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Extra cash.......Firecalc says just pay off the house
Old 07-20-2009, 10:47 AM   #1
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Extra cash.......Firecalc says just pay off the house

OK, I know this subject has been beaten to death on this forum and I apologize.

I ran the numbers on Firecalc and my success rate goes from 96% to 100% if I pay the house off and lower the portfolio value by the same amount (and decrease my spending by the amount of the house payment). My cash is earning only 1.6% and the house is at 5%, so it sounds like a no brainer.

The reason I ask is because I've been agonizing over what to do with the 10 years of cash I built up the last couple of years, but which is now earning almost nothing, and it just dawned on me I should probably just pay the stupid house off and go on to the next problem. I wanted the extra secuirty blanket of all that cash when I FIRED, and I though I would be able to put a bunch of it to use when the market tanked last year, but all I did was suck my thumb and do nothing so that obviously didn't work.

Am I thinking right? After paying off the hosue I will still have about 6.5 years of expenses in cash if DW keeps working and the rental properties hold up, and about 4.5 years if one of the shakier rentals goes south (the old car dealerhips) and the wife quits.
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Old 07-20-2009, 12:18 PM   #2
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OK, I know this subject has been beaten to death on this forum and I apologize.
I don't know why you should feel the need to apologize, it's just another FIRECALC run with different data - these are discussed all the time.

I think you are doing the right thing by running the numbers and seeing how it comes out for you. When I've run them, there seems to be a *slight* advantage to keeping the mortgage, but of course it depends on the actual numbers used. Here is maybe why your numbers are different:

You are changing horses mid-stream. You wanted a big cash reserve, and clearly that 1.6% will not offset a 5% mortgage. But normally, over a 30 year run, a little higher allocation to stocks (60/40 75/25?) will beat the 5% and show a better success rate with the mortgage and the larger portfolio.

Now I know, people will say that that money is "at risk" with so much in the market.... but, if it results in a higher success rate, isn't that overall a lower risk?

So, if you really don't think you need the cash, stick it into your normal AA and see how it goes. Or, if you really are uncomfortable with that, do whatever makes you feel good and ignore the numbers. In either case, I think you will find the $ differences to be relatively small.

edit/add: look at it this way, you said:

After paying off the house I will still have about 6.5 years of expenses in cash

you could also say:

After investing the money in equities I will still have about 6.5 years of expenses in cash



Hope that helps - ERD50
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Old 07-20-2009, 03:11 PM   #3
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Have you given up on the idea of selling the house?
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Old 07-20-2009, 06:02 PM   #4
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Have you given up on the idea of selling the house?
We put it on the market for a few months when we were thinking of moving to Costa Rica with no success, and now DW has decided she would rather go back to work than sell the "cool house". Long involved story actually............

I have found once you upsize it's not as easy to downsize.
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Old 07-20-2009, 06:10 PM   #5
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You are changing horses mid-stream. You wanted a big cash reserve, and clearly that 1.6% will not offset a 5% mortgage. But normally, over a 30 year run, a little higher allocation to stocks (60/40 75/25?) will beat the 5% and show a better success rate with the mortgage and the larger portfolio.
That's the way I always thought in the past, but after I closed my business and now that I don't have any earned income coming in, I've kind of lost my nerve a little bit when it comes to investing. I've gotten way more conservative and risk averse over the last year after I've got beaten around by the market and economy. I guess that's why I was thinking I could just do the safe thing and just pay off the house.
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Old 07-20-2009, 06:45 PM   #6
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I don't see a problem paying off the mortgage. Normally, I am all for not paying off the mortgage until one is retired and has or desires reduced cash flow. You are in that category, so pay it off.
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Old 07-20-2009, 08:06 PM   #7
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Old 07-20-2009, 08:30 PM   #8
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Originally Posted by cardude View Post
I ran the numbers on Firecalc and my success rate goes from 96% to 100% if I pay the house off and lower the portfolio value by the same amount (and decrease my spending by the amount of the house payment). My cash is earning only 1.6% and the house is at 5%, so it sounds like a no brainer.
Am I thinking right? After paying off the hosue I will still have about 6.5 years of expenses in cash if DW keeps working and the rental properties hold up, and about 4.5 years if one of the shakier rentals goes south (the old car dealerhips) and the wife quits.
In one of the earlier horse-flogging threads, we decided that a larger portfolio was better for FIRECalc survivability. But that also assumed the portfolio would earn a higher market return than you're paying on the mortgage, and your extremely large cash position (40%, is that right?) is only going to beat the mortgage if inflation takes off and we return to 6% CDs.

Another "risk" of paying off the mortgage is losing liquidity, but it doesn't look like you're going to suffer if you still have 4-6 years left. Those rentals are probably cashflowing and won't need any major recapitalization in the next few years, right?

How much liquidity do you feel comfortable with? What happens if your local housing market crashes another 20-30%? Will you still be hoping to sell your home and contemplating a humongous loss? Or would you guys stay put and wait the 5-10 years for it to recover? (I speak from personal experience here.) How long would your cash last if the bad housing market was compounded by all your rentals going vacant at once?

Is there any reason to pay it off all at once? Your FIRECalc survivability ain't too shabby at 96%. You've already won the game in the third quarter and now you're running up the score. If you paid off a little extra each year (just enough to sleep better at night) and gave yourself a 4-5 year plan, then if inflation took off you'd be earning more from your CDs than you'd be paying on the mortgage.

I don't think you're susceptible to boredom or business opportunities. But paying off the mortgage would keep you from being tempted to buy more rentals, to invest in somebody's great deals, or to take up surf collecting...
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Old 07-21-2009, 06:47 AM   #9
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How many years left on the mortgage? 25 or so? I recently bought some GO muni bonds at 6%. Why not put the same amount you would use to pay off the house into tax free, relatively secure, long munis? In this case, they would pay the mortgage plus, and the priciple is still there, as long as you are patient and ride out the fluctuations. You would also still have 6.5 years in cash, but the mortgage would be covered, tax free. Give it some thought...pretty safe (never 100%, but neither is cas in a bank), pays a higher return than your mortgage APR, and cash left at the end...

FWIW

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Old 07-21-2009, 07:44 AM   #10
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Is there any reason to pay it off all at once? Your FIRECalc survivability ain't too shabby at 96%. You've already won the game in the third quarter and now you're running up the score. If you paid off a little extra each year (just enough to sleep better at night) and gave yourself a 4-5 year plan, then if inflation took off you'd be earning more from your CDs than you'd be paying on the mortgage.

I don't think you're susceptible to boredom or business opportunities. But paying off the mortgage would keep you from being tempted to buy more rentals, to invest in somebody's great deals, or to take up surf collecting...
Well, I actually am susceptible to boredom I'm finding out. I never thought I would get board when I quit, but it's already happening to me. To compound that, I'm already constantly looking around for new businesses to start and have even contemplated getting back into the car business. So, there is that temptation that I need to squash, or at least sweep under the bed for now. Paying off the house and locking that cash up would take away the means to do something stoooopid.
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Old 07-21-2009, 07:53 AM   #11
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I recently bought some GO muni bonds at 6%.
The mortgage has a long time left on it. Tell me more about this. My tax bracket is pretty low right now with the big mortgage interest and no job so I never really considered munis, but locking up the cash in a long term bond would do the same thing almost as paying it off I guess, if I kept the house that long.

The problem with this plan is I only see us in this house until the kids are through high school, or another 8-9 years. Can I match up some kind of bond term with that time frame that would pay more than 5% and be very low risk? Doesn't have to be tax free.
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Old 07-21-2009, 08:07 AM   #12
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Another "risk" of paying off the mortgage is losing liquidity, but it doesn't look like you're going to suffer if you still have 4-6 years left. Those rentals are probably cashflowing and won't need any major recapitalization in the next few years, right?
The rentals are all paid for and don't need any huge repairs that I forsee. The only shaky rental is the old car dealership that I am renting out to some of my x-employees as a repair shop-- if they don't make it that income would be gone so I'm kind of planning on them maybe not making it, unfortunately.


Quote:
How much liquidity do you feel comfortable with? What happens if your local housing market crashes another 20-30%? Will you still be hoping to sell your home and contemplating a humongous loss? Or would you guys stay put and wait the 5-10 years for it to recover? (I speak from personal experience here.) How long would your cash last if the bad housing market was compounded by all your rentals going vacant at once?
Na, I think we would just stay put if that happened. If all the rentals went vacant at once and we couldn't sell them, and my wife quit her new job we would still have 3 years of cash in living expenses left after paying the house off. If all that happened and all expenses held the same we would be at a 3.25% SWR at today's portfolio level.
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Old 07-21-2009, 08:14 AM   #13
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If your tax rate is pretty low, you could get a mix of AA and A rated corporates in the 5-10 year range yielding between 5-7.5% (not exact, just from a quick peek at the bond board as Schwab). Mix that maybe with some 3.5-4% yield 5-10 year munis to keep the taxes down.

OR

You could buy MO (Altria), priced about 17.27 per share and yielding 7.4% dividends...analysts' target price is 21.85 so you have a nice yield, and a nice upside potential as well. The tax on the divvies is limited, the divvies are strong (would cover your mortgage, with the mortgage providing a nice deduction, and nice upside potential. If you have a strong moral objection to smoking, or if you think that the tobacco market is going to die before you want to leave the house, you will have to be prepared to sell and move into something else.

Another strategy would be to find several MO type equities.

Yet another would be to mix all of the above such that the cash thrown off covers the tax and the mortgage payments, and still provide upside.

Hey wait a minute...that's what a good balanced AA will do for you anyway!!!

Just some ideas...I really think you can find a good mixture of divvies, corp bond interest, and muni interest that will give you the cash cover you need, maintain the mortgage deduction, and provide upside, and still have 6.5 years of cash.

Remind me, what state are you? and how much $$ and how many years left? I'm intrigued now...want to see if we can figure out a good combination that would do the trick.

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Old 07-21-2009, 07:11 PM   #14
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I know its a very unsophisticated way of looking at the pay off the house question... but for some of us the psychological relief of knowing that the roof over our heads is paid for is worth far more than twenty bushels of analysis all based on underlying assumptions that will work out beautifully if the assumptions actually come to pass. But what if they don't?

All I can say is that over the last year or two of financial markets insanity, knowing that the house is there no matter what translated into very restful sleep at night.
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Old 07-21-2009, 08:03 PM   #15
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All I can say is that over the last year or two of financial markets insanity, knowing that the house is there no matter what translated into very restful sleep at night.
I think that's a rather extreme way of looking at it. I'd expect that a FIRE'd person's mortgage would represent much less than 20% of their net worth (maybe need to include the "phantom asset value" of pensions, if those are large). Even if it was, the portfolio would be 20% bigger with the mortgage, which adds some buffer (I believe that is why FIRECALC often reports that keeping the mortgage is marginally safer).

So, if a balanced portfolio dropped like it has in the past few years, would that really mean that you'd lose your house, that you wouldn't have any money left to make the mortgage payment? If that's the case, I'd suspect that you were not FI in the first place. I have had no problem making my mortgage payments, even though I have a fairly aggressive AA.


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twenty bushels of analysis all based on underlying assumptions that will work out beautifully if the assumptions actually come to pass. But what if they don't?
So what is your portfolio invested in, nothing but Treasuries? I guess that is the "safest" thing out there (ignoring inflation eroding the purchase power of your money).

And what is your SWR based on? Twenty bushels of analysis and underlying assumptions?

I still fall back on FIRECALC, it is a historical report, not a predictor. I think it is one of the best tools we have. If that indicated to me that a mortgage payoff was far safer, I would go for it. But it has never told me that. And it does not assume that everything works out beautifully, it just reports what has happened in the past. No bias that I am aware of. It does not know whether you paid off the mortgage or not, it only knows the size of your portfolio, your AA, and what you spend.

It also tells me that an AA of 60-75% equities is safest (highest success rate), historically. So I follow that too. Why follow one set of outputs from a tool and ignore another set of outputs?

-ERD50
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Old 07-21-2009, 08:22 PM   #16
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So what is your portfolio invested in, nothing but Treasuries? I guess that is the "safest" thing out there (ignoring inflation eroding the purchase power of your money).



-ERD50
Well, of course not all treasury's that assumes that inflation in the future will be mild - again the assumptions will get you if they go wrong.

I'm not sure we aren't on the same side of the argument. I have a 50-60% equities AA the rest cash and bonds. ( My SWR is generally around 3 to 3.5%)

All I'm saying is that I sleep better knowing my house is paid for. If that's not important to you by all means, invest it, donate it to a worthy (or unworthy) cause, play it all on the roulette whatever floats your boat.
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Old 07-21-2009, 08:38 PM   #17
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Well, of course not all treasury's that assumes that inflation in the future will be mild - again the assumptions will get you if they go wrong.

I'm not sure we aren't on the same side of the argument. I have a 50-60% equities AA the rest cash and bonds. ( My SWR is generally around 3 to 3.5%)

All I'm saying is that I sleep better knowing my house is paid for. If that's not important to you by all means, invest it, donate it to a worthy (or unworthy) cause, play it all on the roulette whatever floats your boat.
And all I'm saying is, if paying down the mortgage really was so much safer than investing the difference in a reasonable AA, FIRECALC would indicate that.

If it helps you sleep at night, by all means do it. But it isn't reasonable to assume that those who make a different decision are taking on extra risk - they may well be taking on *less* risk than you.

Again, from the FIRECALC runs I've done, the difference is pretty small either way. It really shouldn't be affecting sleep one way or the other - there are far, far bigger things to worry about, or feel good about.

-ERD50
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Old 07-21-2009, 09:35 PM   #18
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I agree with almost all you said. However, you might want to consider that all FIRECALC runs look at the past. This was a period of time when the USA became the preeminent world power with an industrial and military might unmatched in the world. It's certainly one path -the future will mirror the past. Another path is to think it might not.

I have never seen the numbers but I wonder what a FIRECALC type analysis of say Germany, Japan or (heaven forbid) Argentina might show
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Old 07-21-2009, 09:57 PM   #19
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I agree with almost all you said. However, you might want to consider that all FIRECALC runs look at the past. This was a period of time when the USA became the preeminent world power with an industrial and military might unmatched in the world. It's certainly one path -the future will mirror the past. Another path is to think it might not.

I have never seen the numbers but I wonder what a FIRECALC type analysis of say Germany, Japan or (heaven forbid) Argentina might show
Very true. It is one reason why I'm not real comfortable with a 95% success rate - I'd like to have a bit more buffer in case the future is bleaker than any of those past scenarios. There is no reason to think that it couldn't be.

But assuming that one investment or another is going to do better under some unknown scenario - I guess I'm just not ready to take that "risk".

Let's meet back in 30 years and see how it went! Good luck to both of us!


-ERD50
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Old 07-21-2009, 10:21 PM   #20
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Very true. It is one reason why I'm not real comfortable with a 95% success rate - I'd like to have a bit more buffer in case the future is bleaker than any of those past scenarios. There is no reason to think that it couldn't be.

But assuming that one investment or another is going to do better under some unknown scenario - I guess I'm just not ready to take that "risk".

Let's meet back in 30 years and see how it went! Good luck to both of us!


-ERD50
A toast to that ! I've of course used FIRECALC for my own ER planning and got my spending down to where the runs show a 100% success rate. But of course, I take that with a grain (giant rock?) of salt mindful that the only true 100 % certainty is D&T
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