post by gilgamesh » Mon Jan 23, 2017 11:40 am

grabiner wrote:
Secondly, about making independent decisions on how much risk to take and what to do given that risk level, do they have to be consistent or not? Do you think not taking a 1.9% risk now, yet taking a 4% risk in retirement ( not quite, but for the sake of argument), consistent?
The decision of how much risk to take is very dependent on your situation. You might prefer to invest in stocks rather than in bonds yielding 3% while you are working, and then prefer to invest in the same bonds rather than stocks after you retire.

But the decision of what to do given that risk level should not depend on your situation (unless your situation adds additional issues such as taxes or liquidity). Regardless of your risk tolerance, you will come out ahead if you buy bonds yielding 3% rather than paying down a 1.9% loan, and you will come out ahead if you pay down a 4% loan rather than buying bonds yielding 3%.

I'm a little confused here. Sounds like you are saying bond returns are guaranteed. How does one know bonds will deliver 3%?

One exception might apply if you don't have any bonds. You might prefer to sell bonds yielding 3% rather than paying down a 4% loan, but if you don't have any bonds to sell, you could rationally keep the loan. However, few investors want to take this much risk, holding a 100% stock portfolio and a loan in addition to that.

Viewing debt as negative bond, which gives the possibility of having more than 100% in stocks is quite fascinating. However, such leverage/debt may sound more riskier than they are. Student loans, business loans etc could be beneficial loans, but looking at it from a strictly asset allocation perspective and saying, whoa! I have more than 100% in stocks misses the bigger picture. Doesn't it?

The more important exception is related to taxes. It may be worth investing in your 401(k) even if the bonds there earn less than your mortgage rate, because you get the longer-term benefit of tax-deferred growth in the 401(k) after the mortgage is gone.

Yes. A different question, when interest on debt is tax deductible like mortgage interest, one often calculates after-tax rate. However, isn't there another safety net with investing. That is, if one takes the bet and loses, the loss to some degree is tax deductible?

hudson
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Re: Pay down 1.9% loan or invest

Post by hudson » Mon Jan 23, 2017 6:28 pm

ssquared87 wrote:Hey everyone,

Quick overview of my financial situation...I max out 401k (18k/yr) Roth IRA (5k/yr) and HSA (3.4k/yr) every year and have 12 months expenses in an emergency fund. My job is fairly stable. I'm 30, single, no kids.

The only debt I have is $9k on a car loan at 1.9%

I want to bring my emergency fund down to 6 months, I don't think having 12 months as I do right now is needed. Should I pay off the loan at 1.9% or invest the money? The interest rate seems sufficiently low that paying off the loan may not make complete sense.
ssquared87,
You look like you're on the right track.
Here's my personal advice to myself. You can decide for yourself.

http://www.gloucesterclam.com/wp-conten ... oulder.jpg

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grabiner
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Re: Pay down 1.9% loan or invest

Post by grabiner » Mon Jan 23, 2017 11:45 pm

gilgamesh wrote:
grabiner wrote:
Secondly, about making independent decisions on how much risk to take and what to do given that risk level, do they have to be consistent or not? Do you think not taking a 1.9% risk now, yet taking a 4% risk in retirement ( not quite, but for the sake of argument), consistent?
The decision of how much risk to take is very dependent on your situation. You might prefer to invest in stocks rather than in bonds yielding 3% while you are working, and then prefer to invest in the same bonds rather than stocks after you retire.

But the decision of what to do given that risk level should not depend on your situation (unless your situation adds additional issues such as taxes or liquidity). Regardless of your risk tolerance, you will come out ahead if you buy bonds yielding 3% rather than paying down a 1.9% loan, and you will come out ahead if you pay down a 4% loan rather than buying bonds yielding 3%.


I'm a little confused here. Sounds like you are saying bond returns are guaranteed. How does one know bonds will deliver 3%?
When you buy a bond, you know exactly what it will return if held to maturity (unless it defaults). The 3% I listed is not representative of any one particular bond, but you could buy a long-term Treasury bond with a guaranteed 3% return.
One exception might apply if you don't have any bonds. You might prefer to sell bonds yielding 3% rather than paying down a 4% loan, but if you don't have any bonds to sell, you could rationally keep the loan. However, few investors want to take this much risk, holding a 100% stock portfolio and a loan in addition to that.
Viewing debt as negative bond, which gives the possibility of having more than 100% in stocks is quite fascinating. However, such leverage/debt may sound more riskier than they are. Student loans, business loans etc could be beneficial loans, but looking at it from a strictly asset allocation perspective and saying, whoa! I have more than 100% in stocks misses the bigger picture. Doesn't it?
This depends on your non-investment assets. Buying a home also increased my risk tolerance, because I now own an asset which is guaranteed to provide me with a place to live for much less than the market rental value. Therefore, I changed to a riskier asset allocation for my investments.

If you have a loan without a tangible asset (such as a student loan), then it does make sense to be more conservative. If you and I have equal investment assets and comparable jobs, but you have student debt and I don't, then you may want more dollars in bonds.
The more important exception is related to taxes. It may be worth investing in your 401(k) even if the bonds there earn less than your mortgage rate, because you get the longer-term benefit of tax-deferred growth in the 401(k) after the mortgage is gone.
Yes. A different question, when interest on debt is tax deductible like mortgage interest, one often calculates after-tax rate. However, isn't there another safety net with investing. That is, if one takes the bet and loses, the loss to some degree is tax deductible?
In a Roth IRA or 401(k), the loss and gain are both tax-free. In a traditional IRA or 401(k), they are effectively tax-free; if you will retire in a 25% bracket, then the IRS owns 25% of your account and you own the other 75% tax-free. In either case, if your investment loses 20% of its value, you will have 80% as much to spend in retirement.

In a taxable account, you can get a tax benefit from losses. If your taxable stock investment gains in value, you don't have to pay any extra taxes (except on an increased dividend yield). If it loses value, you can sell to harvest the loss, offsetting gains you take elsewhere, or taking up to $3000 per year against ordinary income.
Wiki David Grabiner

gilgamesh
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Re: Pay down 1.9% loan or invest

Post by gilgamesh » Tue Jan 24, 2017 12:52 pm

grabiner wrote:
gilgamesh wrote:
grabiner wrote:
Secondly, about making independent decisions on how much risk to take and what to do given that risk level, do they have to be consistent or not? Do you think not taking a 1.9% risk now, yet taking a 4% risk in retirement ( not quite, but for the sake of argument), consistent?
The decision of how much risk to take is very dependent on your situation. You might prefer to invest in stocks rather than in bonds yielding 3% while you are working, and then prefer to invest in the same bonds rather than stocks after you retire.

But the decision of what to do given that risk level should not depend on your situation (unless your situation adds additional issues such as taxes or liquidity). Regardless of your risk tolerance, you will come out ahead if you buy bonds yielding 3% rather than paying down a 1.9% loan, and you will come out ahead if you pay down a 4% loan rather than buying bonds yielding 3%.


I'm a little confused here. Sounds like you are saying bond returns are guaranteed. How does one know bonds will deliver 3%?
When you buy a bond, you know exactly what it will return if held to maturity (unless it defaults). The 3% I listed is not representative of any one particular bond, but you could buy a long-term Treasury bond with a guaranteed 3% return.
One exception might apply if you don't have any bonds. You might prefer to sell bonds yielding 3% rather than paying down a 4% loan, but if you don't have any bonds to sell, you could rationally keep the loan. However, few investors want to take this much risk, holding a 100% stock portfolio and a loan in addition to that.
Viewing debt as negative bond, which gives the possibility of having more than 100% in stocks is quite fascinating. However, such leverage/debt may sound more riskier than they are. Student loans, business loans etc could be beneficial loans, but looking at it from a strictly asset allocation perspective and saying, whoa! I have more than 100% in stocks misses the bigger picture. Doesn't it?
This depends on your non-investment assets. Buying a home also increased my risk tolerance, because I now own an asset which is guaranteed to provide me with a place to live for much less than the market rental value. Therefore, I changed to a riskier asset allocation for my investments.

If you have a loan without a tangible asset (such as a student loan), then it does make sense to be more conservative. If you and I have equal investment assets and comparable jobs, but you have student debt and I don't, then you may want more dollars in bonds.
The more important exception is related to taxes. It may be worth investing in your 401(k) even if the bonds there earn less than your mortgage rate, because you get the longer-term benefit of tax-deferred growth in the 401(k) after the mortgage is gone.
Yes. A different question, when interest on debt is tax deductible like mortgage interest, one often calculates after-tax rate. However, isn't there another safety net with investing. That is, if one takes the bet and loses, the loss to some degree is tax deductible?
In a Roth IRA or 401(k), the loss and gain are both tax-free. In a traditional IRA or 401(k), they are effectively tax-free; if you will retire in a 25% bracket, then the IRS owns 25% of your account and you own the other 75% tax-free. In either case, if your investment loses 20% of its value, you will have 80% as much to spend in retirement.

In a taxable account, you can get a tax benefit from losses. If your taxable stock investment gains in value, you don't have to pay any extra taxes (except on an increased dividend yield). If it loses value, you can sell to harvest the loss, offsetting gains you take elsewhere, or taking up to $3000 per year against ordinary income.
David

Thanks, very helpful.

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unclescrooge
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Re: Pay down 1.9% loan or invest

Post by unclescrooge » Tue Jan 24, 2017 5:26 pm

dm200 wrote:
ssquared87 wrote:Hey everyone,

Quick overview of my financial situation...I max out 401k (18k/yr) Roth IRA (5k/yr) and HSA (3.4k/yr) every year and have 12 months expenses in an emergency fund. My job is fairly stable. I'm 30, single, no kids.

The only debt I have is $9k on a car loan at 1.9%

I want to bring my emergency fund down to 6 months, I don't think having 12 months as I do right now is needed. Should I pay off the loan at 1.9% or invest the money? The interest rate seems sufficiently low that paying off the loan may not make complete sense.
I would invest, since 1.90% is very low and rates are trending upward.
+1

A 2% hurdle should be an easy hurdle to beat. However, it often isn't. Know thyself!

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