Paying off debt vs. max savings

[kmox]

Hi everyone:

I'm a long-time reader and find many of the posts very inspirational, but I have hardly ever posted anything. So here goes, our situation that I'd like feedback on from the greater community...

Both me and my DW now have fairly stable jobs with a pretty high rate of income (combined +/- $150k/yr, with pay raises of abt 5%/yr), after many years of low-paying jobs, graduate school, time-off for kids, etc. At this point we can max out our 401(k)/457(b) plans with no problem. We also have some debt, which is rather manageable: $110k mortgage on a rental property (4.25% interest), $15k student loan (2.25% interest), $23k car loan (0% interest). Somehow, through all of this, we have been able to scrap together $150k in savings.

Now, it feels like we are ready for the next big step. Do we: pay down the debt? Or, max out RothIRA? We also have two small kids (5 and 2) that we would like to put money towards their 529 account (we get a state income tax break in our state), which we currently contribute nominally.

P.S. we do receive rental income, but the property is a housing bubble purchase (unbeknownst to me), which I could never shake lose of and is way underwater, and the rental only covers about three-quarters of the mortgage.

Thanks in advance for any advice.

[mortfree]

Pay off the student loans.
Max the Roth for 2017 ($11k)
Wait for Jan 2018 and max the Roth again

That leaves you with 113k

[niners9088]

I don't see any mention about your current living arrangements. Are you renting or do you own a house? My reason for asking is do you plan to buy a house in the near future in which case you would need a 20% down payment? Also how much of the money do you need for an emergency fund?

[kmox]

We currently rent ($1210/mo) with no plans to buy. At this point in our life, we have already owned two homes (sold one), and don't see the value in owning any more (personal preference). We expect to be living overseas in about 15yrs and don't want to tie up our savings in an illiquid asset.

[TravelforFun]

- If your or your wife's employer matches your 401k/457b contribution, contribute enough to get the maximum match but no more, if they don't match, don't contribute and go to the next step.

- Put in $5,500 per year into your and your wife's Roth IRA accounts, $11k total.

- Attack all the non-mortgage debts.

- Build an emergency fund of 6 months of your expenses.

- Open 529 accounts for your kids, calculate the amounts you think they would need, and divide them by the remaining years so you know much you need to fund them per year.

- Pay off your mortgage.

- Put any left-over money into taxable accounts.

[Watty]

There is a wiki on this choice.

https://www.bogleheads.org/wiki/Paying_ ... _investing

P.S. we do receive rental income, but the property is a housing bubble purchase (unbeknownst to me), which I could never shake lose of and is way underwater, and the rental only covers about three-quarters of the mortgage.

That would mean that you are also not building up reserves for eventual major repairs, vacancies, bad tennants, etc.

What do the numbers look like on the rental property?

It might make sense to go on and sell it even though you would need to pay to get out of the house.

In most areas the housing markets are pretty strong right now so it might not be too hard to sell. If you wait five years you could find yourself being forced to sell it in a bad housing market.

[kmox]

Good point, and I have thought of that--selling the property. However, the house is currently valued at $80k (according to Zillow based on surrounding comps). We receive about $950 in rental income with $90/mo going to property management (it is too far from us to manage ourselves). So, if we sold it, that would mean a possible $30k haircut from current loan amount (we originally bought for $160k), of which we would not be able to cover except for borrowing more money.

[kmox]

Thanks for the wiki link.

Also, we currently don't have six months emergency savings (for the reason specified above), but maybe only a few months at most.

[CppCoder]

Good point, and I have thought of that--selling the property. However, the house is currently valued at $80k (according to Zillow based on surrounding comps). We receive about $950 in rental income with $90/mo going to property management (it is too far from us to manage ourselves). So, if we sold it, that would mean a possible $30k haircut from current loan amount (we originally bought for $160k), of which we would not be able to cover except for borrowing more money.

You're losing money on the rental every month. How many months would you have to hold it until the monthly loss adds up to your current capital loss or loan payout amount? What if you lost your tenant? Don't avoid a small loss now to avoid a big loss through perpetual small bleeding. I would not want to hold a capital asset that I wasn't using with a guaranteed loss. Take your lumps, learn your lesson, and move on.

[indexonlyplease]

I would look at the Dave Ramsey 7 step process to becoming debt free. Check online its simple process that works. You will be half way there when you pay off the debt. Then check on the Boglehead site for how to invest.

[grettman]

After fully saturating tax advantaged accounts, I would write a check and clear out all consumer debt asap with cash reserves not associated with emergency fund. Consumer debt should be avoided at all costs (IMHO) and student loans should be put to bed quickly.

[JGoneRiding]

Meg just posted a funding list on the retirement vscollege savings thread with ratios and int rate cut offs. you should read that and follow her suggestions.

For what it is worth Meg is a banker and worth over 1 mil at 31 and not to insane an income

[chicagoan23]

Both me and my DW now have fairly stable jobs with a pretty high rate of income (combined +/- $150k/yr, with pay raises of abt 5%/yr), after many years of low-paying jobs, graduate school, time-off for kids, etc. At this point we can max out our 401(k)/457(b) plans with no problem. We also have some debt, which is rather manageable: $110k mortgage on a rental property (4.25% interest), $15k student loan (2.25% interest), $23k car loan (0% interest). Somehow, through all of this, we have been able to scrap together $150k in savings.

Now, it feels like we are ready for the next big step. Do we: pay down the debt? Or, max out RothIRA? We also have two small kids (5 and 2) that we would like to put money towards their 529 account (we get a state income tax break in our state), which we currently contribute nominally.

My hierarchy of savings, which has worked well for me and was also recommended to me by Fidelity:

1. Contribute up to the employer match in a qualified retirement plan; and then
2. Contribute the annual max ($6,750 for family coverage) to an HSA invested in low-cost funds and do not take distributions for medical expenses; and then
3. Contribute up to the annual max ($18,000 each) for the two qualified plans; and then
4. Contribute up to the annual max ($5,500 each) to two Roth IRAs (assuming both spouses ineligible to make traditional IRA contributions but still within Roth contribution limits); and then
5. Contribute to the Section 529 account up to the maximum for the state tax deduction; and then
6. Pay off high-rate, nondeductible and secured debt (say, anything higher than the then-current Prime Rate); and then
7. Everything else goes to taxable savings.

I see no reason to pay off early a student loan at 2.25%--fixed low-rate, long-term, and unsecured. You could never walk into a bank and get a personal loan for $15k on those terms, so take advantage of it while you can. Obviously the same deal with the car loan. Roth IRAs can be used to fund education on the same basis as the 529 plans up to the amount of the cumulative contributions, making them preferable to the 529 plans, even with the state tax deduction.

Tax-advantaged space is precious, which is why it is so limited by the Internal Revenue Code. Do not let it go to waste if you can afford to contribute. And definitely don't waste it by paying more tax than you need to now in order to use after-tax money to unnecessarily wipe out low-rate, long-term debt. Especially when you are a double-income couple with stable jobs.

[FiveK]

See also Investment Order for a prioritization similar to what chicagoan23 posted. It also includes some reasons behind the ordering.

[bayview]

Good point, and I have thought of that--selling the property. However, the house is currently valued at $80k (according to Zillow based on surrounding comps). We receive about $950 in rental income with $90/mo going to property management (it is too far from us to manage ourselves). So, if we sold it, that would mean a possible $30k haircut from current loan amount (we originally bought for $160k), of which we would not be able to cover except for borrowing more money.

lol @ Zillow comps We like to look at their estimates for our two properties and snicker. Your haircut might be a lot less drastic than $30k. On rental properties especially, I doubt if they factor in "successful rental history", because how would they know?

Even if it's an accurate figure, I agree with the other poster that it might be worth cutting your losses just to simplify and streamline, although I know that's a good-sized chunk of change.

[beth65]

I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go? I have read so many books on good debt vs bad debt (Thomas Anderson's The Value of Debt is one I'm currently reading) that I would think saving in investment accounts and compound interest would be more important than paying down low-interest debt. Is it better to be debt free with $500k in the bank, or owe $300k but have $1.5 million in the bank? Obviously high-interest debt is bad, but low interest debt is not.

[beth65]

Both me and my DW now have fairly stable jobs with a pretty high rate of income (combined +/- $150k/yr, with pay raises of abt 5%/yr), after many years of low-paying jobs, graduate school, time-off for kids, etc. At this point we can max out our 401(k)/457(b) plans with no problem. We also have some debt, which is rather manageable: $110k mortgage on a rental property (4.25% interest), $15k student loan (2.25% interest), $23k car loan (0% interest). Somehow, through all of this, we have been able to scrap together $150k in savings.

Now, it feels like we are ready for the next big step. Do we: pay down the debt? Or, max out RothIRA? We also have two small kids (5 and 2) that we would like to put money towards their 529 account (we get a state income tax break in our state), which we currently contribute nominally.

My hierarchy of savings, which has worked well for me and was also recommended to me by Fidelity:

1. Contribute up to the employer match in a qualified retirement plan; and then
2. Contribute the annual max ($6,750 for family coverage) to an HSA invested in low-cost funds and do not take distributions for medical expenses; and then
3. Contribute up to the annual max ($18,000 each) for the two qualified plans; and then
4. Contribute up to the annual max ($5,500 each) to two Roth IRAs (assuming both spouses ineligible to make traditional IRA contributions but still within Roth contribution limits); and then
5. Contribute to the Section 529 account up to the maximum for the state tax deduction; and then
6. Pay off high-rate, nondeductible and secured debt (say, anything higher than the then-current Prime Rate); and then
7. Everything else goes to taxable savings.

I see no reason to pay off early a student loan at 2.25%--fixed low-rate, long-term, and unsecured. You could never walk into a bank and get a personal loan for $15k on those terms, so take advantage of it while you can. Obviously the same deal with the car loan. Roth IRAs can be used to fund education on the same basis as the 529 plans up to the amount of the cumulative contributions, making them preferable to the 529 plans, even with the state tax deduction.

Tax-advantaged space is precious, which is why it is so limited by the Internal Revenue Code. Do not let it go to waste if you can afford to contribute. And definitely don't waste it by paying more tax than you need to now in order to use after-tax money to unnecessarily wipe out low-rate, long-term debt. Especially when you are a double-income couple with stable jobs.

I agree - 2.25% rate is so low it's not worth paying off early. Once you pay that money, it's gone, you don't win an award for paying it off early, you have no equity and no liquidity. If the markets do have a downturn/recession, I would rather have more liquidity if needed.

[willthrill81]

I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go?

Because many of us, along with millions of Americans, have been burned badly with debt in the past.

Debt can certainly be a useful tool, but it can also be a very deadly one. FAR more people have been hurt by debt than helped by it, and even the best laid plans for using it properly can go awry.

"The rich rules over the poor, And the borrower becomes the lender's slave."
- Proverbs 22:7

[beth65]

I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go?

Because many of us, along with millions of Americans, have been burned badly with debt in the past.

Debt can certainly be a useful tool, but it can also be a very deadly one. FAR more people have been hurt by debt than helped by it, and even the best laid plans for using it properly can go awry.

"The rich rules over the poor, And the borrower becomes the lender's slave."
- Proverbs 22:7

But if you are earning 6% returns in the market, and you have a student loan debt of 2.5%, assuming that's fixed, why pay that off sooner? How do you get burned on a student loan debt with a low fixed rate? If you have 2x the amount of the loan in liquidity, even a job loss should not prevent you from making payments. I think good debt is one that you CAN easily pay off, but you make more money elsewhere. Meaning you can't actually get burned by it. I don't like to put all of my liquidity in risky investments, either, because then it's not really liquid. Like I mentioned above, if you pay of debt too soon, that money is gone, and if the market crashes, you can't get it back without taking more loans at a higher interest rate.

[mortfree]

But if you are earning 6% returns in the market, and you have a student loan debt of 2.5%, assuming that's fixed, why pay that off sooner? How do you get burned on a student loan debt with a low fixed rate? If you have 2x the amount of the loan in liquidity, even a job loss should not prevent you from making payments. I think good debt is one that you CAN easily pay off, but you make more money elsewhere. Meaning you can't actually get burned by it. I don't like to put all of my liquidity in risky investments, either, because then it's not really liquid. Like I mentioned above, if you pay of debt too soon, that money is gone, and if the market crashes, you can't get it back without taking more loans at a higher interest rate.

sorry for jumping in, you're getting hung up on percents and riding the good times for the market and the economy...

OP has 150k cash losing money sitting his bank account.

15k in student loans is pennies, might as well just get rid of it.

underwater house. (financially )

what would you do with the 150k cash?

[willthrill81]

I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go?

Because many of us, along with millions of Americans, have been burned badly with debt in the past.

Debt can certainly be a useful tool, but it can also be a very deadly one. FAR more people have been hurt by debt than helped by it, and even the best laid plans for using it properly can go awry.

"The rich rules over the poor, And the borrower becomes the lender's slave."
- Proverbs 22:7

But if you are earning 6% returns in the market, and you have a student loan debt of 2.5%, assuming that's fixed, why pay that off sooner? How do you get burned on a student loan debt with a low fixed rate? If you have 2x the amount of the loan in liquidity, even a job loss should not prevent you from making payments. I think good debt is one that you CAN easily pay off, but you make more money elsewhere. Meaning you can't actually get burned by it. I don't like to put all of my liquidity in risky investments, either, because then it's not really liquid. Like I mentioned above, if you pay of debt too soon, that money is gone, and if the market crashes, you can't get it back without taking more loans at a higher interest rate.

If the market crashes, how will you earn that 6% return in the market?

The twist to using leverage to increase your returns is that you usually need to be really leveraged in order for it to make a significant difference in your situation. The OP's case is no different. It isn't going to move the needle much regardless as to what he does, so why not remove obligations on future money when it can be done painlessly now?

[niners9088]

Here is what I would do.

I'd keep about 6 months cash in an emergency fund in a high yield savings account. (~40k)
I'd payoff the student loans. While it might not be the best bang for your buck it will simplify things and it is a small amount. (15k)
For the car I'd either pay it off or add the remaining onto my emergency fund and bank the 1% risk free rate. (23k)
I'd max my 401ks (36k)

This should be about ~114k so 36k remaining.
I'd figure out what I want to do with the rental. I'd either sell it or do something to get it to cash flow positive. If you have a good history of rental income at $950 I would think you can easily get $110-130k for it. Don't trust Zillow it is often way off.

Then I'd fund the 529

[kmox]

Getting back into this topic, because I see there has been some mis-reading of my original post. We do not have $150k sitting in a bank account. That's our gross pay this year, and doesn't take into account all of our other expenses (rent, daycare, food, insurance, etc). We are currently maxing out our respective before-tax retirement accounts (this will be the first year we could actually do that). Next in our program is to max out Roth IRA. Possibly once the kids start leaving daycare (in the next year for one, and two for the other), we can use that extra money towards paying down debt. Of course, none of this includes pay raises (we usually get about 5%/yr), which will also go towards debt.

[Chadnudj]

Good point, and I have thought of that--selling the property. However, the house is currently valued at $80k (according to Zillow based on surrounding comps). We receive about $950 in rental income with $90/mo going to property management (it is too far from us to manage ourselves). So, if we sold it, that would mean a possible $30k haircut from current loan amount (we originally bought for $160k), of which we would not be able to cover except for borrowing more money.

You're losing money on the rental every month. How many months would you have to hold it until the monthly loss adds up to your current capital loss or loan payout amount? What if you lost your tenant? Don't avoid a small loss now to avoid a big loss through perpetual small bleeding. I would not want to hold a capital asset that I wasn't using with a guaranteed loss. Take your lumps, learn your lesson, and move on.

If you want to keep the property, consider recasting the mortgage (i.e. paying off the principal but keeping the same interest rate/loan terms) down to a point where your monthly rent exceeds the monthly mortgage price plus some safety buffer. That way, what is currently a cash-flow drain is, at minimum, cash-flow positive/neutral.

[kmox]

If you want to keep the property, consider recasting the mortgage (i.e. paying off the principal but keeping the same interest rate/loan terms) down to a point where your monthly rent exceeds the monthly mortgage price plus some safety buffer. That way, what is currently a cash-flow drain is, at minimum, cash-flow positive/neutral.

The problem with that is getting an appraisal to show that the house isn't still underwater, and plus the added complexity of being a rental. We did have the mortgage refinanced under HAMP 2 (or HARP, I don't remember which one), which allowed us to get into a 15-year, pretty reasonable mortgage.

[ThriftyPhD]

Getting back into this topic, because I see there has been some mis-reading of my original post. We do not have $150k sitting in a bank account. That's our gross pay this year, and doesn't take into account all of our other expenses (rent, daycare, food, insurance, etc).

Somehow, through all of this, we have been able to scrap together $150k in savings.

I think the quoted line is where people assumed you had $150k liquid. Is this a typo, or is the $150k invested in other places?

[Chadnudj]

If you want to keep the property, consider recasting the mortgage (i.e. paying off the principal but keeping the same interest rate/loan terms) down to a point where your monthly rent exceeds the monthly mortgage price plus some safety buffer. That way, what is currently a cash-flow drain is, at minimum, cash-flow positive/neutral.

The problem with that is getting an appraisal to show that the house isn't still underwater, and plus the added complexity of being a rental. We did have the mortgage refinanced under HAMP 2 (or HARP, I don't remember which one), which allowed us to get into a 15-year, pretty reasonable mortgage.

Recasting your mortgage does not require an appraisal, and can be done on a rental property -- basically, the loan terms do not change at all from the original terms that you got approved on, you just put a lump sum toward principal and have the monthly payment go down as a result.

But since you don't have a large lump sum (I misread your initial post to mean you had $150k available), this may be moot.

[kmox]

But since you don't have a large lump sum (I misread your initial post to mean you had $150k available), this may be moot.

Ah yes, I see the confusion now. We do have $150k saved, but it is in tax-deferred accounts, not simply saved in savings acct. So, that would be untouchable.

[ThePrince]

Hi everyone:

I'm a long-time reader and find many of the posts very inspirational, but I have hardly ever posted anything. So here goes, our situation that I'd like feedback on from the greater community...

Both me and my DW now have fairly stable jobs with a pretty high rate of income (combined +/- $150k/yr, with pay raises of abt 5%/yr), after many years of low-paying jobs, graduate school, time-off for kids, etc. At this point we can max out our 401(k)/457(b) plans with no problem. We also have some debt, which is rather manageable: $110k mortgage on a rental property (4.25% interest), $15k student loan (2.25% interest), $23k car loan (0% interest). Somehow, through all of this, we have been able to scrap together $150k in savings.

Now, it feels like we are ready for the next big step. Do we: pay down the debt? Or, max out RothIRA? We also have two small kids (5 and 2) that we would like to put money towards their 529 account (we get a state income tax break in our state), which we currently contribute nominally.

P.S. we do receive rental income, but the property is a housing bubble purchase (unbeknownst to me), which I could never shake lose of and is way underwater, and the rental only covers about three-quarters of the mortgage.

Thanks in advance for any advice.

Would you take out loans and invest the proceeds in the stock market? That is effectively what you are doing by keeping the student and car loans. Pay them off and reduce your risk.

[heybro]

I think this is a 'sticky' somewhere.


WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.

WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.*
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between. See also Traditional versus Roth.
See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals.
5. See #4 for choice of traditional or Roth for 401k
6. Applicability depends on the rules for the specific 401k
7. Again, take the risk-free return if high enough
8. Because earnings, even if taxed, are beneficial

[grabiner]

I think this is a 'sticky' somewhere.


WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.

The HSA has almost the same guaranteed return as a 401(k) match; if you are in the 25% tax bracket, it costs you $750 to get $1000 invested tax-free, for a 33% bonus. Therefore, it is better than paying off most debts.

Also, I would set a lower interest-rate threshold; see Paying down loans versus investing on the wiki. If your after-tax loan rate is the same as the after-tax return on a low-risk bond of the same duration, you gain nothing by keeping the loan to invest. If you invest in the bond, you break even; if you invest in something riskier, you may come out ahead with more risk, but you could do this even if you paid down the loan, selling your existing bond holdings to buy more stocks.

For example, if you have seven years left on your mortgage (either the remaining term, or the time before you expect to sell the house), a fair comparison is Admiral shares of Vanguard Long-Term Tax-Exempt, which yield 2.31%. If your mortgage rate is 3.5% and you are in the 28% tax bracket, you get a 2.52% risk-free 7-year return from paying down the mortgage. Even though 2.52% isn't very high, it's the best you can do for that risk level, once you have maxed out your tax-deferred accounts.

Similarly, if you have a 5-year car loan at 2% and could pay it all off, that has a duration of 2.5 years. Investor shares of Vanguard Limited-Term Tax Exempt have a duration of 2.4 years and yield 1.08%. You'll come out ahead paying off the car loan at the same risk level, even with just a 2% return. (But you should keep this loan if you aren't maxing out your retirement accounts; getting more money into the retirement accounts gives you a benefit long after the car is paid off.)

[Coachrhino11]

I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go?

Because many of us, along with millions of Americans, have been burned badly with debt in the past.

Debt can certainly be a useful tool, but it can also be a very deadly one. FAR more people have been hurt by debt than helped by it, and even the best laid plans for using it properly can go awry.

"The rich rules over the poor, And the borrower becomes the lender's slave."
- Proverbs 22:7

But if you are earning 6% returns in the market, and you have a student loan debt of 2.5%, assuming that's fixed, why pay that off sooner? How do you get burned on a student loan debt with a low fixed rate? If you have 2x the amount of the loan in liquidity, even a job loss should not prevent you from making payments. I think good debt is one that you CAN easily pay off, but you make more money elsewhere. Meaning you can't actually get burned by it. I don't like to put all of my liquidity in risky investments, either, because then it's not really liquid. Like I mentioned above, if you pay of debt too soon, that money is gone, and if the market crashes, you can't get it back without taking more loans at a higher interest rate.

Risk, plain and simple. Now we know OP doesn't have 150k liquid so doesn't really matter, changes entire conversation. Regardless of interest rates, being debt free dramatically reduces risk and increases leverage because it frees up a ton of monthly cash flow. That property sounds like a black hole. Student loans and car payments are just obnoxious, but that's just my opinion. Like Ramsey for that reason regardless what Bogleheads think.

[book lover]

I have always viewed debt as a squeeze which we were blessed to be able to rid ourselves of early in my career. Another way to look at it is as negative compounding that the sooner you can get on the positive side of things the better. My earliest thinking about this was influenced by the author Ron Blue whose books were excellent. This was prior to me discovering the Bogleheads for which I will always be grateful.

[FiveK]

I think this is a 'sticky' somewhere.


WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.

The HSA has almost the same guaranteed return as a 401(k) match; if you are in the 25% tax bracket, it costs you $750 to get $1000 invested tax-free, for a 33% bonus. Therefore, it is better than paying off most debts.

The sticky is on the MMM forum: Investment Order. It goes into more detail than excerpted here.

Note that both the MMM advice and Prioritizing investments - Bogleheads suggest paying "high" interest debt before HSAs.

Perhaps at least some of the detail in the MMM post ought to go in the wiki here, and perhaps more discussion is needed to confirm the "appropriate" (to the extent one-size-fits-all will work) placement of HSA contributions. E.g., compare Suggestions for the Wiki - Page 6 - Bogleheads.org vs. Prioritizing investments- HSA goes where? - Bogleheads.org - but that discussion might be better held in a separate thread.

[spammagnet]

... I see no reason to pay off early a student loan at 2.25%--fixed low-rate, long-term, and unsecured. ...

I don't dispute your general argument about low-interest loans but I would not regard student loans as unsecured. If they cannot be discharged in bankruptcy and the lender can garnish your wages to get paid back, I'd say they're pretty secure.

[FiveK]

Perhaps at least some of the detail in the MMM post ought to go in the wiki here, and perhaps more discussion is needed to confirm the "appropriate" (to the extent one-size-fits-all will work) placement of HSA contributions. E.g., compare Suggestions for the Wiki - Page 6 - Bogleheads.org vs. Prioritizing investments- HSA goes where? - Bogleheads.org - but that discussion might be better held in a separate thread.

See Prioritizing investments- HSA goes where? - Bogleheads.org for the separate thread mentioned here.

[jgdsss]

I think this is a 'sticky' somewhere.


WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.

WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.*
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between. See also Traditional versus Roth.
See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals.
5. See #4 for choice of traditional or Roth for 401k
6. Applicability depends on the rules for the specific 401k
7. Again, take the risk-free return if high enough
8. Because earnings, even if taxed, are beneficial

Can anyone shed any light on why you want to only contribute to the match for 401k and THEN fund a Roth. Why wouldn't you want to max out the 401k first (18k/year) then do the Roths if you could.

[avalpert]

Regardless of interest rates, being debt free dramatically reduces risk and increases leverage because it frees up a ton of monthly cash flow.

I'm not sure you understand what the the term 'leverage' means in regards to debt - paying off debt most certainly does not increase it and all that cash flow you free up comes at the expense of giving up the cash itself - cash on hand beats future cash flow in my book.

No rational decision on debt can be made 'regardless of interest rates' - it just isn't true to say that regardless of interest rate paying off debt reduces risk (let alone dramatically). If the interest rate is less than the risk free rate (say the appropriate term treasury) it increases risk to pay off the debt. If the interest rates are low, the risk of the debt may still be worth the expected returns that comes from leveraging it elsewhere.

[FiveK]

4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA...swap #4 and #5)

Can anyone shed any light on why you want to only contribute to the match for 401k and THEN fund a Roth. Why wouldn't you want to max out the 401k first (18k/year) then do the Roths if you could.

Often the fees in a 401k (and especially in a 403b) are higher than one pays in an IRA, thus the default ordering. But see the conditional statement highlighted above.

[avalpert]

I think this is a 'sticky' somewhere.


WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.

WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.*
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between. See also Traditional versus Roth.
See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals.
5. See #4 for choice of traditional or Roth for 401k
6. Applicability depends on the rules for the specific 401k
7. Again, take the risk-free return if high enough
8. Because earnings, even if taxed, are beneficial

Can anyone shed any light on why you want to only contribute to the match for 401k and THEN fund a Roth. Why wouldn't you want to max out the 401k first (18k/year) then do the Roths if you could.

It depends on circumstances - you could have a case where the limited investments of a 401k make it less valuable than an IRA (whether Roth or Traditional which is a separate decision). On the other hand, if your income is above the limit for deductible IRA contributions and your 401k options not horrible, you may very well be better off maximizing your pre-tax space before doing a backdoor Roth (or direct Roth contribution if eligible).

These generalized prioritizations are never really a substitute for considering your particular situation.

[FiveK]

These generalized prioritizations are never really a substitute for considering your particular situation.

Amen.

[heybro]

I think this is a 'sticky' somewhere.


WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
3. Max HSA
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.
8. Invest in a taxable account with any extra.

WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.*
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between. See also Traditional versus Roth.
See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals.
5. See #4 for choice of traditional or Roth for 401k
6. Applicability depends on the rules for the specific 401k
7. Again, take the risk-free return if high enough
8. Because earnings, even if taxed, are beneficial

Can anyone shed any light on why you want to only contribute to the match for 401k and THEN fund a Roth. Why wouldn't you want to max out the 401k first (18k/year) then do the Roths if you could.

I think the main reason is Control. You usually have more and better options when you pick your own IRA. When you use your company's 401k, the choices are usually limited and can easily change without much notice. If your own personal IRA changes too much, you can always move it.

[heybro]

I have always viewed debt as a squeeze which we were blessed to be able to rid ourselves of early in my career. Another way to look at it is as negative compounding that the sooner you can get on the positive side of things the better. My earliest thinking about this was influenced by the author Ron Blue whose books were excellent. This was prior to me discovering the Bogleheads for which I will always be grateful.

I completely agree with this. Also, I am much more likely to invest in riskier investments (and thus most likely get higher returns) if I know my house is paid for and I have no debt. Furthermore, someone mentioned once that people who have their house paid off usually don't go take a mortgage on it so they can dump the money in the stock market.

[selters]

What order you do things in is less important than how much you save, invest or pay down debt. $50,000 a year in the wrong order will always trump $40,000 in the right order.

[Coachrhino11]

Regardless of interest rates, being debt free dramatically reduces risk and increases leverage because it frees up a ton of monthly cash flow.

I'm not sure you understand what the the term 'leverage' means in regards to debt - paying off debt most certainly does not increase it and all that cash flow you free up comes at the expense of giving up the cash itself - cash on hand beats future cash flow in my book.

No rational decision on debt can be made 'regardless of interest rates' - it just isn't true to say that regardless of interest rate paying off debt reduces risk (let alone dramatically). If the interest rate is less than the risk free rate (say the appropriate term treasury) it increases risk to pay off the debt. If the interest rates are low, the risk of the debt may still be worth the expected returns that comes from leveraging it elsewhere.

Oh I understand very well. I just worded that wrong. I understand what leverage means and I worded that part wrong, I was very correct about being debt free dramatically reduces risk, you can debate all you want. Plenty borrow to become wealthy, I just refuse to be one.

[avalpert]

Regardless of interest rates, being debt free dramatically reduces risk and increases leverage because it frees up a ton of monthly cash flow.

I'm not sure you understand what the the term 'leverage' means in regards to debt - paying off debt most certainly does not increase it and all that cash flow you free up comes at the expense of giving up the cash itself - cash on hand beats future cash flow in my book.

No rational decision on debt can be made 'regardless of interest rates' - it just isn't true to say that regardless of interest rate paying off debt reduces risk (let alone dramatically). If the interest rate is less than the risk free rate (say the appropriate term treasury) it increases risk to pay off the debt. If the interest rates are low, the risk of the debt may still be worth the expected returns that comes from leveraging it elsewhere.

Oh I understand very well. I just worded that wrong. I understand what leverage means and I worded that part wrong, I was very correct about being debt free dramatically reduces risk, you can debate all you want. Plenty borrow to become wealthy, I just refuse to be one.

Again, that just is false when you say it is 'regardless of interest rates'. Maybe a concrete example would help. Let's say you can get finance a car purchase of $30k at 0.99% for 5 years and 5-year treasuries yield 1.75% - what is riskier, paying for the car in cash or borrowing to buy the car and putting the cash in Treasuries? Not only would be debt free not dramatically reduce your risk it would actually increase it in this case (you are taking on liquidity risk at a cost of the rate difference on risk-free Treasuries).

It isn't a matter of borrowing to be wealthy, it is a matter of taking a clear-headed view of debt detached of emotions - including the emotional fear of debt.

[Coachrhino11]

Regardless of interest rates, being debt free dramatically reduces risk and increases leverage because it frees up a ton of monthly cash flow.

I'm not sure you understand what the the term 'leverage' means in regards to debt - paying off debt most certainly does not increase it and all that cash flow you free up comes at the expense of giving up the cash itself - cash on hand beats future cash flow in my book.

No rational decision on debt can be made 'regardless of interest rates' - it just isn't true to say that regardless of interest rate paying off debt reduces risk (let alone dramatically). If the interest rate is less than the risk free rate (say the appropriate term treasury) it increases risk to pay off the debt. If the interest rates are low, the risk of the debt may still be worth the expected returns that comes from leveraging it elsewhere.

Oh I understand very well. I just worded that wrong. I understand what leverage means and I worded that part wrong, I was very correct about being debt free dramatically reduces risk, you can debate all you want. Plenty borrow to become wealthy, I just refuse to be one.

Again, that just is false when you say it is 'regardless of interest rates'. Maybe a concrete example would help. Let's say you can get finance a car purchase of $30k at 0.99% for 5 years and 5-year treasuries yield 1.75% - what is riskier, paying for the car in cash or borrowing to buy the car and putting the cash in Treasuries? Not only would be debt free not dramatically reduce your risk it would actually increase it in this case (you are taking on liquidity risk at a cost of the rate difference on risk-free Treasuries).

It isn't a matter of borrowing to be wealthy, it is a matter of taking a clear-headed view of debt detached of emotions - including the emotional fear of debt.

Really? You are now comparing 0.99 vs. 1.75? I would pay cash any day personally and many here would as well if given those two options. Something happens to my job, I have no car payment. Something doesn't happen to my job, I have much more monthly freed cash flow to invest and most years easily defeat 1.75%. No "fear" here boss, I feel very good.

[grabiner]

Again, that just is false when you say it is 'regardless of interest rates'. Maybe a concrete example would help. Let's say you can get finance a car purchase of $30k at 0.99% for 5 years and 5-year treasuries yield 1.75% - what is riskier, paying for the car in cash or borrowing to buy the car and putting the cash in Treasuries? Not only would be debt free not dramatically reduce your risk it would actually increase it in this case (you are taking on liquidity risk at a cost of the rate difference on risk-free Treasuries).

It isn't a matter of borrowing to be wealthy, it is a matter of taking a clear-headed view of debt detached of emotions - including the emotional fear of debt.

Really? You are now comparing 0.99 vs. 1.75? I would pay cash any day personally and many here would as well if given those two options. Something happens to my job, I have no car payment. Something doesn't happen to my job, I have much more monthly freed cash flow to invest and most years easily defeat 1.75%. No "fear" here boss, I feel very good.

You miss the point here. If you take out the loan and invest the money in Treasury bonds, you still have a car payment, but you also have money available to make the payment in case you lose your job, so you aren't taking an extra risk. And if you don't lose your job, then you can sell part of your bond investment as your debt declines.

In this situation, suppose that you pay cash for the car, and I take out a loan and buy a bond fund. Every month, I remove money from the bond fund to make the car payment; this will cover principal and interest, and I have a small amount left because the bond interest is more than the loan interest. I manage the rest of my investments the same as you; if we lose our jobs, I continue to make the payments from the bond fund, and if we keep our jobs, I invest as much in stock as you do. After five years, my car loan is gone, and I am guaranteed to have a bit more money than you do.

I recently bought a car, and would have taken the financing deal (four years at 0%, or five at 0.99%) had it been free, by exactly this logic. However, at the time, Toyota was giving the choice of these low rates or $1500 cash back, and the $1500 cash back was a better deal. If I had needed a loan (I didn't), I would have paid less than $1500 in extra interest if I took the cash back and financed the car through my credit union instead.

[ThePrince]

Regardless of interest rates, being debt free dramatically reduces risk and increases leverage because it frees up a ton of monthly cash flow.

I'm not sure you understand what the the term 'leverage' means in regards to debt - paying off debt most certainly does not increase it and all that cash flow you free up comes at the expense of giving up the cash itself - cash on hand beats future cash flow in my book.

No rational decision on debt can be made 'regardless of interest rates' - it just isn't true to say that regardless of interest rate paying off debt reduces risk (let alone dramatically). If the interest rate is less than the risk free rate (say the appropriate term treasury) it increases risk to pay off the debt. If the interest rates are low, the risk of the debt may still be worth the expected returns that comes from leveraging it elsewhere.

Oh I understand very well. I just worded that wrong. I understand what leverage means and I worded that part wrong, I was very correct about being debt free dramatically reduces risk, you can debate all you want. Plenty borrow to become wealthy, I just refuse to be one.

Again, that just is false when you say it is 'regardless of interest rates'. Maybe a concrete example would help. Let's say you can get finance a car purchase of $30k at 0.99% for 5 years and 5-year treasuries yield 1.75% - what is riskier, paying for the car in cash or borrowing to buy the car and putting the cash in Treasuries? Not only would be debt free not dramatically reduce your risk it would actually increase it in this case (you are taking on liquidity risk at a cost of the rate difference on risk-free Treasuries).

It isn't a matter of borrowing to be wealthy, it is a matter of taking a clear-headed view of debt detached of emotions - including the emotional fear of debt.

Really? You are now comparing 0.99 vs. 1.75? I would pay cash any day personally and many here would as well if given those two options. Something happens to my job, I have no car payment. Something doesn't happen to my job, I have much more monthly freed cash flow to invest and most years easily defeat 1.75%. No "fear" here boss, I feel very good.

+1

[Coachrhino11]

Again, that just is false when you say it is 'regardless of interest rates'. Maybe a concrete example would help. Let's say you can get finance a car purchase of $30k at 0.99% for 5 years and 5-year treasuries yield 1.75% - what is riskier, paying for the car in cash or borrowing to buy the car and putting the cash in Treasuries? Not only would be debt free not dramatically reduce your risk it would actually increase it in this case (you are taking on liquidity risk at a cost of the rate difference on risk-free Treasuries).

It isn't a matter of borrowing to be wealthy, it is a matter of taking a clear-headed view of debt detached of emotions - including the emotional fear of debt.

Really? You are now comparing 0.99 vs. 1.75? I would pay cash any day personally and many here would as well if given those two options. Something happens to my job, I have no car payment. Something doesn't happen to my job, I have much more monthly freed cash flow to invest and most years easily defeat 1.75%. No "fear" here boss, I feel very good.

You miss the point here. If you take out the loan and invest the money in Treasury bonds, you still have a car payment, but you also have money available to make the payment in case you lose your job, so you aren't taking an extra risk. And if you don't lose your job, then you can sell part of your bond investment as your debt declines.

In this situation, suppose that you pay cash for the car, and I take out a loan and buy a bond fund. Every month, I remove money from the bond fund to make the car payment; this will cover principal and interest, and I have a small amount left because the bond interest is more than the loan interest. I manage the rest of my investments the same as you; if we lose our jobs, I continue to make the payments from the bond fund, and if we keep our jobs, I invest as much in stock as you do. After five years, my car loan is gone, and I am guaranteed to have a bit more money than you do.

I recently bought a car, and would have taken the financing deal (four years at 0%, or five at 0.99%) had it been free, by exactly this logic. However, at the time, Toyota was giving the choice of these low rates or $1500 cash back, and the $1500 cash back was a better deal. If I had needed a loan (I didn't), I would have paid less than $1500 in extra interest if I took the cash back and financed the car through my credit union instead.

I completely understand everything you are saying, I just think it's a very small amount to argue borrowing money for is where I was going. Now if we are talking about a significant difference in rate, ok, but we are not.