| Pay off debt or start investing? |
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kecook09
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Joined: 24 May 2011
Location: Syracuse, NY
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| Pay off debt or start investing? |
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Hello Everyone, this is my first post here, and I think it's going to be a rather long one. I need advice however on whether I should eliminate debt, or start investing. I will give you a full picture of my life situation:
Personal Life: I am 23 years old, married, with a baby girl on the way in July. I work as a researcher for a local University, earn a salary and have a secure job. My wife is a high school spanish teacher (who would prefer to be a stay at home mom).
Finances: My wife and I have saved diligently and have a 6 month emergency fund squirreled away in a traditional savings account (earning nothing - I know). We currently do not have retirement savings, unless you count about $1,000 my wife contributed to her teachers pension fund, of which she will not be fully vested in for 10 years. We currently save about 40% or more of our monthly incomes. We are very frugal day to day, but do occasionally splurge big (we just went to Spain for a week in April).
Debt: We carry no credit card debt. We have student loans totalling $28,000 at 6.8% that we just started repaying (to be paid back over ten years). We have a $7,000 auto loan that will be paid off in 3.5 years at 4%. Finally, we just bought a home in February. We have a traditional 30 year mortgage of $100,000 at 4.875 % (we put 20%, all of our own money, no help from our parents on this).
Our dilemma: Now that we have an emergency fund saved up, we are currently debating what to do with extra funds. Should we forego retirement savings for two years and start at 25, and try to eliminate all debt except for our mortgage? Or should we start investing now and get an extra two years of compound interest? Any advice would be greatly appreciated!
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Tue May 24, 2011 1:57 pm |
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littleroc02us
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IMO, you kind of did things backwards, but your very young. You kept large amounts of debt around postponing the payments on cars and student loans totalling around 35k. The story changes again now that you have a baby on the way. Here is what I would do. Keep the 6 months EF fund for security purposes, but start building a baby fund of what you think the expenses would be for 6 months time. This will give you a nice cushion and allow you to pay cash for everything. My wife and I are 5 months pregnant and each month I am putting money away to pay for baby classes and items we will need in the future. Once the baby is 6 months and we have to do part time day care I have put that in the future budget. As for the large debt I would work on eliminating that before turning up your investments, because if you don't then it will take forever to try conquering both investing and paying off debt at the same time. What you have going for you is time, your young and even if you starting investing heavily at age 30 you still have 30 years. You could easily have millions for retirement.
Risk comes from not knowing what you're doing. (Warren Buffet)
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Tue May 24, 2011 2:25 pm |
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kecook09
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Location: Syracuse, NY
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The six month savings includes child care costs (estimated of course). I personally want to save as much as possible for the next 2 years and then just eliminate the car and student loans in one fell swoop, leaving only my mortgage as debt. If I did start investing now, I would consider investing into an S&P 500 index fund, and some bond funds for security.
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Tue May 24, 2011 2:34 pm |
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kecook09
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By "security", I meant a hedge against wild market fluctuations. The student loan rate is steep because that's the rate that's given to you by the feds for grad school. Both the wife and I graduated undergrad debt free. I just don't like the idea of this debt hanging over my head (especially the car loan). At the same time, I'm worried that I'm missing valuable opportunities to start investing. If I were to buy into index funds, should I do it through an online brokerage, or just go to a real person? I have real a lot about investing, and I feel like index funds are the best strategy for someone with minimal startup capital and lots of time. The issue is, I just don't know the best way to buy them.
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Tue May 24, 2011 5:01 pm |
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clintdavis
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You need to pay off the debt. With the debt, you are paying out interest and bringing risk into your financial life. I would pay off the debt as fast as possible and stop wasting money on interest. Just think how much you will be able to invest if you have NO PAYMENTS in just a few years? Don't try to build your financial house on a shaky foundation.
That being said, you guys are obviously doing a great job with your money. Now just tighten up the plan, dump the debt, and get on about the business of building a bunch of wealth!
Thanks for sharing!
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Tue May 24, 2011 5:14 pm |
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littleroc02us
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quote:
Originally posted by kecook09
By "security", I meant a hedge against wild market fluctuations. The student loan rate is steep because that's the rate that's given to you by the feds for grad school. Both the wife and I graduated undergrad debt free. I just don't like the idea of this debt hanging over my head (especially the car loan). At the same time, I'm worried that I'm missing valuable opportunities to start investing. If I were to buy into index funds, should I do it through an online brokerage, or just go to a real person? I have real a lot about investing, and I feel like index funds are the best strategy for someone with minimal startup capital and lots of time. The issue is, I just don't know the best way to buy them.
I feel that when one is having a baby the home takes priority over the debt and investing. Establish a proper EF fund of 3-6 months and a baby fund of 6 months. Then when all is settled start tackling the debt and then invest. You have time, you can't do everything all at once. Focus!
Risk comes from not knowing what you're doing. (Warren Buffet)
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Tue May 24, 2011 6:08 pm |
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oldguy
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quote:
Or should we start investing now and get an extra two years of compound interest? Any advice would be greatly appreciated!
You've done a great job in just a few short years - and you know the right questions. 
I vote for keeping the entire $135K of debt, the 6.8% rate is dicey but I'd keep it. You are currently saving 40% of your income while servicing the $135k debt - so that demonstrates an ability to manage it.
Don't think of investing as a 'retirement' fund, think of it as your family wealth-building. You can use all three account types - taxable, posttax, and pretax. The taxable account is unrestrained - not tied to age 59 1/2, you can get the money back in a couple days if wanted/needed - ie, a fallback EF. Good for cars, rental houses, children's college, early retirement, and so on. But in all three account types, the key is 'years' and 'return'. Use products that historically compound at >10%/yr - and yes, 37 yrs is better than 35 yrs. (A $5M account at 11%/yr grows by $1.1M in the last 2 yrs, an extra $1.1M at age 60 might be nice.
And no bonds - what's wrong with market fluctuation? You care about the account value in 37 yrs, it doesn't matter to you how it gets there. Actually, in your dream, the Market stays low for 30 yrs so that you can buy shares on sale and then it spirals up exponentially for 7 yrs to make you wealthy. LOL, but not likely.
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Tue May 24, 2011 11:10 pm |
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ttammie98
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I agree that you should first fully fund your emergency fund especially with a baby on the way. After you have a good amount set aside, then you really should tackle your debt next to eliminate as much as you can outside of your mortgage. At that point, you should begin your investing.
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Wed May 25, 2011 2:21 am |
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kecook09
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Thanks for the advice everyone. Oldguy - what types of accounts are you talking about specifically when you say taxable/pretax/posttax? I know that a traditional IRA is post-tax account (tax you when you try to withdraw funds) and and a Roth IRA is a pre-tax account (nail you before hand, money grows tax free). But what would be what you call a taxable account? Is this just an account with an investment brokerage? Also, I definitely follow what you're saying about the compound interest for the last two years, as well as not needing bonds right now. It seems everything I have read up to this point suggests that you should have 20% of you investment portfolio in bonds for security's sake, but I can see why that isn't really necessary at this point. You don't actually realize losses until you sell, and I don't plan on selling anytime soon. What is your take on overpaying on my mortgage each month? My standard mortgage payment is about $535, but we pay $600 right now. I know that if I bring that number up $1,000 I could have the mortgage paid off in ten years. At the same time however, I do realize that would be eating into any investments I plan on making. More advice would be great from everyone. I really appreciate it!
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Wed May 25, 2011 11:45 am |
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littleroc02us
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It all depends on your risk level. When you have a family to provide for I feel that a low risk conservative method is best. I personally don't have any interest in taking huge risks with debt and mortgages because you can lose your job or you can become injured and by you continuing to carry 38k in student loans and 100k in mortgages you increase your risk of not being able to pay for them. Your first responsibility is making sure your family is protected and secure with cash reserves, then you can worry about the debt and finally the investments. It's not that hard to become a millionaire if you and your wife have 25 years to invest. You can have a paid for house, no debt and invest in Roth IRA's and 401k's for 25 years making 11% and have a couple million to show for it. I think most can live with that...
Risk comes from not knowing what you're doing. (Warren Buffet)
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Wed May 25, 2011 1:24 pm |
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oldguy
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Yes, $1000/m would pay down the 4.875% note in about 10 yrs. But if you put the extra $470/m into an 11%/yr fund instead, it would be about $104k in 10 yrs. And $402k in 20 yrs. And $1,245,000 in 30 yrs.
A good example of properly directing your income to become wealthy w/o constraining your lifestyle. Ie, both scenarios cost $1000/m. One ends up with a paid-for house in 10 yrs, and about $855k at the end of 30 yrs if you keep investing at $1000/m. The other gets you at paid-for house in 30 yrs AND the $1.25M.
For taxable accounts, we use SP500 Index Funds at Vanguard or Fidelity.
The books (and many planners) need to tell you 20% bonds to mitigate market swings. If you tell a young client that 100% stock is mathematically best over a 30-yr period and then the market takes a one-yr hit, the client is furious and fires you. The 'i want it now' emotion is powerful.
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Wed May 25, 2011 1:30 pm |
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Lisa00
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Investment for future is good but always try to remain debt free
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Sat Aug 06, 2011 10:39 am |
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keshavmish
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Although it would be nice to pay off debt, for many it is unlikely that they will ever be debt-free. As a result, they do both; invest while simultaneously paying off debt. The big plus to this approach is that these individuals can start enjoying some of the power of compounding early, allowing for some decent growth over the years as they pay off debt. The big downside is that they are only half-heartedly investing. It doesn't take much to imagine the growth that their existing savings plus their debt payments would yield.
This option makes the most sense. In other words, rather than invest at all, allocating all resources to debt repayment frees up a substantial amount of funds for savings down the road. Now, the average fifty year old should not stop contributing to his or her retirement plan and instead pay off debt exclusively. For the indebted soon-to-be-retired, there is turning back.
However, for a younger individual in his or her mid- to late- thirties (and even early forties) paying of off debt exclusively, and then using part or all of those same resources down the road to catch up will usually make the most sense.
Consider someone who needs to retire on $40,000 per year, starting at age 60. At thirty, that individual would need to save $420.52 every month. Let's assume that this thirty year old also has $25,000 in debt and pays $588.20 per month (it will be repaid over 5 years). And let's assume that this 30 year old will need another 5-year loan for $25,000 in five years from now.
It actually makes more sense for that 30 year old to use the savings amount of $420.52 and either repay the first $25,000 sooner, or save for the next $25,000. Then, in five or, let's go all-out and say TEN years time, start saving the equivalent of the loan plus the savings for a total of $1,000 (rounded down for fun).
Assuming all things are equal, over the next 25 years (remember he now lost 5 years of savings by repaying the loan in 1/2 of the time), this individual can now retire on $53,065 per year or retire roughly 5 years earlier with the original $40,000 per year requirement.
So Now What?
If you have time on your side, it makes much more sense to accelerate the rate of payment and pay off debt and then use the amount you save in debt payments to fund your future savings needs. Even though you sacrifice some of those early years of compounding, the higher monthly investment amount (usually, if you can double or more for a time that is two or three times longer) will more than offset this.
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Sat Aug 20, 2011 12:54 pm |
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Estella09
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Nowadays debt free life is quite difficult but not impossible. It just takes some organizing and planning. With a little effort, we easily come out from debt free.
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Wed Sep 07, 2011 12:14 pm |
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littleroc02us
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quote:
Originally posted by keshavmish
Assuming all things are equal, over the next 25 years (remember he now lost 5 years of savings by repaying the loan in 1/2 of the time), this individual can now retire on $53,065 per year or retire roughly 5 years earlier with the original $40,000 per year requirement.
Things cannot be equal for both individuals because one has more risk then the other. The one who is in debt has more risk because if the individual has a health problem or god forbid loses their job he would have more problems because his money is tied up in investments and if the market is down at the same time he may not have much left. The one who has all of their debt paid off would be in a better position financially if tragedy strikes. So remember that risk needs to be calculated.
Risk comes from not knowing what you're doing. (Warren Buffet)
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Wed Sep 07, 2011 5:45 pm |
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